July 2006
How successful chiropractors think ...
Qualified plans ‑‑ the 'grand illusion'
by Bruce Rhymer
IRAs, SEPs, Keoghs,
401(k)s, defined benefit plans and profit‑sharing plans are all IRS/government‑sponsored
retirement schemes that "pretend" to save you taxes. The operative word here
is "pretend" because the purported savings are an illusion. This illusion is
then propagated by short‑sighted, micro‑thinkers who say, "Invest your money
in a qualified plan to save 30‑40% of your contribution in taxes this year."
After closer analysis
of the true long‑term cost of this approach, why so many accountants and
attorneys recommend these plans is beyond rational thought. They have
obviously not considered the shortfalls, inefficiencies and destructiveness
of this financial strategy, as they are so often the not‑so‑bright soldiers
of the financial institutions that gain tremendously from the influx of
pre‑tax dollars these plans create.
Are you thinking micro
or macro when it comes to qualified plans? Macro‑thinking says structure
your contributions, look at ALL the pieces and players in your financial
plan and create more wealth by eliminating, rather than
deferring the lion's share of the tax.
Outrageous still
sells
Ask yourself whether
you would still contribute to a 401(k) or other qualified tax‑deferred
scheme if you knew the IRS/government was going to get back 10 to 20 times
more than it gave you in benefits. Your answer would undoubtedly be a
resounding "NO!" Yet, a macro‑thinker will discover that this is the case.
Now it's time to
put on your critical thinking cap.
Why do you think the
government created tax‑deferred plans? If the purpose of the IRS/government
is to collect as much tax as possible, do you actually believe they'll
volunteer to forego the collection of immediate tax revenue out of the
kindness of their heart? While these plans do encourage Americans to
save for retirement it behooves us to remember the
IRS/government
has unilaterally "negotiated" this arrangement. What at first glance
appears to be a win‑win, positions them to become the ultimate benefactors
of your tax‑deferred plan to the tune of 10 to 20 times what they gave you.
Unraveling the
"grand illusion"
There's no better way
to dispel disbelief than to spell things out in cold, hard numbers.
To begin, let's assume
that you're 35 years‑old, you begin contributing $40,000 annually to a
401(k)/PROFIT SHARING plan, you're going to continue your contributions for
30 years until you're 65, and you have a combined 41% tax rate (6% state and
35% federal) on the dollars going into this plan.
With these assumptions
you're looking at an annual tax savings of $16,400 each year ($40,000 x 41%
= $16,400). Over a 30‑year period of time, you will have contributed a
combined total of $1,200,000 and saved $492,000 in taxes.
Now watch your money
grow...then disappear
At this point let's
assume that your 401(k) compounds at 10% per year in a well‑managed
portfolio. Over 30 years your total $1,200,000 in contributions has grown to
$7,237,737 ‑‑ assuming a consistent 10% rate of return.
Not bad! You've worked
hard, so now it's time to have a little (conservative) fun. To finance your
adventures, you decide to withdraw the interest only that's being generated
by your 401(k), an amount of $723,773 annually ($7,237,737 x 10% =
$723,773).
(Special Note: This
$723,773 has not yet been taxed and will be taxed at the prevailing tax rate
at the time. At this writing it's anyone's guess what that rate might be but
it is highly unlikely it will be less than what it is right now. Especially
as we watch our government accumulate debt at a record rate.)
For our illustration
we'll be conservative and use our original assumed 41% federal and state
tax. Therefore, in your first year of taking distributions you'll pay
$296,746 in taxes.
Now, take a moment to
recall the $492,000 of tax‑deferred savings the government so graciously
gave you over a 30‑year time frame, as you funded your plan. (NOTE: Once
you begin distributions the government will recoup $593,492 in only two
years. More than $100,000 over the amount you saved by deferring the tax!)
This wouldn't be such a
negative thing if you were to depart the planet after the second year, since
taxes would be of little concern to you at that point. Then again, the
$7,237,737 you have left in your 401(k) wouldn't matter much either, so for
the sake of our illustration we're going to make one more assumption: You
take the interest‑only distributions of $723,773 for 20 years. This results
in taxes being paid to the IRS/government of $5,934,920!
This is more than 10
times the temporary benefit the government gave you!
Are you feeling those
little knots in a pit of your stomach? Could it get any worse? Well, the
price tag gets even bigger!
Continuing with the
assumption that you're taking your distributions for 20 years and live to
age 85, when you depart this earth there will still be $7,237,737 left in
the pot.
At that point we would
assume you'd like to leave that remaining asset to your heirs or to the
charities of your choice. However, someone still has their hand in your
pocket and the IRS/government becomes
the biggest benefactor again!
Here's what they get,
from the $7,237,737. They take an ADDITIONAL $5,240,000, an amount comprised
of state, federal income tax and estate tax.
When you add this
amount to the $5,934,920 they've already collected, the IRS/government
has traded $492,000 of temporarily "lost" tax revenues for $11,175,066. In
other words, you've paid 22 times what you originally saved in taxes!
(see table)
