Is That Really Your Money?

Uncle SamWhen you look at your monthly brokerage statement, you see the values and what has happened in your account over the last 30 days.  It’s pretty simple math: “You started there, you finished here, and what happened to cause the changes—dividends (increase), market gains (increase), market decline (decrease), and withdrawals and fees (decreases).  But we are not fooled—we know that your focus is on the Ending Balance!

Is that Ending Balance all yours?  To the extent that it is IRA money, it’s not!  Part of it belongs to the government.  A $600,000 IRA might really be worth $500,000, $400,000 or $300,000 because when you draw those funds, the IRS and most state taxing authorities want a cut.  In California, that can be as high as 37% federal and 13% state.  Hmmm, sounds like 50% to me.  There are a lot of factors that determine that tax rate.  If you withdraw all in one year, you push yourself into your highest tax bracket-maybe it is 50%.  If you take only your required minimum distributions (“RMDs”) or have a reasonable, planned withdrawal strategy, maybe you are down in a 20% or 30% effective rate.

If you have heard me in meetings, I talk about this concept as a tax lien on your IRA, meaning part belongs to the IRS.  If you sell your home and it has a mortgage on it, you don’t get the selling price.  The mortgage company takes what’s owed off the top.  With an IRA, because of the varying circumstances, we can’t specifically identify the exact amount of that lien.  But you have to recognize that the lien exists!!!

So when you look at your IRA account, know that it is not all yours.  It is co-owned with your uncle (Sam is his name).

This brings me to the concept of pre-tax dollars (like an IRA) versus after-tax dollars (like your individual or joint or trust account).  In retirement, it’s good to have healthy balances in both.  When you need a withdrawal (monthly income, new car, gifting to children), many people will only draw from the after-tax dollars so they don’t have to pay taxes on the withdrawal.  After a few years of that, they are boxed in.  There is nowhere to go but the IRA and there is no hiding from the IRS.  Tax management is very difficult.  You will live a life of paying your uncle a toll to get to the funds, probably a heftier toll than if you had a balanced approach.

While I’m being a Danny-downer, let’s look at the benefits of the pre-tax (IRA-401K) accounts.  You saved taxes, enabling you to save even more!  It grew without your uncle taking a bite of the apple every year.  That compounded, tax-deferred growth enabled it to get to the nice healthy balance that it is!

At Inspired Financial, we attempt to have clients save in different asset “buckets”:  IRAs/401Ks, Roth IRA accounts, and individual accounts. On the back end, we try to manage the distributions to give the best, long-term, after-tax results.

The moral of the story is that if your quarterly statement from Inspired Financial says you have $1 million, it’s not the whole truth!  Your uncle has his hand on your virtual wallet.

Mark Prendergast on Linkedin
Mark Prendergast
“I’m a problem solver, and pride myself on my ability to recognize tax nuances, evaluate complicated estate and tax planning issues and provide sensible easy-to-understand solutions that fit each unique client situation. 95% of financial planning has tax implications, and most wealth management firms do not have the estate and tax horsepower that we have at Inspired Financial.”

Leave a Reply

Your email address will not be published. Required fields are marked *