Shoring Up the Wobbly Retirement Stool

Whether you are standing on it, sitting on it, or hiding underneath it, a stool is only as stable as the number of legs supporting it and that’s no different than our retirement stool. And since it isn’t as much what you save as it is what you keep, the tax treatment of each of those legs is what creates that stool’s strength. So how many potential legs are out there?


Leg #1: The Pre-Tax Leg
This is the leg everyone focuses on and the one that makes our government happy since they now know there will tax revenue for many, many years to come. This is going to include everyone’s 401(k) / 403(b) / 457 / SEP / SIMPLE, and plain ole’ IRA plans. You put the money in now (either from your paycheck, by way of a company contribution, or simply making a personal deposit), take a tax deduction for the year, and let those dollars build and build, tax-deferred, until age 72 when the IRS says “thanks for the memories, where’s our dosh…”

Leg #2: The Partial Tax Leg
When Social Security was first established, it was tax-free but thanks to President “lower taxes” (but only for some people) Reagan, Social Security is now up to 85% Federal taxable (it’s still tax-free in some states). Here’s a fun challenge—take too much from Leg #1 and you run the risk of making more of Leg #2 taxable, effectively decreasing your available cash…talk about conundrums. Here’s a fun fact—the average person collecting Social Security gets back everything they contributed in less than 10 years.

Leg #3: The Post-Tax Leg
Have cash in the bank, in a money market, or under the mattress? That’s a #3 leg. Money in an investment account? Ditto. How do we know the difference between this leg and other legs? If you take money from this leg, the taxes are called “capital gains” whereas the taxes on other legs are called “income taxes.” While both taxes are somewhat manageable, managing “capital gains” taxes is much, much easier than managing “income taxes.”

Leg #4: The No-Tax Leg
Wait, What? There’s a leg where I won’t pay any taxes??? Yup, under certain circumstances and like a truffle, not the easiest to find and use. It’s called a Health Savings Account and it allows you to deduct the contributions from your current year taxes, invest those dollars tax-deferred, and take the proceeds out cash free. Of course, in order to use this account, there are challenges worthy of a medieval knight but yes, the prize at the end is not only a slain tax-dragon but a lovely golden goose laying tax-free eggs in retirement.

Leg #5: The Mystery-Tax Leg
While many people consider anything including the words tax, financial, and investing to be a mystery (but not any of you because I know you faithfully absorb these weekly emails), there is one type of retirement vehicle that does have the air of mystery about it and that’s the Roth IRA. Established in 1997 by Senator Roth, the theory goes that you put the money in AFTER paying taxes and let it sit there for a specified period of time, then, when you take it out, the government won’t tax the earnings. Of course, this would mean that the Senators of today could balance more than a Venmo account and a handful of uppers so I’m sure none of you are surprised that there have already been several bills presented to Congress to tax the earnings on these accounts the same way Social Security is taxed. We’ll call this the “balsam-wood leg” and wait & see.

As you look at your retirement (whether you are in the throes of it, can see it floating on the horizon, or it rests somewhere in the hazy future), adding as many legs as possible to your retirement stool puts you in charge of your retirement tax picture, which means you keep more of what you have.