The Best Retirement Plans: Approved By Your Uncle Sam

We all had that crazy uncle that we only saw on holidays and family reunions. Half the reason you looked forward to those get-togethers was because of your crazy uncle. His jokes, crazy stories, wisdom only a crazy uncle could provide, and the occasional finger pulls made it all worthwhile.

Sure, we had to deal with hundreds of cheek pinches and people telling us we're “growing like a weed,” but your crazy uncle more than made up for that.

You admired your uncle. He never let you down, and he always knew how to make you smile. He knew how to make everyone smile. He was as fun as any video game you owned, and you knew you could count on him.

As you got older, though, you started to see your uncle in a new light. You probably learned that he wasn't the poster child of virtue, and there was a reason you only got to see him at family gatherings.

Your uncle could be a good time, but he was greedy. He thought he was above the law, and he played by his own rules. No one else's. Worst of all, he was arrogant and self-centered. People couldn't tell him anything.

Finding out what your uncle was really like made you appreciate your parents even more. But you still loved your uncle. There's no way you could turn your back on the guy who brought you firecrackers!

Now you have to be cautious when it comes to his motivations, especially when it comes to money.

Sound like another uncle, you know?

Maybe it sounds lie the Uncle Sam we all have. As well all know, Uncle Sam is the personification of these United States that we all love. But, as a country, we've started to become a little cynical when it comes to Uncle Sam and what he does with our money.

Are we just being paranoid? Not really. As much as we'd like to just blindly trust all of our finances to Uncle Sam's in-house accountants, it would be kind of foolish to do so. We've seen what he's done to other people.

But still, Uncle Sam has a massive influence over all of our monetary decisions, including what we do for retirement. Let's make one thing clear about how Uncle Sam handles our retirement funds: just because it's legal doesn't mean it's beneficial.

Just because Uncle Sam makes out like a bandit doesn't mean you will. This uncle probably isn't going to let you keep those quarters he finds behind your ears.

Let's talk about the 401k, IRA, and other IRS-preferred plans.

The 401K and IRA Seduction

It's something for nothing. Who doesn't want something for nothing? But is there any such thing as a free lunch? I think we all know the answer to that.

Pre-tax (tax-deductible) contributions to a retirement plan seem like something for nothing. The payments come right off the top of your paycheck, so you never miss the money. It's like it was never even there.

Your money grows, and the best part of it all is that there aren't any taxes due. But, when you thought it couldn't get any better than that, your employer throws in a few dollars by way of a matching contribution.

But don't get your hopes up just yet. You're going to have to pay for that free lunch at some point. The unfortunate truth is that you're being seduced by your crazy Uncle Sam.

The IRA, 401K, 403B, 457, and similar retirement savings plans are the holy grails of the financial advisory word. They're the sacred cow for every financial advisor.

The truth is that there's no pot of gold at the end of the decades-long rainbow. Your retirement savings plan is substantial, but only in theory.

There are a few reasons these “tax-favored” programs don't turn out the way we hope them to or the way we've been told they would. These programs have an undeniable, near-fatal flaw: crippling tax implications.

The Tax Facts: Why the IRS Adores 401Ks and IRAs

Let's think back to the day you signed up for your employer-sponsored 401K. It shouldn't be hard to remember because not only was your employer giving you money in the form of a contribution match, but you were getting the chance to deposit pre-tax or tax-deductible funds.

What a day it was! Finally, Uncle Sam was letting you keep some of the quarters he kept finding behind your ears. But wait a second, when was the last time Uncle Sam – your government – gave you something for nothing?

I'm not trying to point any fingers here or jump to any conclusions, but let's take our time to figure this out together. Let's hop in the Delorean and go back in time for a few minutes.

chart courtesy of The Tax Policy Center

The Revenue Act of 1913 re-establishes the income tax in the United States. The tax rate is 1% on incomes above $3,000; 6 % is the top rate on incomes above $500,00.

Now, let's make our way to 1943. Any earnings over $200,000 are taxed at 94%.

Off to 1963 now, where they tax incomes over $200,000 at 91%. As we make our way through the 1970s, the highest marginal tax bracket is 70%. Now let's head home to the present, where it sits right around 37%


If you ask most people, they would think that income-taxes today are at an all-time high, especially if they listen to talk radio or pay attention to financial media. But as we found out during our trip through history, they're as low as they've ever been.

