Author Archives: fitaxguy

Future Tax Hikes On Retirees

In this post, I offer a brief response to a recent thoughtful Reddit post. Credit to the poster for putting his or her views out there in an organized fashion and continuing the discourse.

The poster is concerned about one of the predictions Cody Garrett and I make in the book Tax Planning To and Through Early Retirement. The prediction, oversimplified, is that current readers of the book are unlikely to experience significant tax hikes in retirement.

Below I present the gist of the poster’s comments and then two brief responses. Note that I speak only for myself in this post. I do not speak for my co-author Cody Garrett.

The Reddit Post

If you are not on Reddit, I offer below a bullet point summary of the post’s highlights. I invite you to read the post for yourself.

The poster acknowledges that in December 2023 I correctly predicted that “temporary” tax cuts set to expire at the end of 2025 would not expire. You can listen to the prediction timestamped here.
The poster is quite concerned with the book’s prediction that taxes are not likely to go up on retirees.
The poster believes it is problematic that the book’s historical analysis is limited to 10 years (2015 through publication).
The post cites the 1983 law change that made Social Security potentially up to 50 percent taxable as a tax hike on retirees that had little adverse effects on the politicians who enacted it. Ronald Reagan was famously reelected in 1984 and won 49 states after signing a tax hike on retirees. Doesn’t the 1983 tax hike and the 1984 election result cast doubt on the analysis in Tax Planning To and Through Early Retirement?

Response: Taxes on Retirees Are Unlikely to Significantly Increase Anytime Soon

I have two brief responses to share. They boil down to (A) the comparison to 1983 supports rather than refutes the book’s argument and (B) the 10 year window in the book helps refute the hypothesis that increasing federal debts and deficits are highly likely to result in increased taxes on retirees.

The World, and More Importantly, the Electorate, Have Changed Since 1983

The poster’s invocation of the 1983 tax hike on retirees supports Cody’s and my arguments in the book much more than it supports the hypothesis that taxes on retirees are likely to increase significantly in the near future.

The 1983 tax increase on retirees was relatively modest. It only subjected up to 50 percent of Social Security benefits to income taxation. Further, it only kicked in at certain levels of income, blunting the impact for many retirees.

Much more importantly, let’s compare the electorate in 1984 to today’s electorate.

According to this research, in 1984 42 percent of the electorate was aged 50 and older.

According to this research, in 2024 58 percent of the electorate was aged 50 and older.

In political terms, this shift is a tidal wave. If 2024 is Earth, 1984 might as well be Mars or Venus, at least when it comes to American politics.

To further the point, recent research indicates that the average age of primary voters is 57 and the median age of primary voters is 59. See page 12 of the linked-to research.

Politicians respond to incentives. They don’t respond to fears promoted by big names in the financial industry.

What about an aging electorate in both primaries and general elections screams “Taxes are going up on retirees!”?

Lastly, the poster’s contention that 1983’s tax hike on retirees is somewhat instructive runs up against a wall just 10 years later.

In 1993 Bill Clinton and a Democrat Congress further increased the taxes on Social Security, subjecting up to 85 percent of Social Security benefits to income taxation. A year later the Republicans took back both Houses of Congress in a historic mid-term election wipeout.

I was in high school at the time. I remember that there were other factors at play. But it is interesting to see that the politicians’ behavior seems to have changed since the mid-1990s. It’s hard to find a significant tax hike on retirees since then.

Perhaps the politicians learned a lesson from the ‘93 Social Security tax increase that stuck.

Hypotheses That Repeatedly Fail When Tested Against Real World Conditions Should Be Strongly Doubted

We have heard it for years: Taxes are going up on retirees because of rising federal government debts and deficits.

That’s a contention that is easily tested, but only if real world conditions feature increasing federal government debts and deficits.

Fortunately, we have a 10 year window that is ripe with increasing federal debts and deficits: 2015 to the publication of Tax Planning To and Through Early Retirement in 2025.

As cited in the book, on September 30, 2014, the federal debt was approximately $17.8 trillion. As I write today, the federal debt is approximately $40 trillion.

Thus, one would expect that in the past decade, a decade featuring more than a doubling of the enormous federal debt, Washington politicians enacted numerous tax hikes on retirees if the hypothesis that increasing federal debts and deficits trigger tax hikes on retirees is highly valid.

Real world experience reveals the exact opposite.

During the past decade we have seen tax cut after tax cut for retirees. There were so many tax cuts for retirees during the past decade that we used a summary table instead of in-line narrative to describe them to avoid boring our readers and reduce printing costs 😉

Our book’s analysis selected a time frame that should have played right into the Reddit poster’s concern. The real world conditions were perfect for the concern to have materialized. Not only did the concern, tax hikes on retirees, not materialize–the opposite materialized.

At some point, we have to question the commentators who continuously predict tax hikes on retirees when real world outcomes point in the opposite direction.

