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401k's have long been the most utilized retirement account, and for good reason. The tax deferral and employer match make them very attractive. But are they the best retirement source for you? We give 4 reasons below to make you think again...
Some points to consider about 401k's to get you thinking about alternative sources for retirement.
1) Distributions are taxed at your highest marginal rate
That's right, you'll pay taxes on all funds distributed, and those funds will be layered on top of your other income, which means it's taxed at your highest rate. And if your house is paid off in retirement, at a time when you also no longer have deductions/credits for dependents, you might find yourself with a tax problem. In addition, many experts think tax rates will be higher in the future. Click here to learn more about tax rates and marginal brackets.
2) You'll be forced to take distributions
In the year you hit 70½, the IRS requires that you take "Required Minimum Distributions" (or RMD's). And you have to take these RMD's whether you like it or not. This means you can no longer allow the full account to sit and grow at a time when you may not need the funds. If you fail to take proper RMD's, there are stiff penalties. Talk about limiting your options!
3) Double Taxation
Not only do you pay taxes on distributions, but your 401k withdrawal income can also affect the taxation of your dividends/capital gains income as well as your social security benefits. That's right, the taxation of these other income sources is directly affected by your overall income. Specifically, social security is taxed at a higher rate when you have "excessive" other income, such as distributions from 401k's. Indeed, it pays to understand social security taxation.
4) Woes for a surviving spouse
Unfortunately when one spouse passes, the other is forced to a new filing status, from married joint to single, which comes with much higher tax brackets. And if you're leaving only taxable funds like a 401k to your spouse, that spouse could be severely crippled by the tax impact, leaving him/her with much less income than planned.
So what can you do about this? DIVERSIFY!!! Consider non-taxable sources like Roth IRA's. In low income years, you might even opt to complete a Roth Conversion. Having non-taxable retirement funds is huge in providing flexibility in retirement...and lower taxes!
Feel free to contact us with questions...we're happy to help!