One of the most common questions I get asked is, “When should I apply for Social Security Benefits?”
My response has always been, “If you can tell me the month and date of your death, then I can easily do the math to tell you the optimal date for the request.”
That may be a rather harsh answer, but it brings a murky problem into sharp relief. The problems with retirement planning, especially for entrepreneurs, include the following…
1 – If we knew when you would die, the job would be easier. Without knowing whether you will have a 5 or 35 year retirement, the job becomes a guess.
2 – If we knew how long you will work, the job would be easier for the same reason.
3 – If we knew what would happen to tax law in the next 40 or 50 years, we could make some informed choices. If taxes go up, we would make different choices than if taxes go down.
In other words, retirement planning comes down to a series of educated guesses. No matter what anyone tells you, the truth is that no one ever truly knows.
That’s a statement that no accountant should ever be forced to make. But given that fact, here are a couple of things to consider…
The Fallacy of the Qualified Plan
Qualified Plans don’t save money on your taxes. The only thing they do is kick the can down the street.
Defined Benefit and Defined Contribution Plans give you a tax break today so that they can charge you more tax tomorrow. The IRS will play that game with you all day long knowing that sooner or later they’ll win.
Let’s use the example of a 401(K).
You put $20K into your 401(K) in 2026 which saves taxes on that same amount at the Federal and State Level this year. That money grows to $75K over the next 25 years.
You now have to pay regular income tax on $75K. How did you save any money?
Financial Planners will say Au Contraire. When that taxpayer retires they won’t need as much money. Their mortgage will be paid, and their kids will be out of college. They’ll be at a lower tax rate when they retire so they’ll obviously save money.
My response to those Financial Planners has always been something like, “So you’re admitting that you’re lousy at what you do.” When I retire I want to spend more money not less.
I’ll be on a 45′ Catamaran anchored on the French Side of St. Martin ordering the lobster, not freezing in a Chicago winter shopping at Aldi.
Other Critics say, “But what about the employer match?”
When you’re an entrepreneur, that’s not free money. It’s yours.
And did we forget that we had to pay another 15.3% in Payroll Taxes to make that contribution in the first place? How did we save any money?
In this instance wouldn’t it have been better to take the $20K out of your distributions and put it into a regular stock account? Think about it.
1 – If it comes out of S Corp Distributions, then you don’t have to pay the 15.3% in Social Security and Medicare.
2 – You would certainly pay income tax on $20K today, but when you withdraw the money you would only pay Capital Gains Tax on $55K.
If you normally pay a combined income tax rate of 30% to 40%, the 25% Long-Term Capital Gains rate is a deal. If on the other hand, your combined tax rate is only 15%, then maybe it’s not so great.
Hence, the guesswork. If we had a crystal ball, this would be easy.
Another question I get a lot is, “Should I Do A Roth IRA conversion?”
Maybe. Again, if only we had that crystal ball. To understand the potential problems, let’s go through some basics.
A Traditional IRA, works the same way as the above mentioned 401(K). You get a tax break today, must pay payroll taxes on the money, and then pay regular income taxes when the money is distributed.
Conversely, Roth IRAs don’t give you an income tax break today. You pay regular income tax on the contributions and don’t pay any regular or capital gains taxes on the distributions.
If you’re sitting on a large Regular IRA, then converting it to a Roth can save a lot of money. But it can also cost you.
To complete a Roth Conversion, you must pay the taxes you would have owed as if the amount were being distributed at the time of conversion. Normally this is done over a period of three years.
So what happens if you pay all of that tax on $1M in your IRA and the market crashes? You’re now sitting on $700K. Did you save any money?
Maybe. Maybe not. That depends on when you take the distributions, whether or not it recovers, and to what extent.
What happens if you do the Roth Conversion, pay all of the taxes, and drop dead the next day? Did you save any money?
Nope. Someone always has to pay the tax.
Let me leave you with this…
I really hate being the bearer of bad news, but unlike most of the people in finance working on commissions, I have no reason to lie.
A reasonable question might then become, “So Chris, what should I do?”
Save. Save. Save.
I have always defined a “Successful Retiree” as a person who doesn’t have to take a pay cut when they retire. Again, imagine me on the deck of that catamaran with the lobster.
The retirees I have who didn’t have to take a pay cut did all of the above.
They have money in Qualified Plans, money in regular stock accounts, and no debt. In other words, they saved.
Get to it already. One last thing.
Using Whole or Variable Life Insurance as a retirement planning vehicle is a rip off.
During the Clinton Administration, when the markets were increasing 30% annually, the Triple A rated life insurance companies were paying 6% and acting like it was a gift because there are no taxes on that money. So if you were to add in the taxes what would that be? Maybe 8%?
What would you rather earn on your money… 30% or 8%?
Life insurance policies have never been a good investment vehicle because they’re not a “clean” investment. They have to pay commissions to the salespeople and pay for the management of those life insurance companies.
They always underperform because of these costs.
We buy life insurance because someday we’ll die and don’t want to leave our spouse and our children with things like a mortgage and no way to pay for a college education. But term policies will do that for a fraction of the cost.
Buy term and invest the rest. And that’s only if you need life insurance.
If your house is paid off, your kids are out of college, and you have a few million socked away, do you really need that extra expense? Probably not.
Again, retirement planning for entrepreneurs is completely different. When you have questions, I’m here.
And if you’re having problems with your accounting and tax work, I’m waiting for your call.
We’re all going to get through this. Let’s get through it together..
Accounting Solutions Ltd. stands ready to complete our mission and purpose of protecting you, your family, and your business. Whether you need Payroll Services, Accounting and Tax Work, Tax Planning, or Tax Representation, you have but to ask. I’m here and I remain,
Sincerely yours,
Chris Amundson
President
Accounting Solutions Ltd.
773-267-7500
888-310-0300
www.AccountingSolutionsLtd.com
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