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It's not what you make - It's What you Keep :: Knowledge Center :: THE RETIREMENT SOURCE®
It's not what you make - It's What you Keep

It's Not What You Make - It's What You Keep


You already know that cash is the only thing you can spend. When you go to the supermarket and the cashier asks you, “Paper or plastic?” he’s not just talking about bags. He wants to know how you are going to pay. You also know that it doesn’t matter what your paycheck stub says your gross income was, the only thing you can spend is the net after all the deductions.

Most people fail to make the connection that the same thing applies to retirement income (and estate transfers). Simply generating the desired amount of capital to meet your goals doesn’t give you assurance that it will work out the way you want. That’s why it is absolutely vital to grasp the importance the five basic keys to MORE CASH, LESS TAX.

1. Cash Is King!

While many people consider cash assets to be a poor investment, they are in fact an important component of retirement success. Consider these qualities of cash:

  • Cash is the singular unit we use to keep score
  • It is the only thing you can spend (paper or plastic)
  • Credit is just borrowed cash
  • Cash is not a tax-related concept, but income is
  • Access to cash is the ultimate measure of control (power)
  • How you access cash has a major impact on your quality of life
  • Cash comes in two flavors: spending cash and strategic cash

Flexibility in managing your cash flow can spell the difference between success and failure in retirement

2. Think Cash Flow, Not Income

This is the biggest obstacle for most people thinking about retirement because it requires a complete shift in thought processing.

Everybody talks about having enough retirement income,
but what they really mean is they want enough spendable cash.

The result is that they constantly seek more gross income and, just like their paycheck, their take-home pay is often much less than they thought it would be. That happens because they fail to take into account all the deductions that come out of the middle. Long range projections of cash needs can give you the control needed to optimize your cash flow strategy. It can also reduce your tax bill so you don’t just make more and pay more. In today’s low-yielding investment climate, few people are able to generate their required spending cash from dividends and interest alone. The common naïve strategy is to assume that staying fully invested will return enough in gains to make up the difference. Many of those who used this strategy in 1999 to 2003 permanently destroyed their retirement.

Wise investors, rather than listening to the product promoting media, are following the strategies of the institutional investors who have been required to make consistent contractual cash payouts for generations. Endowment funds and pension plans that are legally required to meet regular cash obligations over periods of many years into the future, understand the difference between relative returns and absolute returns. They have developed plans to meet these cash needs by using strategic cash holdings, broader asset allocations and targeted maturity securities. Investors using similar strategies should be able to achieve a smoother flow of spendable cash as well as a lower long-term tax expense.

3. Think Net4

The only thing that matters is what is left after market depreciation, all costs and expenses, income taxes, inflation and ultimately estate transfer taxes. That is Net4. It’s easy to fool yourself about how much capital you have or how much “income” you have. For example, a person with a $1,000,000 IRA account does not really have a million dollars. He has a million dollars of untaxed income. Every dollar that comes out will be taxed by Uncle Sam and perhaps by the state. If it is left to a non-spouse at death, it may also be subjected to estate taxes as well. Certain other retirement accounts and fixed annuities are similarly taxed. Even stock and other asset profits require capital gains taxes.

The only realistic way to evaluate your net worth and income situation is to apply Net4 calculations. That is, in the short-term, to see what they are worth after all costs, expenses and taxes. In the long-term it is often necessary to adjust for inflation and estate transfer costs. In the example of the person with the million dollar IRA, an immediate withdrawal of all funds could result in net after tax cash of approximately $610,000. This considers only federal and Ohio income taxes, not the cost of selling assets. Taking the money out over a longer period of time could lower the tax bite, but not eliminate it. Typically, a person taking 6%, or $60,000 per year who was also drawing Social Security would be in a combined state and federal tax bracket of approximately 25%. That means taking an additional distribution of $10,000 could net only $7,500. If they wanted $10,000 in cash, they would have to take a gross distribution of $13,333. Strategic cash flow planning involves not only how your money is invested and how distributions are taken, but also what specific types of ownership registration are used.


Not Tax Now
No Tax Deferred
Not Tax Now
Tax Deferred
Tax Now
No Tax Deferred
Tax Now
Tax Deferred

4. Understand the Tax Position of Your Money

In our opinion most people having high income and/or high net worth are overpaying taxes now or will be in the future. Different types of asset ownership may have dramatic differences in the tax treatment of cash flows, income and profits. In fact, over the long-term, the efficient tax position of a given asset may mean more to your Net4 value than your raw rate of return.

One example is the Traditional IRA versus the Roth IRA. Traditional IRAs are in Quadrant II, which is not all bad unless a large proportion of your assets are in that quadrant. This can result in substantial income taxes and, in some cases estate tax problems. Roth IRAs, on the other hand, are one of the few ownership forms that are in Quadrant I - no income tax on contributed after-tax dollars or earnings ever during the owner’s lifetime (for owners over age 59 1/2 after the account has been active for five years).

If Roth IRAs are left to beneficiaries after death, they will be subject to estate taxes if applicable. However, while heirs are required to withdraw funds based upon their life expectancy, they will never have to pay income taxes. By understanding the tax position of your various assets and making key adjustments, you may be able to significantly lower your long-term tax expense and increase your spendable cash for yourself and your heirs.

5. Stop Growing Dollars for Uncle Sam

In the process of accumulating wealth most people think about the taxes going in, but few consider the tax costs of getting money out. For example, virtually everybody has been advised to put as much as they can into deferred accounts so it can grow “tax free”. Because they ultimately must take distributions, they unknowingly take Uncle Sam and other tax agents on as partners in every dollar of growth. We call this the “Reverse Rumpelstiltskin Effect” because it spins gold into straw (taxes).

As an example, high growth assets outside deferred accounts could be taxed at capital gains rates or not at all if passed through an estate with a stepped-up basis. When the gains are withdrawn from a deferred account, they are taxed as ordinary income at perhaps more than twice the capital gains rate. Rumpelstiltskin! Certain deferred accounts can be veritable “tax traps” for some people. On the other hand, there are ownership forms that may offer benefits of superior liquidity and both income tax and estate tax advantage. Some people, ignorant of the alternatives, pay penalty taxes on early retirement distributions due to misunderstanding the tax position of their money. Others unwisely rollover their entire retirement accounts and pass up the opportunity for much more favorable tax position of net unrealized appreciation (NUA) of employer stock.

For many people it is not only a matter of changing the tax position of some of their money as it is changing the timing of their distributions. By delaying all retirement plan distributions until they reach their Required Beginning Date (RBD) at age 70½, they inadvertently push their later years’ income into much higher tax brackets thus growing dollars for Uncle Sam. A strategic cash flow plan could result in dramatically lower total taxes and more spendable cash in your family’s pocket. The bottom line is by understanding the basic keys to MORE CASH, LESS TAX, you may be able to keep more of what you have and generate more spendable cash.

Obviously, this is just the tip of the tax saving iceberg; so pleased don’t take these ideas out of context. Our only advice to you is that you take the time to carefully review your long-term cash flow strategy in light of the ultimate costs and consequences. Always consult with qualified tax advisers before making any significant changes. Please let us know if you would like additional information.

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