The Reddit post states that the book’s “limiting the look-back window to 10 years of tax policy is a problem.” However the book does not limit the look-back window to 10 years. On page 240, the book discusses a retiree tax cut passed by Republicans in 2003 and draws a lesson from the 2008 Democrat election sweep not resulting in repeal even though the Democrats had commanding majorities and the Presidency in 2009. A tax planning book cannot be a tax history treatise. But my view is that the historical data Cody and I present is accurate and relevant in planning.

Conclusion

My prediction is that politicians will continue to act in the politicians’ own best interests.

I offer this post to reason through an often stated concern about taxes on retirees in the future. The above predicts likely outcomes. There are no guarantees when it comes to future tax rates on retirees. But there are the lessons of logic, reason, incentives, and history.

My view is that the most likely outcome for those thinking about retirement planning in 2026 is a future with little in the way of significant tax increases on retirees. Frankly, we’re at the point that some tax increases would not make up for the decade of continuous tax cuts for retirees. Nevertheless, I believe the most likely outcome for those thinking about taxes in retirement in the year 2026 is a future tax environment that looks similar to the very retiree-friendly tax environment we have today.

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on LinkedIn: @SeanWMullaney

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.

The Best Tax Deduction

Ed Slott says traditional 401(k) tax deductions aren’t real tax deductions. He claims that traditional 401(k) deductions are not real deductions because the deducted amount and future growth must ultimately be taxed at a later date.

My view is different. Not only do I believe traditional 401(k) tax deductions are real tax deductions, I go further. I believe that traditional 401(k) tax deductions are the best tax deductions!

Keep reading to find out why.

A Brief Note on Terminology

Before we proceed, I and other financial advisors often use the term “deduction” when the more technically appropriate term is “exclusion.” At W-2 jobs, employee contributions to traditional 401(k)s (and traditional 403(b)s, 457s, and SIMPLE IRAs) are not deducted from taxable income. Rather, they are excluded from W-2 income. There’s no “deduction” to take. Rather, W-2 income is reduced because the contribution to the traditional 401(k) is excluded from W-2 income (see Box 1 of Form W-2).

Nevertheless, I believe that it is appropriate to use “deduction” as a colloquialism for the tax effect of a traditional 401(k) contribution. From a planning perspective, there’s no real difference between an exclusion and a deduction that reduces adjusted gross income. Further, those not in the personal finance industry might be confused by the term “exclusion” but tend to understand the meaning of “deduction.”

Note that for Schedule C solopreneurs, employee traditional Solo 401(k) contributions and traditional SIMPLE IRA employee contributions are deducted on a tax return on line 16 of Schedule 1. Self-employed employee contributions are not excluded from Schedule C income.

Comparing and Contrasting Tax Deductions

Let’s consider the three most common itemized deductions.

Home mortgage interest is paid to the bank
State and local taxes are paid to state and local governments
Charitable contributions are paid to charities

Yes, the person gets a tax deduction. But they don’t get to keep the money! The bank, a charity, or a government keeps the money.

This is generally true of business deductions as well. People talk about “bonus depreciation” but all that means is the timing of the tax deduction is more advantageous. The vendor or contractor still got the money!

What about the deduction into the traditional 401(k)?

You get to keep the money! Yes, the money legally goes into a 401(k) plan. But later in life, perhaps not that much later in life, the money and its growth is yours!

To my mind, the best deductions are the ones I keep! That is much better than the bank or the county government getting the money. I favor deductions I keep even if I have to later include that amount and its growth in taxable income.

I like myself more than I like the bank!

No offense to the bankers reading this.

Do You Get to Enjoy All the Money in a Traditional 401(k)?

You might be reading this and thinking:

Wait a minute, Sean. There’s no way I will ever personally spend every last penny of a multimillion dollar retirement account. I won’t “Die with Zero.” How then do I ‘get to keep’ the amount I deducted into the traditional 401(k)?

You are correct in terms of actual spending. Will every last penny of your traditional 401(k) go to upgrade you and/or your spouse to a junior suite at the Fairfield by Marriott?

No.

But I contend you get to benefit from every last penny in that traditional 401(k) to a greater extent than buying hotel room upgrades.

Every last penny in your traditional 401(k) supports you as you make the most important financial decisions.

When you are considering when to retire, what do you look at? One of the most important numbers is the amount in your traditional 401(k). The greater that number, the more likely you are to be able to decide to retire.

Without spending a penny of your traditional 401(k) balance, your entire traditional 401(k) balance benefits you when making one of the most important financial decisions you’ll ever make–the decision to retire!

Compare the deduction that can help you make a positive retirement decision to the deduction paid to the bank, paid to the state government, or paid to charity. Outside of a paid off home supporting a positive retirement decision, those deductions have no value to you when you’re looking at your current wealth and trying to make a retirement decision.

Deferring Tends to Reduce Both Tax Rate and Tax Impact

Now you might be thinking:

Sean, sure, your traditional 401(k) balance helps you achieve retirement and other financial goals. But don’t you pay more in taxes by deferring?

