The benefits of deferring your taxes by contributing into an IRA.

“What difference does it make whether I pay taxes now or I pay taxes later? I’m still going to be paying the same amount of taxes!”

As a financial advisor I get this rhetorical question all the time. I say rhetorical because most people don’t actually expect me to have a good answer for them.

While it is true that you are merely putting off paying taxes until a later date, it is absolutely not true that you will be paying the same amount of taxes.

There are two magic words to keep in mind when discussing the benefits of tax deferral.

Interest and income.

Interest

Realize that the money that you can contribute into an IRA is going to be gaining interest until that point at which you decide to begin making withdrawals. The more money you have gaining interest, the more you are going to have down the road.

A hypothetical example, but one that is very similar to cases I encounter regularly is the following.

The client retires with $100,000 in his 401(K) or 403(b) but does not wish to use that money as income yet, either because the spouse is still working or because the client is planning on continuing to work in some other capacity. If that $100,000 is rolled over into a variable annuity with a guaranteed 8% rider and is kept there for 10 years on a tax deferred basis, assuming the client is in the 25% tax bracket and does not make any further monthly contributions, it will become:

$191,473 after taxes, compared to only, $181,940 in a taxable investment.

Income

Also realize that, more than likely, in retirement you are going to have a lower income; since you will not be working and will have your house and cars paid off. Thus, at this point, you will fall into a lower tax bracket, meaning you will ultimately pay a lower percentage on your money overall.