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Retirement Terms You Need To Know

I recently had a conversation with a high school friend. He said this CPA suggested he put $19,500 into his 401(k) because he needed the 2021 tax deduction.

We walked through the math:

  • 35% tax bracket.

  • $19,500 x 35% = $6,825 

  • Tax deduction of $6,825 for 2021.

  • Rule of 72 - in 20 years the $19,500 grows tax-deferred into $76,000.

  • $76,000 x a conservative 20% tax rate in retirement  = $15,200 tax bill.

Bottomline - The $6,825 loan cost you $15,200. 

In a rising tax environment, tax-deferred investing needs to be questioned.


Retirement Terms You Need To Know

  • Adjusted Gross Income versus Taxable Income?

    • AGI is gross income before any standard or itemized deductions or tax credits.

      • The best tax strategies are focused on lowering AGI. And thus lowering your tax bill.

        • Example – QCD’s – IRA to charity. Lowers your AGI. 

  • After-tax versus pre-tax money.

  • Cost versus basis:

    • Cost- What you paid for the property or stock.

    • Basis- Used to figure any gain or loss when an asset is sold.

      • Adjusted added or subtracted from your cost.

      • Home: improvements

      • - > basis.

      • Stock – any reinvested dividends that you paid tax in the year that they were earned will be added to the purchase price of the stock and thus a new increased basis.

      • Tractor – depreciation will be subtracted from the purchase price to arrive at a decreased basis.

      • Increasing basis results in a decrease in capital or ordinary gains and the tax you pay.

      • Decreasing basis results in increasing capital or ordinary gains and the tax you pay.

      • You have to earn basis – by spending after-tax dollars. When you invest money in which you have already paid the tax, you earn basis.

      • You lose basis when you contribute pre-tax accounts. The deduction negates basis.

      • Basis is helpful when taking distributions – basis money versus non-basis money.





  • Beneficiary, Designated Beneficiary versus Eligible Designated Beneficiary

    • Designated Beneficiary-Most lose stretch IRA beneficiary.

      • Named on a IRA or company beneficiary form.

      • Must be a person – pulse and a DOB.

      • Not eligible- An estate, trust, charities, pets.

    • Beneficiary-some can inherit via probate if the form is not signed before your death. They are deemed a non-designated.

      • The payout rules for a beneficiary versus designated are very different as it relates to tax consequences.

      • Non-Designated are subject to a 10-year rule.

    • Eligible designated Beneficiary-Continue to enjoy stretch IRA perks.

      • First must qualify as a DB to become a EDB.

      • Eligible for the stretch IRA.

      • 5 Classes:

        • Surviving spouse.

        • Minor children up to majority.

        • Disabled individuals

        • Chronically ill

        • Individuals are not more than 10 years younger. Sibling, partner, or friend.

        • Grandfathered classes.

  • Capital Gains Versus Ordinary Income:

    • Everyone wants capital gains.

      • From the sale of a capital asset- stocks, bonds, mutual fund shares, or home.

      • Held more than 1 year (long-term gain) before sale – taxed at 15%.

      • Minimum bracket = 0% and the highest current bracket is 20%.

      • 3.8% additional tax on Net Investment Income for HNW. This makes the maximum long-term capital gains tax rate 23.8%. Applies when AGI exceeds $250,000- married filing jointly and $200,000 filing single.

    • Ordinary income is what most people get.

      • Income from work, trade, or IRA distribution.

      • Taxed at your ordinary income levels (higher).

  • Roth Contribution versus Roth Conversion:

    • Two different methods to add money to Roth IRA’s.

    • The Roth contribution applies to the limited annual amount you are permitted to contribute to your Roth IRA.

    • A Roth conversion occurs when you transfer funds into your Roth IRA from an account such as a 401(k) or your IRA. The government does NOT limit how much you can put in. Keep in mind any pre-tax funds that you convert will be taxable. This is where the strategy of filling up your existing tax bracket comes into play.




  • Conversion Versus Re-characterization:

    • Conversion can occur via a rollover or a trustee to trustee transfer.

    • A re-characterization of a Roth conversion is when you transfer converted funds back to an IRA thereby negating the conversion. The tax law did away with re-characterizations after 2017.

    • Roth conversions are now permanent and can’t be undone.

  • Deductible IRS Versus Non-Deductible IRA Contributions:

    • Deductible IRA contributions – secure a current tax deduction.

    • A non-deductible contribution receives no deduction when made and is NOT taxable when withdrawn.

