Retirement savers: Remember the taxes – Encore – MarketWatch

Retirement savers: Remember the taxesMarch 26, 2014, 12:26 PMSHARE:MORE EmailPrintBy Alicia H. MunnellTwo things happened recently that made me think about taxes and retirement saving. First, my husband and I prepared our taxes and for the first time had to take money out of a tax-deferred plan and pay taxes on those withdrawals. Since I think about pensions all day long, it should probably not have come as a surprise that after decades of deferring tax payments the day would finally come when taxes were due. But it was a surprise. And I realized then when the Center for Retirement Research reports figures of how much people have in retirement saving, we never mention that these sums are pre-tax amounts.The second thing that happened is that the Employee Benefit Research Institute EBRI released its 2014 Retirement Confidence Survey. The headline was that – after being at record lows for the period 2009-2013 – 18% of American workers are now very confident up from 13% in 2013 that they will have enough money for a comfortable retirement. Another 37% reported that they were somewhat confident. EBRI reports that the gain in confidence occurred primarily among the higher-income households. My concern is that these respondents, like me, forget that they will have to pay taxes on their 401k balances.Now, we have all benefited throughout the years by not having to pay taxes on contributions paid into our 401k plans and on the investment returns on those contributions. Deferring taxes for decades has real value. A little algebra reveals that the benefit is equal to exempting investment returns on plan assets from taxation. So we come out ahead, even after we pay taxes on the withdrawals. Therefore, the issue is not whether the tax treatment accorded 401ks is a good deal. Rather, my concern is that these higher income people haven’t taken taxes into account in assessing how well prepared they are for retirement.This higher income group – and here I am not talking about the rich for whom 401ks are little more than a nuisance, but couples with incomes above, say, $75,000 – will face substantial taxes on their retirement income. Most likely they will be taxed on 85% of their Social Security benefits and certainly will be taxed on 100% of money received from a 401k.Taking taxes into account, the balance that we report for the median household approaching retirement of $120,000 see the table above overstates the resources that near-retirees will have to support themselves in retirement. And for those in higher income groups – facing higher marginal rates – the overstatement is particularly great.The point of this discussion is not to suggest that we need to reduce the progressivity in our personal income tax structure, but merely to remind all of us who think about the adequacy of retirement savings that we need to pay the piper when we start drawing on our sources of retirement income. Maybe the respondents in the EBRI survey were smarter than me and considered taxes in their response. But I fear we all suffer from the same illusion that our entire pile is there for us to spend. 

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