If Retirement’s Called Your ‘Golden Years’ Why Shouldn’t You Keep The Gold?

by Jeff Brown

Real Estate Investments Broker

Author website

If you’re in the state/fed combined tax bracket of 33.3% and your home mortgage is interest only at 6%, your after tax rate is 4%. But you knew that, right? And if your loan is say, $200K, then your annual interest deduction is $12k. At your 1/3 tax bracket your actual interest paid is only $8K. This means you are not paying $4k in income taxes just because you own your home. Big deal you say, everyone knows that. True enough. But is there a way to take further advantage of that tax break?

What if you’re married and you’ve been putting $4k annually in your 401k. Why do people do this? They do it because they’ve been pounded since they can remember — “you’re saving taxes on every buck you put into your 401k. Don’t be an foolish, keep doing it.” What if you took the $4k in tax savings from your home interest deduction and put it into something that might grow tax free? Why would you insist on taking an additional $4k and locking it inside a retirement plan that’s telling you up front it’s going to tax everything that comes out in retirement income? And that tax rate will probably be the same or more than what you’re paying now. And we’ll tax your heirs when both of you are gone.

“But my retirement tax bracket will be significantly lower than it is now” you reply confidently. Not so fast. Aren’t you and your wife doing your best to end up with a free and clear castle by the time you pick up your gold watch? If you guys put the same $4k in the retirement plan (401k/IRA) every year for 35 years and it grows at an average rate of 8%, you’ll have around $690K. At that same 8% you’ll have an annual income to add to your Social Security check (laughing in backround) of roughly $51,750 — pretty nice, eh? Not so fast. You’re earning too much possibly. What? Social Security may become taxable with your increased income. In any case, your retirement income is about what you were earning back in the day. And that could present the ‘too much earnings problem’.

Isn’t making that much in retirement a good thing? You’re still in the 1/3 tax bracket — maybe. Remember, you’re making the same money you did when you had all kinds of deductions you simply don’t have now. The kids are long gone. And your interest deduction? In anticipation of retirement you sold your home, took the tax free proceeds, and bought a smaller less expensive place for cash. (often a fatal planning mistake) No interest deduction there. So it’s very possible your taxes could be roughly the same or even more than before retirement. Social Security regulations already change yearly. Sometimes too much income causes benefits to shrink.

Either way, by benefit reduction, or taxes, or both, your income shrinks. Not a good thing any way you look at it.

If you retired at 65, the numbers say you’ll live another 20 years or more. If you’re pretty healthy, way more than 20 years isn’t out of the question these days. (My grandma is 93 and still walks over a mile daily!)

Think back to your parents’ retirement. They thought if they could just pay their mortgage off and generate a permanent income of $20k a year they’d be in the high clover. They longed for their own ‘mortgage burning’ party. What did the passage of 30-40 years do to that plan? Exactly. Social Security plus $51,750 before tax just isn’t gonna do it for you, is it?

What if, instead of the 401k or IRA, you took after tax money each year and found investment vehicles yielding 6-12% annually (average of more than 8% the last half century) TAX FREE? Let’s use 8% for this example. Surprise, surprise, surprise, you end up with the same $690k! However there’s a huge difference. This money isn’t tax deferred, but tax free — forever. And the income is — tax free forever. Now you have Social Security (stop laughing!) which is not taxable, plus $51,750……Tax Free — which doesn’t impact your Social Security income. Now you’re approaching an annual $70K tax free retirement income. All because you stopped investing in your 401k or IRA just to save a few bucks every year in taxes. You didn’t even increase your annual $4k investment — you just decided you’d already paid your fare share of taxes.

This incredibly simple manuver generally increases the taxpayer’s after tax retirement income by over $1,000 a month, and in many cases much, much more. And the income is for life. Your life and her life. And when you’re both gone, your heirs will inherit the untouched principal….wait, here it comes……TAX FREE. Not so with your current so called, ‘qualified (tax deferred) plan’.

Is it possible to do several times better than this by studiously avoiding a free and clear home? How about investing in real estate along the way? Of course it is. I wouldn’t have asked the dang question otherswise. 🙂 But we’ll keep that for later.