Most people see their CPA once a year. The conversation is usually about what happened last year and what you owe this year. But there is a second conversation – one about the future – that most CPAs never initiate.
The Missing Conversation
When you contribute to a traditional 401(k) or IRA, you get a tax break today. But that money will be taxed as ordinary income when you withdraw it in retirement. Every dollar. At whatever your tax rate is at that point.
Most families assume their tax rate will be lower in retirement. That may or may not be true. If tax rates increase – which many policy analysts expect given current deficit levels – your effective rate in retirement could be higher than it is now. And every dollar in that 401(k) is exposed to that risk.
The question your CPA may not be asking: “What is your plan for tax diversification at distribution?”
Tax Diversification
Just as you diversify investments across different asset classes, you can diversify your retirement income across different tax treatments:
Tax-deferred: Traditional 401(k) and IRA. Taxed as ordinary income at withdrawal.
Tax-free (under current law): Roth IRA and Roth 401(k). Funded with after-tax dollars. Qualified withdrawals are not taxed.
Structured to be more tax-efficient: Cash value life insurance policies and certain annuity structures, when properly designed, can provide income that receives more favorable tax treatment under current law. This is the category most families have never heard of.
A retirement plan that draws from all three categories gives you more control over your annual tax bill. You can adjust which accounts you draw from based on your needs and the current tax environment.
What This Means for Business Owners
Business owners face an additional layer. How you compensate yourself – salary, distributions, dividends – affects what is available for tax-advantaged retirement vehicles. An S-Corp election, for example, changes the math on self-employment tax and opens options for retirement plan contributions that a sole proprietorship does not.
If your CPA’s annual conversation is limited to “here is what you owe,” you are missing the strategic conversation about how to build retirement income that keeps more of what you earned.
Ask the Question
The next time you sit down with your CPA, ask: “What will the tax treatment be when I start drawing from my retirement accounts?” If the answer is “it will all be taxed as ordinary income,” that is the gap. And closing it starts with understanding the alternatives.
Under current tax law. Individual results depend on personal circumstances. Consult a tax advisor. Products and features vary by carrier and state.
