So You Want to be a Millionaire!

Though most advisers accept that a goal-oriented cash flow approach is the best way to determine your readiness for retirement, some people still look for their “number” – a metric made popular by ING commercials back in 2010.  You know, the dollar amount that is saved somewhere that guarantees sunny days and margaritas on the beach during retirement. 

Most of the time, this hypothetical “number” is never adjusted for the dreaded “deferred tax liability.”  Let’s see how this works and can impact your retirement readiness.

Let’s say you have $1,000,000 saved in two equal buckets; one tax-deferred and one taxable, each with $500,000.  Let’s also assume you grew each account by saving $5,000 per year for 25 years and earned a bit over 10% on your investment portfolios.


The benefits of compound interest are immense (see chart), since each account would have unrealized gains equal to about $375,000 on cumulative deposits of $125,000 to total $500,000.

For the taxable account, if we assume a 15% Federal long-term capital gains rate and a 5% state tax rate, the deferred tax liability is simply $375,000 * (0.15+0.05) = $75,000.  The trouble gets bigger for the tax-deferred account, since the whole account is taxed at your ordinary income rate.  Assuming a 22% tax bracket and a 5% state tax rate the deferred tax liability is $500,000 * (0.22+0.05) = $135,000!

So, you may have $1,000,000, but your total $210,000 deferred tax liability takes a big bite out of the glowing aura! Goal-oriented cash flow investment modeling software does a good job adjusting for this and is a much better way to evaluate your retirement readiness.