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Having tax free retirement income eliminates a large degree of risk from your life. We’ve probably all seen the historical tax rate chart that show us the ebbs and flows of income tax rates over time.
If you could put yourself in a position where you are not subject to the whims of these tax rate fluctuations, income planning for your retirement gets significantly easier.
Today, we're really attacking the myth that you don't have to so much worry about having all that tax-deferred money sitting in qualified accounts (401k, IRA, TSP, 403b, SEP, and 457 plans) because you'll be at a lower tax bracket when you retire. The reality is that we all too often see it not work out that way.
You generally lose a lot of tax deductions as you get older, ex. Kids are gone, mortgage is paid down or paid-off completely, and once we stop working we can’t make 401k or IRA contributions anymore. Some witty practitioners have labeled this “reverse tax planning” because you are taking all sorts of deductions while you're working to save on paying income taxes, only to create a tax liability for yourself when you retire.
Back in the 70’s and 80’s when tax rates were much much higher, it was highly probable that someone would retire to a lower income tax bracket. Now that is more unlikely since they were reduced so much in the 90’s and 00’s.
Wouldn't it be more wise to pay the taxes now and pay less later (on a potentially bigger pot o'money)? Why do you think the IRS gives you incentives (deductions) for putting money into qualified plans while you're working?
Let's not forget there are a couple of other benefits that will be derived from having a source of non-reportable, tax free income:
1. You can live wherever you want and not be concerned with state income tax.
2. You can maximize social security benefits. No reportable income will ensure that none of your SSI benefits become taxable. If your taxable income is above certain thresholds, a portion of your social security income will become taxable as well.
The only thing better than a pre-tax retirement account where you defer taxes for decades, and an after-tax tax-free account that will grow completely free of tax (like a Roth IRA and PLI) is using the two together.
Seriously, each financial tool worth employing in your life has upsides and downsides. Most of the downsides can be tame significantly simply by having assets elsewhere that compensate. 401(k) downsides are lack of liquidity, taxable proceeds, and RMD’s…
All three of these can be severely neutered in their negative impact on our overall flexibility if we simply don’t put the majority of our money in that environment, and all the benefit of the 401(k) (deferring tax, protection from creditors) maintain themselves, and are actually strengthened by our assets elsewhere (having tax-free assets somewhere makes it much easier to lower your average & marginal tax-rate in retirement with remarkable precision.
Similarly, PLI’s disadvantages (modest rate of return, short-term illiquidity/inflexibility (less-so if properly-designed), after-tax contributions) are made up by not only its advantages (disability protection, stable value, guaranteed levels of future performance, tax-free benefits), as well as the fact that it helps maximize the benefits of everything else you do.
The whole idea is to first identify the financial fundamentals that engineer financial stability and success. Then, you want to use products that reflect those fundamentals in the face of an uncertain future.