Finances For Everyday

Is Tax Deferred Still a Good Idea?

If you look at tax rates in comparison to income we are sitting right now with some of the lowest tax rates sincethe early 1970s.  If you consider the impending costs of health care, the current wars, Social Security and Medicare costs you will realize that the tax rates are likely to go up when we get past this two year reprive that Congress just gave us by extending the tax cuts set to expire at the end of 2010.

That raises the question, is deferring taxes still good?  Is the most appropriate place for your retirement savings still the traditional 401(k) or 403(b)?  Does it make more sense to pay the tax now and fund a Roth IRA or fund a Roth 401(k) if your company has one?  

My thought is that makes a lot of sense.  Pay the tax now and generate tax free not tax deferred income.  That is money that you will never have to pay taxes on!

The same is true when you consider using a 529 plan for college savings.  These are tax free distributions that you are paying tax on the money before it goes into the plan.

As you are considering where to put your taxable type investments, does it make more sense to invest in assets that generate current income rather than having tax deferred appreciation to pay tax on later?

2010 was a big year for Roth conversion due the ability to spread the tax out over two years.  Realize though if you did not convert all that you could convert you can still continue to do so in 2011 and forward.  It just means that you will have to pay the tax in the year of the conversion rather than being  able to spread it out over two years.

Does it make more sense to delay collecting Social Security and start using some of your tax deferred dollars?  You will be able to pay the tax on those at the lower rate.  Is there the possibility later when you start collecting Social Security you would then not have to pay tax on your Social Security and also be able to collect at a higher percentage due to the delay?  This consideration must also look at whether or not you anticipate there will be changes to the Social Security system and how they would effect you.

In the same token of pulling income back, are there deductions that you can push into later years where they would have a bigger effect?

I often hear “but I will be in a lower tax bracket when I retire” but this is  not necessarily true.  Years ago when there were 15+ tax brackets it was likely that you would be.  That is not true so much any more.  For a married filing joint couple to fall from the 15% to the 10% bracket means their taxable income would have to be less than $14000?  Is that likely for you?  To change from one to another can mean a $35000 or more change in taxable income. 

Do not just continue to the old thoughts of delay income and accelerate expenses.  Consider the more current strategy of taxing income now to generate tax free income later.

Tags: Social Security