If someone came to you and said something like this...“You will be able to put money away for the future without the worry of paying taxes on it now. We can do that later. To make it even better for you we will allow you to lower (theoretically) how much you pay in taxes now. The rules are as follows. Once you choose to do so you cannot access that money without there being a cost to you until you are 59 ½ years old. When you access the money at 59 ½ + or any other time, then you can pay the taxes. That will of course include paying taxes on what you put in originally and all the growth. You also have to start pulling money out and paying taxes when you are 70 ½ or there will be another significant penalty for not doing so. Would you like to do that?”

What would you say? When framed this way, most would say no way, or perhaps something a little more colorful. Originally, the intention behind encouraging retirement savings this way was good. To be clear, I am not suggesting that you should not use or have tax deferred savings. What I am saying is that you should examine the facts and compare the outcomes.

When do most people have the lowest tax obligation in their life cycle? When they are accumulating wealth, working up the ranks, creating businesses, having children, buying a home, etc. All of these items lower taxation. It just doesn’t make as much sense to defer taxation when you have large write offs like homes, children, businesses, and the like. The vast majority of retirement (later) money is placed in tax deferred structures and the taxman comes to collect later in life. That is the moment most people have the fewest write offs. The children are grown, the house is paid off or down, the business is sold or being sold. The vast majority of people have, for decades, saved almost all of their future money toward retirement in tax deferred structures. The Boomer Generation is learning that lesson up close and personal as of this writing. The taxman comes later and collects on what you saved and grew for all of those years.

Taxation is inherently uncertain. This topic begs the question: is taxation going to be lower down the road or is it more likely to be higher? To keep things simple, our government has to balance budgets (eventually) the same way we do. Money in and money out. Our Government's income is taxation. With our national debt climbing, what is the most likely course of action for them to take?

There are really only two basic ways to solve the money issue. Make more or spend less, and our government is no exception. When I ask people which they think is most likely, they usually say “make more,” because I don’t see the government spending less. The truth is that we don’t know exactly what will happen down the road, but it is reasonable to guess that the probability of taxation being higher as we move into the future is very high.

The myth we’ve bought into is that you are saving money by deferring taxation, which is the primary attraction or benefit sold. For the overwhelming majority of people (90-95%), that simply is not true. We work with tax planners everyday, who themselves say very plainly that tax deferred structures do not save people anything. The “Tax Incentive” to save money on current taxation is, for the most part, a unicorn. There is no real tax savings. Only a deferred tax calculation. In other other words, all you do is kick the Tax Can down the road.

In short, you are lowering your adjustable gross income, thereby lowering how much you paid that year in taxes. The fact remains that deferring taxation does not create savings. All it does is defer the tax calculation. Again, it kicks the can down the road. If you actually calculate paying taxes now on the money you have set aside for later, then show how much your money has grown and compare it to paying taxes later, you will find that you pay significantly more in taxes by deferring your tax calculation.

We actually run a significant number of evaluations just like that with real people every day. If you pay taxes now and put your money into something that is tax exempt later, then the calculations are even more dramatic. When has paying later ever been a good idea? The term “Tax Advantaged” is subjective at best. Who determines the advantage? When do you see that advantage? Tax Deferred is touted as tax advantaged. It simply is not true for 95% of our tax paying citizens.

Let’s look at a real world application. Let’s say you are a 45 year old woman. You are driven, strong, and independent. You are a self employed as a CPA. Like many you have a SEP IRA. It is a traditional IRA specifically for self employed people. The contribution limits are higher and you decide you will put away $7500/yr until you are 65 and then start using that asset to pull income from at age 66.

Comparatively, you could instead pay the tax man today and put that money into a tax exempt option. You would put in $6,000/yr because you paid the tax man $1500 up front. Assuming the following factors for both options:

• You earned a 7% annualized return
• Your tax rate pre-retirement was 25% and your post retirement tax rate is 20%
• At age 66 when you begin to pull money from that asset you were still earning roughly 7% annual rate of return.

The results are staggering! If you chose the SEP IRA, you would have paid the tax man through age 83 $93,000 in taxes. Conversely, if you chose the Tax Exempt option and paid the tax man up front, you would have paid $31,000. That is $62,000 less or 200% less in taxes! I’m all for playing my part, but that is alarming. When is paying later ever a good idea? Usually pay later comes with a price and this price is very high. Tax efficiency is important. It directly affects how much of your money stays your money. How much you get to utilize will depend on how tax efficient your money is.

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