The 10th Man

Retirement Idiots

May 9, 2019

Uncle Sam doesn’t give out too many freebies when it comes to tax time, except in the form of retirement plans.

Surprisingly, not many people take advantage of them.

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Only 41% of people contribute to a 401(k) when they have the option to do so. A 401(k) allows annual contributions up to $19,000. If you maxed out your contributions, you could save thousands of dollars on your taxes.

For the people who ran out of cash during the government shut down, that money would have come in handy.

Why do more people not contribute?

  1. They say they don’t have the money. Wrong—everyone has the money. This is what saving is all about.
  1. They don’t know about it. Sounds hard to believe, but I have met people who don’t know about the existence of these tax-advantaged retirement plans.
  1. Laziness.
  1. Taxes are too hard to figure out.
  1. Etc.

That is a lot of money to leave on the table. You know what? If you make $100,000 a year, you can max it out. I guarantee you can do it. You can still have a cup of coffee once in a while!

At a 25% tax rate, you will save almost $5,000 a year in taxes. That is a lot of money to a lot of people. People don’t really view it as money, because many things feed into your income taxes. But let me tell you, if you contribute zero one year, and max it out the next, you will notice a big difference on your taxes.

Smart investors save as much on taxes where they can. Warren Buffett saves pretty much all of his taxes. He hardly has any tax liability at all. We can’t all be Warren Buffett, but the least we can do is take advantage of very obvious tax breaks where we can.

     
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The SEP IRA

The one retirement plan that goes completely overlooked is the SEP IRA. The SEP is for self-employed people, sole proprietors, single-member LLCs, etc. With a SEP IRA, you can shield a massive $56,000 a year from taxes. If your tax rate is 30%, that’s almost $17,000 in tax savings.

I have been taking advantage of the SEP IRA for years. 50-odd thousand goes into my retirement account every year. You don’t even need any growth in your retirement funds for this to add up quickly. If you do this over the course of your career, you’ll have over $2 million, with no investment gains. Not to mention the tax savings.

I run into a lot of self-employed folks who don’t even know of the existence of a SEP IRA. It is very common. If everyone who could contribute, did contribute, I wonder what it would “cost” the government in terms of lost revenue?

Those discussions haven’t started yet. They might someday. The government is spending a lot (an understatement) and currently nobody seems to care about debt. That might change, in which case the government will be looking for every bit of revenue they can find.

Retirement plans have been sacrosanct, but nothing is permanent. These plans might one day disappear. You can see how the narrative will run: “Who needs a $17,000 tax break? Only rich people.” And so on.

Tax Aggression

Some people are very aggressive on their taxes.

I am not. There’s not much I can do, anyway. Newsletter-writing is not a capital-intensive business and I have huge margins. Outside of travel and a couple of computers and a little market data, there’s not much to write off.

Having said that, I take every benefit I am entitled to. Let me put it this way: you wouldn’t not take your mortgage interest deduction because… you didn’t feel like it? Or it was hard? The bank makes it easy, they send you a 1099 with the interest you paid, and you or your accountant plug it in the computer. Retirement plans are really no different.

My guess is that the savings reflex for a lot of people is weak, which is a running theme in this newsletter. Maxing out a $19K 401(k) contribution seems distasteful, compared with the alternatives. To me, Alpo seems distasteful, compared with the alternatives. If the tax code encourages you to do something—whether it is buy a house, buy a Tesla, save for retirement, or something else—I suggest you do it.

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Nobody is going audit you because you took every dollar of a SEP IRA contribution. There are a million ways to get audited, but that is not one of them.

Open up any popular finance website and you will get bombarded with propaganda telling you to save for retirement. The participation rate is nowhere near 100%, for basically the same reason that people don’t refinance their mortgages when interest rates go down. Lots of people moan about Wall Street taking advantage of Main Street all the time.

Well, that’s because you make it easy.

Jared Dillian
Jared Dillian

 

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Comments

frank.dibernardino@viennahca.com

May 11, 7:51 p.m.

Jared,

Technically taxes are being deferred, not saved in 401(k) and other types of retirement programs, save Roth IRAs. Also, all investment income is taxed at regular tax rates, not capital gains when distributed. So Uncle Sam is better off than if people just saved on an after-tax basis and accumulated capital gains.

mike.strevell@gmail.com

May 9, 2:21 p.m.

> If you maxed out your [401K] contributions, you could save thousands of dollars on your taxes.

Certainly it is wise to max out retirement savings.  The next question is, is it better to use a traditional 401K or a Roth 401K?

A traditional 401K does not actually save you taxes, it just DEFERS your taxes until you take the money out in retirement.

Some people think that the US is at historically low tax rates now, and they will go up as scheduled in 2026.  In addition, due to the “chained CPI” provision in the tax law, people will be pushed into higher brackets over time.

By using a Roth 401K instead of a traditional 401K, you would pay less taxes because you are paying your taxes now at presumably lower rates, rather than later at higher rates with a traditional 401K.  In addition, with a Roth 401K you never have to pay taxes on the gains.

The comments below this article have some good analysis (the article itself is slightly flawed):
https://millennialmoney.com/roth-401k-vs-traditional-401k/

carlos.quintero@gmail.com

May 9, 2:16 p.m.

One can only contribute 20% of their income into a SEP - you made it sound like everyone could contribute $56,000.  Someone would have to be making and paying taxes on $280,000 a year, a big number.  Just felt that you could have written it with the limitations.

skier99ca@yahoo.com

May 9, 11:34 a.m.

Spot on.

Les Pearce

May 9, 9:57 a.m.

I know it’s a short piece and not really to discuss the nuances, but I think it’s always worth noting that you don’t SAVE the taxes, you DEFER them. This is a GOOD thing but should be part of an overall investment strategy.
It’s equally amazing how many people are surprised/resentful when they start their withdrawals and find out how much extra they need to draw to cover the taxes due. This can start as early as 59 1/2, but really seems to bite those who also find that they are REQUIRED to draw down at 70 1/2. If the 401K/IRA balance was maxed out over 30 years or so, there’s quite a large required distribution and much less wiggle room on how to manage taxes at that stage.

droesspe@gmail.com

May 9, 9:36 a.m.

Right or wrong, your letter here indicates wrong, I put in the minimum percent to get my employer match. I save, invest, and pay down debt with whatever I can and still not be a CF. Thanks for the entertaining and informative perspective.