Hey, what’s almost 50? Many people own one, and everybody wants it, yet very few understand it, including HR and Business owners.
It’s the IRA and its slightly younger cousin, the 401(k).
The IRA and Section 401(k) were established as part of the Employee Retirement Income Security Act (ERISA) of 1974 to help people save for retirement. Also, part of the Act is section 404(c), which applies responsibilities to HR and employers to maintain employee education. Your account growing tax-deferred each year was a great idea; therefore, more of your money grow because less is going to the IRS. Two years later, the 401(k) was added to the tax-saving marketplace, and this new plan became the new pension for many workers.
Tax savings was welcomed back in 1971-1980; the highest marginal Federal Income Tax rate was 70%. With that in mind, everybody started pouring money into these accounts and took advantage of the tax deduction for faster growth. Another benefit we were told of was that taxes during retirement would be lower because retired people have lower incomes.
People were so stuck on tax savings and poured trillions into these accounts. Sadly, these trillions hastened the ending of many guarantees in traditional pension plans.
Several flaws have developed or worsened over the last few decades with the 401(k) and IRA, yet we were so stuck with what we were doing already that it was hard to see the truth.
Flaw #1 Believing a 401(k) plan is a pension plan.
What is a 401(k) plan? We will tell you what it is not to get to the point. Contrary to what many believe, it is not a Pension Plan-it is a Retirement savings account. And that is very different.
A pension plan guarantees that you will receive a specified sum for your and or your partner’s lifetimes, and a 401 (k) does not have that protection. If the market crashes or your investment decreases in value, there is no floor, and you’re on your own. There is no guarantee of how much income you will get or how long it will last.
To safeguard the guarantee of income for life in pension plans. The US government created an insurance company called the Pension Benefit Guarantee Corporation (PBGC). The PBGC guarantees you will get your monthly pension up to its legal limits even if the company you worked for goes belly up or the market crashes, depleting pension assets.
Was The PBGC ever used? In 2021 the PBGC paid monthly retirement benefits, up to legal limits, to nearly 1.5 million retirees in over 5,000 employer plans that ended. That’s a lot of protection you do not have with a 401(k)!
Flaw #2 Believing you will be in a lower tax bracket
That high 70% marginal tax rate that was used in marketing only affected a tiny percentage of the population, and the great majority paid much less. It is a very good possibility that taxes will rise and not be lower. I mention this because, in the long-term, the only way to deal with the National Debt, deficit, Social Security, and Medicare trust funds will be to increase tax rates. We can safely say that taxes will not be lower in the future!
Flaw #3. The New Jersey double tax.
Many people are surprised to learn that New Jersey does not allow a deduction for contributions to IRAs and 403(b) plans, even if they are deductible for federal income tax purposes. With that in mind, preserving your tax records showing your deposited amount each year is critical. Keeping old tax records is challenging enough. However, if you cannot show how much you put
- Then every dollar you take out will be taxed again. Wow, paying taxes again on the money you already paid taxes on. Therefore. It is critical to permanently maintain tax records to determine how much of the account has been taxed. These records are vital for our beneficiaries of your retirement accounts, who will be clobbered if unavailable.
Flaw #4 Believing your retirement savings plans can pass tax-free.
Most people realize that you can leave a large estate without having estate taxes due. However, retirement dollars like IRA, 401K, 403(b) will always be subjected to income taxes at the state and federal levels. Estates of 6.5 million and more for a couple will pass estate tax-free to beneficiaries. Income taxes will be due, and the beneficiary tax rates from the first dollar.
Flaw #5 For certain people, an additional tax is due – NJ. Inheritance taxes.
Yes, NJ has both an estate tax and an inheritance tax. New Jersey residents must be aware of the effect of the Inheritance Tax, which is applied to 100% of the balance in these accounts. Luckily, spouses, children, grandkids, and even your parents are exempted and charities.
Everyone else is like brothers, sisters, nieces, nephews, cousins, and close friends. Inheritance Tax rates range from 11% to 16%, depending on the beneficiary’s relationship with the account owner and the estate’s value. For these reasons, planning for these accounts is essential and should not be delayed.
Flaw #6 Believing the family can continue these accounts.
IRS took away a great family IRA planning tool. The/Stretch IRA, as it was referred to, allowed an IRA owner to continue payments to their children, grandkids, and even great-grandkids over their lifetimes (spouses are exempted). Sometimes, this wealth-producing engine could last 80 years after your passing. Passing wealth over many generations was what the super-wealthy were for generations.
Sadly, the IRS decided you no longer could use what the rich were doing. Even though it is your money, you are being denied the ability to continue payments for decades. They decided that the inherited IRA must have some distributions taken yearly and must be emptied entirely by the end of the ten years. Decades of deferred tax growth are lost forever. I joke; the tax rules are written in pencil – easily and frequently changed.
The Six Flaws will be addressed in a little more depth over the next few days.
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