When it comes to retirement planning our clients have a number of different choices. Typically, they must decide between a tax deferred retirement plan or a Roth retirement plan. A tax deferred plan offers a tax deduction for contributions and then the money grows tax deferred. A Roth has no tax deduction on contributions but money grows tax free. Cash value life insurance can also be thrown into the mix as a potential retirement planning vehicle. There is no tax deduction for money contributed to a life policy but, if withdrawals are structured as loans, money can be taken out tax free. With all of these options it is helpful to compare them and see the advantages and disadvantages of each.
Tax Deferred Retirement Plan; Tax advisers often counsel clients to take full advantage of tax deferred retirement plans (traditional IRA, SEP, SIMPLE, 401k, etc). The advantages of these types of plans are:
1. Client receives a tax deduction for contributions
2. Gains grow tax deferred
3. It is possible that money will be taken out when the client is in a lower tax bracket
4. Funds have some protection from lawsuits and bankruptcy
Below is a numerical example of an IRA at work with a sample client.
1. Client is a 35 year old male in good health
2. He earns a net return of 7.5%/yr
3. He is going to contribute $4,000/yr to a tax deferred retirement plan every year until age 65 when he will retire
4. He is in a flat 25% tax bracket now and in retirement
5. He earns $100,000/yr and will get Social Security in retirement based on that income
6. His retirement goal is to generate the future value of $24,000/year after tax, that amount will increase every year with inflation.
7. Inflation is 3%
8. He will live until age 90