    • A Traditional IRA allows deductible contributions as long as you don’t make too much money while active in the company plan.

      • 2021 single income under 140K

      • Married -208K

    • Roth IRA is a non-deductible IRA.

  • Direct transfer versus a Rollover:

    • A direct transfer is a process of moving retirement from one account to a new account. AKA a trustee to trustee transfer. One bank or brokerage firm to another without you ever touching the funds. Preferred, tax-free.

    • A rollover is when you withdraw the funds from your IRA or qualified plan such as a company 401(k) and redeposit it into an IRA or new employer’s qualified plan.

      • If you get the funds paid directly to you the IRS allows you 60 days to redeposit the money. Some refer to this as a 60 IRA loan.

      • If you miss the deadline the withdraw becomes taxable. This spells the end of your retirement account.

      • You also only get one IRA to IRA rollover or Roth IRA to Roth IRA only once- every 365 days.

      • You can do as many direct transfers per year as you wish as long as the assets go from trustee to trustee.

  • Estate Tax Versus Income Tax:

    • Estate tax

    • Income tax – the one you pay when you are alive.

  • Final Tax Return Versus Estate Tax Return:

    • Final – the final 1040 prepared during the year of death.

    • Estate tax return – Form 706 is used to determine how much tax the estate owes.

  • Gift Versus Bequest:

    • A gift is presented while you are alive.

    • A bequest is given after death via a will or trust.

  • Gift Tax Versus Estate Tax:

    • Gift tax is assessed on taxable gifts such as property that are made by the giver during their lifetime. The giver is responsible for paying any required tax.

    • Estate Tax is levied on assets of an inherited estate. The taxes are paid out of the estate.

    • Paying a gift tax will cost less than paying the estate tax on the same asset.

  • IRA Versus Inherited IRA:

    • An inherited IRA is an IRA that is inherited from anyone except a spouse. Spouses enjoy special tax benefits that other inheritors like children do not enjoy.

      • Example: A spouse can perform a spousal rollover, transferring his deceased wife’s IRA to his own IRA and treat the funds as if they were always his.

      • A non-spouse beneficiary cannot do this type of rollover.

      • The SECURE Act eliminated the Stretch IRA for most non-spouse beneficiaries

      • You can never contribute to an inherited IRA.

      • You cannot mix personal IRA and inherited IRA funds (except a spouse). Doing so will result in immediate taxation of all the funds and will be gone.

  • Qualified Plan Versus Non-Qualified Plan:

    • Qualified –benefits have to be offered to all eligible employees. They provide tax advantages. Employers receive current tax deductions for contributions to the plan made to the employees. Contributions grow tax-deferred.

      • 401(k), defined benefit, defined contribution, and Keoghs.

      • 403(b) and 457(b) (deferred comp plans) technically are not qualified but follow the same distribution rules.

      • IRA, SIMPLES, SEP IRA’s, and Savings Incentive Match plans are not qualified plans but also follow the same distribution rules.

    • Non-qualified – fewer rules governing – not required to have spousal consent. Not required to be offered to all employees. But DO NOT enjoy the same tax benefits as qualified plans. They help attract and keep important employees.

      • Employers offer them for special employees:

        • Special tax-deferred compensation packages.

        • Pension arrangements.

        • Insurance.

        • Annuities.


  • Roth IRA, Roth 401(k) and Roth 403(b) and Roth 457(b)-Contributions are all after-tax funded: Funds grow tax=free inside the account

    • Roth 401(k) allowed in 2006 for employer-sponsored plans.

    • Roth 403(b) –Offered by schools, universities, hospitals, and other public institutions.

    • Roth 457(b) – deferred compensation plan offered to certain state and local government employees – firefighters and police.

    • Once you have the funds x 5 years and you reach age 59.5 years of age you can withdraw them tax-free. The tax-free benefit carries over to the beneficiary.

    • Roth 401(k) do require distributions at age 72 - to avoid all the distributions –just rollover to a Roth IRA or another Roth 401(k).

    • Roth 401(k)s have higher contribution limits.

    • A Roth IRA funds can’t be rolled over to Roth 401(k)s.





  • Traditional IRA Versus Roth IRA Versus Coverdale Savings Accounts (Ed IRA):

    • Individual Retirement Arrangement (trivia) Ira Cohen (1975)- Plain vanilla IRA

      • Tax-deductible or not- depending on the level of income.

      • Can continue to contribute to an IRA after 701/2 if you have the earnings to qualify.

      • Can’t withdraw from a Traditional IRA without a penalty:

        • There are a few exceptions.

