Through the years there have been lies said on almost a daily basis. Today, one of the biggest just happens to come when the advice of investing for retirement is to take advantage of an employer’s Traditional 401(k) plan.
The reason is simple: Due to federal regulations surrounding health coverage in retirement as well as the United States income tax system there is never any reason to ever suggest to anyone that they should take advantage of their company’s Traditional 401(k)…ever.
To illustrate, let’s take a 55-year-old person who:
- Plans on retiring at age 70.
- Earns $200,000 a year in income.
- Is maxing out their company’s Traditional 401(k) (investing $18,000 a year)
- Is receiving a 5 percent company match on their salary ($10,000 a year)
- Is receiving a 5 percent rate of return on their investments through for life.
- Has already saved $200,000 in their Traditional 401(k).
- Is in the 33 percent tax bracket.
The great part of this scenario is that by age 70, when this person retires, they will amass $1,019,985.42 in savings to be able to fund their lifestyle. They will also at retirement:
- Enroll in Social Security, which, according to Social Security’s Quick Calculator, they will receive $72,780 in benefits.
- Be subject to the required minimum distribution (RMD) which will generate another $37,225.75 in income
- Have a total income of $110,005.75.
- Will save $147,840.00 in taxes due to the tax deferred investment.
- Drop into a lower tax bracket which is currently 28 percent.
Everything seems all well in good, however, in order to receive their Social Security benefit, this person must also enroll into Medicare. Unfortunately, what no one is planning for is that Medicare adjusts the cost of premiums charged to a retiree by income.
Due to Medicare’s Income Related Monthly Adjustment Amount (IRMAA) retiree’s that enroll into Medicare will face a surcharge on top of their Medicare Part B and Part D premiums, the brackets are below:
Part B and Part D IRMAA brackets:
This may not seem like a big deal to many, but, historically Medicare has been inflating at over 7.5 percent year of year and is expected, according to the Medicare Board of Trustees, to maintain this rate of inflation for the foreseeable future.
In fact, Medicare Part B is expected to inflate by over 5.5 percent while Part D is expected to inflate by over 8 percent.
Due to these surcharges this person, if their nest egg remains untouched as they rely on their RMD’s and Social Security benefits, which is expected to have a cost of living adjustment of 2.6 percent according to the Social Security Board of Trustees, will not only start retirement in the 2nd IRMAA bracket, but by age 84 they will enter the 3rd bracket as well.
If health coverage inflation rates remain constant through retirement of age 85, this person will:
- Pay an extra $56,834.00 in Part B surcharges.
- For Part D they will pay an extra $45,735.00 in surcharges.
- Receive a tax on their RMD’s. For this person the tax appear to total $108,312.41 if they remain in the 28 percent tax bracket.
While there is a savings of $147,840 due to the tax deferral during working years there will still be $210,000 in taxes and surcharges in retirement!
That’s despite a lower tax bracket in retirement.
Again, placing investments in a Traditional 401(k), due to income being used against you when your health is on the line, is never a prudent thing to do…ever.
What could be argued as a more prudent way to lessen tax liabilities while controlling health costs in retirement would be to take advantage of a company’s Roth 401(k)…but again, that would be the prudent thing to do when your health is on the line.