There’s a vital bit of information your working-age clients need to understand, whether they want to or not.
We’ll warn you up front – the concept has an acronym: MAGI. That refers to the modified adjusted gross income that clients can hope to retain in retirement.
Most of your working customers rely on 401(k) plans and IRAs for their retirement plans. Their popularity is partially explained by the fact that contributions to these plans are pre-tax – they reduce the client’s taxable income. Anything that leads to a bigger tax return is popular with customers and with their advisors and tax accountants, who can claim the credit.
Companies sometimes sponsor 401(k) plans, automatically deducting the employee’s contribution and even providing matching payments, in some cases. It all sounds highly appealing, even seductive.
Unfortunately, these plans aren’t really providing tax relief; what they’re giving clients is tax deferment. The income a younger client contributes to a 401(k) or IRA today won’t be taxable this year, but when they retire in a few decades, the taxman will call – and there’s no certainty over what rate will apply at that later date.
The money in these accounts is also effectively tied up; there’s no way to directly access it without penalty. Indirect approaches are possible, including loans secured by the accounts or hardship provisions, if available.
Distributions can push the recipient into a higher tax bracket. In effect, they increase the client’s MAGI, potentially leading to a host of other problems: the Social Security income tax rate can be boosted; Medicare payments increased; richer clients exposed to the Medicare surtax, and so on.
The solution is for clients to diversify away from sole reliance on 401(k) plans and IRAs. Holdings of securities should be increased and other strategies considered to avoid excessive dependence on easy to apply but potentially tax-tricky retirement accounts.
For more information, please read:
Your Working-Age Clients Need to Understand MAGI | ThinkAdvisor