Yep, you read the headline correctly - - accumulating assets has consequences - - and sometimes they’re more burdensome than you might have previously considered!
While preparing for retirement, many of us focus on the top-line gross account value(s) we’ve saved. However, the real number that controls what we can truly spend is more importantly known as a “net amount.” In other words, the final amount after income TAXES have been paid.
Everyone likes the idea of a large savings nest egg and comfortable retirement. Consider however the more post-tax money we desire to spend or use for our goals, the greater the ratio of taxation we’ll need to plan for, thanks to our progressive income-tax system. This means that for every additional dollar we withdraw, we should anticipate having a greater percentage taken in taxation. This makes large withdrawals very expensive because you may need to draw down considerably more income just to foot the tax bill.
In our experience, Career Law Enforcement professionals often find themselves with up to 3 or 4 significant pools of money at the time of their retirement transition. We’ll categorize them as:
Sick, Annual, and Compensatory Leave Buyouts - - Generally fully taxable as earned income, whether you take it as a lump-sum payout into your bank account at the time of retirement, including when you delay retirement by any method of “burning hours.” We would encourage you to think twice about burning leave in this manner because in a very rudimentary way of looking at this - - delaying your pension also results in you collecting fewer pension payments over your lifetime.
If your buyout is distributed to you, it often happens around the time of your final normal pre-retirement paycheck, and you will likely experience a very significant tax withholding as a result (also normal and customary). You may be able to reduce your taxable buyout amount by strategically deferring funds pre-tax into your 457b or other pre-tax deferred compensation plans, also a great way to play a bit of catch-up on your retirement.
Deferred Comp (457b, 401a, 403b, 401k and / or Thrift Savings) - - While usually given the option to save pre-tax or post-tax Roth with most employers, we commonly see participants making pre-tax contributions to these accounts, often not knowing they may have had other choices. The chief benefit of a pre-tax savings strategy is lowering your taxable income via payroll deferrals in the year contributions are made. Unless you’ve selected the post-tax Roth option, these accounts are to be considered fully taxable as income when funds are withdrawn; therefore, pre-planning is advised to avoid creating an unnecessarily high income-tax bill. As a side note, any employer additions such as a matching contribution are also made pre-tax by your employer, therefore fully taxable when you go to withdraw these dollars for use in retirement.
Most plans do allow age 50+ catch-up contributions and some plans, 457 specifically, have had tax code provisions that can allow for increased deferrals shortly before retirement. Leveraged tactfully, this pre-tax deferral of additional income could work to your advantage with lump-sum retirement payouts, as the year of retirement can often be the highest income year.
DROP or Pension Lump Sum distributions - - Not all agencies support DROP or withdrawal of Pension Lump Sums, however, because of the sometimes-sizeable accumulations, we see an important opportunity for future planning in households eligible for this benefit. What is the biggest pitfall to avoid? For most, it is the accelerated distribution of pre-tax dollars, such as paying cash for that vacation home, fancy truck, or the sports car of our dreams. A byproduct of such spending is the likelihood of pushing oneself into a much higher effective income tax rate and spending down our savings too early in life.
If you’re thinking all of this is boring tax talk, you might have missed the bigger picture. Creating wealth through the mindful accumulation of assets has many benefits, most importantly in the form of having “choices” throughout our retirement years. This a luxury many others in our society may not get to enjoy but reaping the rewards means we need to be savvy about how we save, the tools we incorporate into our strategy, and recognize the taxation we’re subject to when processing withdrawals.
“Figuratively, saving money is the easy part anyone can do with a little discipline, but creating a comprehensive financial plan - - which incorporates the spend-down of accumulated assets in retirement - - requires a trained eye and specialized knowledge.”
Because the retirement transition is full of pitfalls and technical details, not to mention irrevocable decisions, we encourage everyone closing in on retirement eligibility to start planning now. Our team has developed tools and checklists to help take the uncertainty out of the police retirement decision-making process. We live (and love) this stuff… So, let’s make a plan together!
Lindenberg Financial, Inc. is an independent financial advisory business that has dedicated itself to serving Career Law Enforcement Professionals and their families. We help strategically plan for your future and thoughtfully assist in living out your best lives - - wherever and however money is involved.
To us, your money is as important as your health. Because results matter, we believe having us at your side with decisions surrounding your life’s savings is like having a personal fitness trainer at your side in the gym when you’re working out.