        • RMD’s required at age 72.

    • Roth IRA

      • Distributions are tax-free.

      • Contributions can be made annually or by converting a traditional IRA to a Roth IRA.

      • Can contribute forever.

      • No RMD’s.

    • Coverdale:

      • Education funding


Retirement Terms You Need To Know

Tax rates will go up if Congress does nothing soon. Why, the tax cuts that were part of The Tax Cuts and Jobs Act of 2017 are sunsetting on January 1, 2025.


History of Taxes:

Back in 1913, Congress passed the sixteenth (16) amendment, which gave Congress the power to tax citizens on their income. In the first year that it was implemented in 1914, Congress authorized a 7% income tax rate. In just four (4) years, the top tax rate spiked dramatically to 70%.



The highest tax bracket in the history of our nation was 94%. During the last two years of WWII, any dollar you made over $200,000 ($3.2M in today’s dollars) was taxed at 94%. The decade of the seventies delivered a top tax rate of 70% for any dollar above $200,000.



The Tax Cuts and Jobs Act – 2018 Gift

We currently have the lowest tax rates in the last eighty years. The top rate dropped to 37% from 39.6% on January 1, 2018.




  • Effective tax rate or average – The effective tax rate for individuals is the average rate at which their earned income, such as wages, and unearned income, such as stock dividends, are taxed. The average tax rate is the total tax paid divided by the total income earned.

  • Marginal tax rate – The marginal tax rate is the tax rate paid on the next dollar of income. Under the progressive income tax method used for federal income tax in the United States, the marginal tax rate increases as income increases. Marginal tax rates are separated by income levels into seven tax brackets.

  • Debt – The amount the government owes.

  • Deficit – The amount the government collects in taxes versus what it spends in a year.

  • Gross domestic product (GDP) – The total value of goods and services produced by our country produces in a year.

  • Key Relationships - Debt and our GDP and our Deficit to GDP.



Our debt ratios have some historical benchmarks. After WWII, the government was essentially out of money; the deficit to GDP (Debt/GDP) was 119%. During the Great Recession of 2008, tax receipts were extremely low - the ratio was 68%. We are on track for a debt/GDP ratio of 130% in 2023. Much of the current trend is in part due to the unprecedented COVID spending by the government.


However, even before COVID, we had normal growth, a decent economy, and still, the government was racking up extraordinary deficits. Tax cuts and spending patterns by the government mathematically drive deficits skyward. The former Comptroller General of the U.S., David Walker, has warned key stakeholders about deficits, spending, national debt and the $330T in unfunded liabilities that we are racking up.



David Walker predicts that the government will have to do the following to address our financial crisis:

  • Double taxes

  • Cut spending in half

  • A combination of the above



As you can see, our tax rates are the lowest they have been in eighty (80) years. The nation is spending massive amounts of money; we print trillions of dollars, our debt and unfunded liabilities are beyond comprehension.


As you create and edit your retirement plan, integrate short-term economic data as well as long-term macroeconomic realities into your planning calculus. 



Retirement Terms You Need To Know

Step 1: Accept the basic premise about taxes.

A foundational concept that one has to understand and agree with is that we are in a rising tax environment, and taxes will be higher in the future.


Step 2: Your three buckets.

There is an ideal amount of money to have in each of your investment buckets in a rising tax environment. The three (3) investment buckets are:

  • Taxable – liquid savings, stock, bonds, and mutual funds.

  • Tax-deferred – 401(k), 403(b), Traditional IRA, and TSB’s.

  • Tax-free – Roth IRA, Roth 401(k), Roth conversions, and properly funded cash-value insurance.



Step 3: Guidelines to consider.

Here are some guidelines about the amount of assets that should be inside your three (3) investment buckets:

  • Taxable – Have the amount of money that is equal to six months of monthly expenses. For example, if your monthly bills add up to $10,000, you would want $60,000 in your taxable investment bucket.

  • Tax-deferred – You want only enough inside your tax-deferred bucket so that future required minimal distributions (age 72) don’t exceed your standard deduction in retirement. A distribution that is at or below your standard deduction will help prevent Social Security taxation.

  • Tax-free – Your Roth IRA, Roth 401(k), and cash-value life insurance can be the vault for the remainder of your investment assets.



Step 4: The tactical shift.

Anything above the idea targets in the taxable and tax-deferred should be systematically shifted to tax-free. This task is stretched out over as many years as necessary; you want to get it done, however, before the lowest tax rates in our life go up.

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