One of the most foolish things done in terms of retirement is thinking of it in a linear fashion-
work work work,
save save save,
boom -
retirement.
Common pitfalls associated is: not having other retirement accounts besides one through work, never diversifying AND/OR never adjusting allocations as you got closer to retirement, lacking awareness of what your retirement income and tax liability will be, among other things.
Simply put,
- MOST of our working years can be lumped into a period labeled 'Accumulation Phase'. We have to grow our nest egg and nurture it to sustain us in the future.
- Prior to retirement, however, there is about a 10 year-ish 'Pre-Retirement' window, VERY often overlooked, that can be labeled 'Preparation and Preservation Phase'. This period HEAVILY impacts the quality and longevity of the Retirement Phase.
- Lastly, the final period is the 'Retirement Phase'.
Let's look at it this way-
From 25-55 (30 years), you may traditionally start out with 1 bucket- we will call this bucket 'pre-tax'. Later during this period, you may decide to let another retirement flow spigot pour into another bucket- we will call this bucket 'post-tax'.
Optimistically, let's hope you have those taps WIDE OPEN, putting as much as you can afford into these Accumulation buckets.
From 55-65 (10 years) it sets in that every time you need to dip your ladle into your 'pre-tax' bucket, you have to pour some into the Government's cup in the form of taxes. Based on the agreement of funding 'tax-me-later' accounts (The Pre-Tax bucket), you essentially have to fill their cup until they say stop and that amount may go up or down.
You may have been told this was the case, but the impact of the message at the time you were told did not matter as much because you were more focused on just accumulating as much as possible.
The Government has their cup partially under the faucet that is flowing into your 'Post-Tax' bucket, so when you dip your ladle in there for retirement income- everything that comes out, goes directly to you.
What you do in this 10 year period will determine how long your bucket(s) will sustain you- provided you were able to truly fill your bucket(s) up during your working years.
When you retire- you turn those faucets off. They may continue to drip into your bucket(s), but for the most part, what you have is what you have.
The 'Strategy' comes into play when you have to figure out how to MINIMIZE the future pour into the Government's cup-
There is no way around it- the Government's cup will get its fill FIRST. The 'Game' is about how/when we give them their pour. The KEY to this game is understanding TAX BRACKETS.
Without diving too deep into taxes, you need to decide, or with the aid of a professional- Do YOU expect YOUR future tax bracket to be greater or less than where you currently are at? (THIS INCLUDES: whether you have a greater income in retirement AND/OR if tax rates are higher for your projected income level in retirement).
If you really believe you will have a lower annual income and face a lower tax bracket in retirement through paying yourself from your 'bucket' you filled up- then it makes the most sense to maximize the 'tax-me-later' bucket. On a comparative basis, you are netting more dollars today by paying taxes tomorrow.
However-
If you really believe that tax rates will be higher in the future- given our issue with the National Debt, or you will need more in annual income in retirement to compensate for medical costs, higher cost of living etc.
Then it makes sense to pay taxes today to avoid taxes tomorrow.
This 'Preparation and Preservation' phase is CRITICAL for making sure you have the right amount of money in the right bucket(s) to sustain you to the finish-line of life.
Uncle Sam didn't clock-in with you.
It is up to YOU to make sure you pay him as little as is required.
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