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The Two Stages Of Preparing For Retirement

Each year since you started working, you diligently saved. The myriad of choices, depending on your type of work, gave you the choice of a Traditional IRA, 401(k), 403(b), Tax Sheltered annuity, Defined Benefit Plan, Defined Contribution Plan, Profit Sharing Plan, Money Purchase Plan... well, you get the idea.

All of the above plans gave you the ability to reduce your current income by an amount outlined by the IRS code, and have it grow (hopefully) tax deferred until that magical age where you planned to use it to support you in the manner you have become accustomed to.

You utilized the deduction from your gross income and paid less taxes each year- great planning. There is one thing, however, you forgot- the taxes you will have to pay once you begin to take it out. As much as you enjoyed the tax break all those years during the accumulation phase, welcome to phase two- the income phase. Now tell the truth…really, how much time did you dedicate to thinking about when you were going to take out the money?

Uncle Sam ( and if he were really your Uncle, he would be gentler and kinder) had a plan- he gave you a deduction on the small amount of your contribution in the current year, and sat back to wait until it grew to many times its original value to slam you with taxes later on.

For example, if you made a contribution to a Traditional IRA today of $5000, you were allowed to reduce your taxable income by $5000. Let's assume it grew by 5% a year for the next 25 years, and the original $5000 is now $16,931.

Now Uncle has you paying not only the taxes on the original $5000, but the additional $11,931 as well. He was willing to wait, but it was worth it- now he's gotcha'! But that's not the worst of it- that means that nest egg you saved all these years to retire on isn't entirely yours: depending on your tax bracket, some belongs to your beloved Uncle. Don't you just love relatives?

Much thought gets put on the accumulation phase of retirement saving, but very little to the income phase. Without concentrating to the latter, the fact is that you will have less to spend after taxes if you don't.

The amount with which you will have to pay your bills in retirement will depend on your gross income less expenses, like taxes, which may reduce your net income significantly. How do we combat this dastardly foe? Enter the Roth IRA!

A Roth IRA is a retirement tool that creates a future tax break, as opposed to the Tradition IRA which you use as a deduction in the current year. Essentially, you pay your taxes now on the amount you are using for the contribution, and the account grows tax free, as opposed to tax deferred.

This means, in contradiction to the tax situation noted above about not paying now and paying more later, you pay less now, and when you are ready to withdraw your income, it's all yours- free from taxes!

Everything in life is about a balance, and your retirement investing is no different: if you incorporate tax free growth and income at retirement you will have more spendable cash to pay bills and have a good time with. While the government has allowed this phenomenon to occur, they do have some restrictions as to how much you can contribute and some income eligibility limits to guide you.

You must have reportable earned income, and if you earn $173,000 and are filing married jointly, it phases out between $173,000 and $183,000. Filing singly, your limits are $110,000, gradually phasing out at $125,000. While the maximum contribution is $5000 ($6000 if you are over the age of 50) you can make a smaller contribution, as long as you earned that amount. You do have to hold the Roth account for 5 years and be 59 ½ to withdraw tax and penalty free, and it does have more flexibility than a Traditional: the most desirous is no required minimum distributions at age 70 ½. There are other advantages, but space constraints keep me from going on.

Planning for your retirement includes income planning as well as just putting money away each year. Consult your advisors as to the best way to plan for your future and don't forget…Uncle Sam is not really your loving Uncle- he's just sitting on the sidelines waiting for his piece of the tax action!!

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