Paul Ferraresi

Popular wisdom tells you the best way to build a nest egg is to maximize your company’s 401(k) plan. Popular wisdom also held that the sun rotated around the earth, the Titanic could not sink, and the Berlin Wall would never crumble. That’s my way of saying that I think you can construct a stronger nest egg if you funnel money into a personal non qualified retirement plan versus a 401(k) program.

Many people feel that by placing the maximum amount into their 401(k) plan and IRAs they will have great benefits, but these qualified plans are also time bombs.

Assume a couple is making contributions of $4,000/year into their IRA or 401(k) for 30 years. Their total 30 year contributions would amount to $120,000. That is, their…

1) Annual IRA/401(k) Contribution = $4,000 x 30 yrs = $120K Total contributions

Assume they are 34% combined marginal tax bracket for state and federal taxes.

2) Tax Bracket (Income > $67,000) = 34% (Fed + State)

Then, their tax savings would be $1,360 per year, or, $40,800 over the 30 years.

3) Tax Savings = $1,360/yr x 30 years = $40,800 Total

Now, assume they invested the $4,000 per year and obtained a hypothetical 10% annual rate of return for 30 years. They would amass a nest egg of $727,773.

4) $4,000 @ 10% for 30 yrs = $727,773

Let’s assume in retirement they could still earn 10% annual return. Then, without touching the principal they could withdraw $72,700 of annual income per year.

$727,773 X 10% = $72,700 per year withdrawal

Since they are retired, the kids have moved on so they have lost those exemptions; they mistakenly paid their home off so they lost those deductions; They will also be receiving Social Security benefits, maybe they have a pension or are working part-time, which will now place them in as high or higher tax bracket as they were in prior to retirement. Let us assume they are in the original combined state and federal rate of 34%. Their tax bill on the $72,700 withdrawal from their IRA/401(k) would be:

$72,700 income from IRA/401(k) X 34% tax bracket = $24,700 Tax bill

So, in the first two (2) years of retirement they will pay $49,400 in taxes. This $49,400 is far in excess of the $40,800 they saved in taxes during the accumulation years (see Section 3 above). Additionally, they will pay the $49,400 in taxes every two years for the rest of their life. Also, they will have to pay income tax on the $727,773 nest egg when it is withdrawn, plus possible estate tax of 45%. Hmmm! Whose retirement were they planning? Theirs or Uncle Sam’s?

In the first 20 months of retirement, every dollar of taxes saved during 30 years of deductions will be paid back. In fact, a person living a normal life expectancy will pay back over 10 times in taxes, on a qualified retirement plan, during the retirement years than the taxes saved during the contribution years.

For an average couple, they will pay over $500,000 in taxes from their IRA/401(k) from age 65 to 85½ for the privilege of saving $40,800 in taxes while they were working.

Why didn’t someone tell me the rest of the story?