This presentation is meant to communicate the concept that the effective taxation can be higher than expected when withdrawing money from a tax deferred account to fund a targeted after-tax retirement income. If a client desires $75,000 in after tax income (with a 25% tax rate), they must withdraw $100,000 to fund the income and the taxes. The $25,000 in taxes is due to tax on tax on tax. Thus, the effective tax rate on the $75,000 is 33% (25,000/75,000). INVESTMENTS: You must be registered with a broker/dealer to discuss investment concepts with a consumer. TAXES: This information is a general discussion of the relevant federal tax laws. It is not intended for, nor can it be used by any taxpayer for the purpose of avoiding federal tax penalties. This information is provided to support the promotion or marketing of ideas that may benefit a taxpayer. Taxpayers should seek the advice of their own tax and legal advisors regarding any tax and legal issues applicable to their specific circumstances. LIFE INSURANCE: Please remember the primary reason to purchase a life insurance policy is to protect one's beneficiaries through the death benefit. However, permanent life insurance can also serve as an accumulation tool that has some very unique benefits. To qualify for life insurance, one must take a health examination to determine insurability. Not everyone is insurable. Life insurance products contain fees, such as distribution fees and mortality and expense charges. The main way that a permanent life insurance policy is positioned to be tax advantaged is though policy loans. Policy loans may reduce the cash value and death benefit of a policy, and if they are not repaid, a loan could cause a policy to lapse. If a policy is over funded and becomes a MEC contract, the contract's earnings will be taxed as ordinary income at withdrawal, and may be subject to a 10% penalty if withdrawn before age 59 1/2. All hypothetical presentations must be based off of policy illustrations, and the illustration must be presented to the client. |
Let’s take a look at the concept of tax on tax. When you think about withdrawing money to fund your retirement, you think in terms of after-tax spendable income. To generate what you want to spend, you withdraw money from your tax deferred account. If you wish to pay the taxes as well from the account, you will need to withdrawal the tax due. So, if you withdrawal $75,000 to fund your income, you will need to also withdrawal $18,750 to pay a tax at a 25% rate. But, unfortunately you are not done. True you now have the $75,000 to spend and you paid tax on it, but because you withdrew the taxes, you now will owe tax on the tax. This cycle keeps repeating itself until the amounts get close to zero. So, for that $75,000, you not only need to pay 25% tax, or $18,750, but you will ultimately pay $25,000 the tax to cover the tax on tax on tax. That equates to paying 33% in taxes on the $75,000 or 8% higher than the 25% tax rate. And it gets progressively worse if tax rates go up. If the tax rate is 30%, the effective tax rate would jump to 43%, or 13% higher. TRANSITION: <Depending on when this is discussed in your process, this may be appropriate.> Now that we can see how much tax needs to be paid when pulling money from your deferred retirement account, how do you feel about (contributing or) keeping money in this environment moving forward? NOTES: Be prepared to explain (or be prepared to defer questions to a tax expert) the differences in the tax rates over the years. Use language such as the following when you cannot answer a particular tax question: That's a good question. I don't know the answer, but I do suggest you consult your tax adviser. Also, I recommend visiting the IRS web site, www.irs.gov, to anyone with tax questions or anyone who would like information about the IRS. |
The math for this calculator is computed similar to a spreadsheet as described below: Column one is the gross withdrawal. First row = Desired Lifestyle, subsequent rows = previous row withdrawal. Column two is the tax due on the withdrawal. Column one * Tax Rate. Column three is after-tax (Lifestyle) dollars generated from the withdrawal. Column one - Column two. Column four is the cumulative gross withdrawal.It is the summation of Column one. Column five is the cumulative taxes paid.It is the summation of column two. Column six is the cumulative lifestyle dollars. It is the summation of column three. |