Various tax advantages can be managed by proper planning.
Hi, folks! Its about time we discuss "A Hidden Tax Hit Waiting To Happen."
Retirement plan assets are favored in our tax code. Their earnings are not taxed, and often the contributions are not taxed either. The absence of these two taxes can mean a great deal.
Lets do a quick comparison to illustrate. Fred saves $10,000 each year for 30 years for his retirement. The money is invested in assets that earn a total return of 10% per year. If he is not taxed on the $10,000 contributions and taxes arent imposed on the growth, he will accumulate over $1.6 million. If he is in the 30% tax bracket and his contributions and earnings are taxed each year, the total will be less than $700,000. However, full 30% taxation each year would be highly unlikely, because many of Freds stocks probably would be held for more than one year, giving rise to capital gains tax as opposed to ordinary income rates. Therefore, a more accurate comparison might be an investment taxed in such a way that the result would be closer to a total of $1 million after 30 years. This, however, is still much less than tax-free growth, and it illustrates the effect of taxes.
Qualified plans include the following: pension plans, profit-sharing plans, stock bonus plans, 401(k) plans, 430(b) plans, and Individual Retirement Accounts (IRAs). One of the most popular of these has become the 401(k) named after the part of the Internal Revenue Code where it is defined. This plan allows for employees to contribute pre-tax dollars (up to a limit) to an investment plan over which the employee has total control. In addition, the company can also make contributions to the employees account. The mix of stocks and bonds, as well as the mix of the categories within each (i.e. small companies, large companies, municipal bonds, junk bonds, etc.) is determined by the employee and not the employer.
IRAs are also popular. An IRA is available to anyone who does not have an employer-sponsored retirement plan. It is also available to those whose retirement plans do not provide for a certain level of contribution. The person is permitted to contribute, and deduct, a certain amount each year. Also, the earnings grow tax-free.
Once distributions are finally taken from a qualified retirement plan, the income is taxed at ordinary rates. This means that when payouts are made, whether as an annual income or as a whole, they are taxed as if they were earnings.
The exception is a new addition to the retirement plan landscapethe Roth IRA. Introduced as part of the Taxpayer Relief Act of 1997, the Roth IRA is a back-ended plan, almost the reverse of the standard IRA. Taxpayers and their spouses are able to make non-deductible contributions of up to $2,000 each year. This is true even of those who have reached age 70½. Yet the distributions are not taxed.
Regardless of the type of plan, however, retirement plan assets are subject to taxation in a persons estate at death. They potentially face an estate tax and (with the exception of the Roth IRA) and income taxes. This means that well over half, and often close to 70%, of retirement assets could eventually end up being forfeited to taxes.
Next month we will share with a possible better alternative.
|Thomas M. Boles
has worked extensively in fundraising for childrens programs throughout our Fraternity. For more information see coupon above, or call Tom at 5626914227 (Fax 5626915327) or the Scottish Rite Foundation, S.J., USA, at 2022323579, ext. 122.