How long will this last? Everyone has a guess, but no one knows for sure. But in 1935, when social security was born, 42 workers were paying for every retiree. Now, just 2 or 3 workers are paying for every retiree.

And medicare is also operating at a deficit, so it's hard not to expect that taxes will go up. But things could change.

Uncle Sam could reverse borrowing and trust-fund-dipping, eliminating the need for income tax hikes. Think about that for a second…is that very likely?

Now that you've formed your own opinion about whether nor not income taxes will be higher or lower when you choose to retire (compared to the income tax rates during your cash accumulation years) you can answer this question:

Do you want to pay income taxes now or in the future?

Wait, don't answer just yet. Let's take a few more things into consideration.

  • How many tax deductions will you have to claim upon retirement?
  • Will you still be having or supporting children?
  • Will you be paying a mortgage?
  • Will you be donating money to charities?

Now, let me ask you something else: Will you have more income tax deductions now or in the future?

One more question: If you do expect to have fewer deductions, will it cause you to be in a higher tax bracket when you start taking money out of your 401k?

Okay, just a few more questions, and then I promise I'm done:

  • Will 401K withdrawals, which qualify as provisional income, cause your Social Security payments to be taxed?
  • If you're lucky enough, and the cash accumulated in your 401K retirement plan outlasts you, is your beneficiary prepared to pay the income taxes due?

Okay, I'll lay off the questions now so you can take a deep breath and digest everything for a second.

I asked you this because the government, your dear old Uncle Sam, has come up with a plan that lulls you into believing that you are getting the most bang for your retirement buck.

You pay them nothing, and your money grows, tax-deferred.

Stop right there.

You don't realize it now, but you're going to pay dearly later. Uncle Sam is going to ask for all of his quarters back when your earned income has stopped. About the time when most of your deductions are but distant memories, and when you need that money the most.

Suddenly the golden years you've been dreaming of for decades feel more like recycled aluminum.

But, you have to give credit where it's due. Uncle Sam's plan is devilishly genius. He wants – needs – as much tax money as he can get his hands on. Taxing your 401k is one option, but that would only give him a small amount of tax revenue.

It makes much more sense for him to wait until the pot has grown as much as it can, when tax rates will probably be higher, and when you'll likely be in a higher tax bracket.

Uncle Sam also insists that you begin drawing 401k and IRA funds by the age of 70.5. If you don't want to withdraw when you're 70.5, fine, you'll pay an excise tax that can equal 50% of your RMD (required minimum distribution).

Then he sets the provisional income trap that multiplies the tax implications of qualified plans. Withdrawing money from your qualified plan (401k, IRA, etc.) counts toward your provisional income calculation.

Calculation for provisional income and tax on social security

That means that it could cause up to 85% of any Social Security funds you're receiving to be taxed at the highest possible rate.

I've had so many people say, “Social Security was a tax in the first place. You mean I pay taxes on the tax?

One more thing. Qualified plans like the 401K and IRA are the only contracts in which one party can change the terms of the contract (i.e., tax rates) to benefit themself without the express written consent of the other party. And, it's 100% legal, because the perpetrator is the lawmaker.

Understand The Implications

I cannot stress this enough: the implications of this qualified-plan system are severely underestimated, even by my fellow financial professionals. The financial services industry has worked alongside the IRS to make you believe that 401Ks and IRAs are the best retirement savings plans available.

It's a mutually beneficial relationship. The IRS collects taxes on a larger pot of money in the future, and the investment industry collects fees for decades.

But, what financial planners have failed to communicate to investors is that the IRS's main objective is revenue. I mean, revenue IS its middle name.

If we're brutally honest, the IRS doesn't care about your financial stability now or after you retire. Any allusion to this by the government or a financial advisor is nothing more than a trickle-down sales tactic.

My intention with this isn't to send you into a panic thinking that your retirement is ruined and you'll be working for the rest of your life. I feel obligated to shed some light on this seduction for what it is; a short-term, feel-good-now plan that has serious long-term implications.

I don't wholly oppose 401K or IRA plans. There are a time and place for each one, and we only encourage turning down free money from your employer in unusual situations.

I still recommend that most people use them as part of a diversified plan. However, you should not tie-up every spare dollar you have into this one, potentially volatile, tax-heavy vehicle. That approach will likely scramble your nest egg.

If you're in a panic, take three deep breathes and keep reading. There's still time to be sure your golden years stay golden, and that your Crazy Uncle Sam lets you keep most of your quarters.

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