For the vast majority of Americans, deferring is the key to reducing taxes. It’s the Pay Tax When You Pay Less Tax concept Cody Garrett, CFP(R) and I discuss in our book Tax Planning To and Through Early Retirement.

Americans tend to pay income taxes at their highest lifetime rates during their working careers. Retirement tends to be accompanied by significant tax cuts. Said differently, retirement tends to be a great time to pay tax because it’s the time most Americans, even most affluent Americans, pay less tax.

On my YouTube channel, I’ve demonstrated that retirees, even very affluent retirees, tend to be lightly taxed. See, for example, a 60 year old retired couple, an 80 year old with RMDs on a $500,000 traditional IRA, an 81 year old widow with RMDs on a $1 million traditional IRA, and an 80 year old married couple with RMDs on a $2 million traditional IRA.

Thus, deduction for traditional 401(k) contributions tends to reduce lifetime taxes. The deduction often enjoys a tax rate benefit greater than the tax rate paid on traditional retirement account distributions in retirement.

Impact of Tax Paid

Outside of unique situations, you or your heirs have to pay tax on retirement account contributions. That tax is paid during one’s career if they choose Roth 401(k) contributions. That tax is generally paid during retirement if one chooses traditional 401(k) contributions. Traditional 401(k) contributions are also likely to trigger some tax paid by beneficiaries after the original owner’s death.

The tax has to be paid (well, it has to be paid in most but not all cases — for example, see these exceptions). When is paying that tax most impactful?

Traditional 401(k) contributions tend to blunt the impact of taxes paid. It gives workers a tax deduction when they need it most: before they’ve accumulated sufficient assets for financial independence or retirement and perhaps when they are paying off their mortgage and feeding their kids.

Compare that to the profile of affluent retirees in their 70s or 80s. These are people who have met their financial goals. Yes, they pay taxes on RMDs. But those taxes have much less impact on the successful retiree’s lived experience than the taxes saved have on a 30-something or 40-something worker trying to pay off the mortgage, build up retirement savings, and possibly feed some kids.

The person electing to pay taxes later in life, which is what a traditional 401(k) contribution does and what avoiding a taxable Roth conversion in one’s 50s or 60s does, elects to pay taxes when taxes are least detrimental–in old age.

In old age either the person will be only moderately financially successful (or worse) and thus will likely have very little in the way of federal income tax, or the person will be very financially successful and any federal income tax is too late to derail their financial success or materially impact their lived experience.

Is it better for your 30- or 40-something self to pay taxes or is it better for your 80-something self to pay taxes?

When our heirs pay tax on our traditional retirement accounts, they pay tax on a windfall. Regardless, they are still the beneficiaries of a windfall, making it unlikely that taxes on the windfall will derail their financial future.

Conclusion

My opinion is the best tax deduction is the one I keep and the one most likely to lower my lifetime tax burden. That’s the contribution to a traditional 401(k) at work.

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on LinkedIn at @SeanWMullaney

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, legal, investment, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.

The Quirky Roth IRA MAGI Rule and In-Plan Roth Conversions

As much as I might not want to admit it, I’m a sucker for complicated tax technical issues. See my writings here and here.

Recently an odd issue has come up: does income created by an in-plan Roth conversion count as modified adjusted gross income for purposes of determining eligibility to make an annual Roth IRA contribution?

What follows below is simply one practitioner’s views on a somewhat ambiguous technical tax issue. It is not financial, legal, or tax advice for you or anyone else.

Issue

The ability to make an annual contribution to a Roth IRA is limited or eliminated at certain levels of “modified adjusted gross income” (MAGI). For example, in 2026 those married filing jointly with MAGI of $252,000 or more are unable to make a 2026 contribution to a Roth IRA.

There is an odd rule: Roth IRA conversion income does not count as MAGI for purposes of determining whether a person has income low enough to make an annual contribution to a Roth IRA. See Section 408A(c)(3)(B)(i).

Why is this rule the rule? It is counterintuitive considering that if a person simply distributes money from a traditional IRA or a traditional 401(k) to themselves, that income is included in MAGI for purposes of determining whether income is low enough to make an annual contribution to a Roth IRA.

The rule has a purpose, which I wrote about back in 2022. In 1997, when Congress first created Roth IRAs, it had to define MAGI for two purposes. First was the eligibility to make an annual Roth IRA contribution. Second was the eligibility to do a Roth conversion. Back then Roth conversions were limited only to those with MAGI not exceeding $100,000. See page 39 of this file.

Congress chose to create only one MAGI definition for these two purposes. Since that MAGI definition policed Roth conversions, Congress had to avoid creating a circular calculation issue. If MAGI included income created by Roth conversions, Roth conversions could disqualify themselves.

A person with $90,000 of other AGI doing any Roth conversion over $10,000 would suddenly be ineligible to have done any Roth conversion by going over the $100,000 MAGI limit if Roth conversions were tested against themselves. Thus, Congress excluded Roth conversion income from the definition to avoid the circular calculation issue.

While entirely rational, that choice had an interesting lingering effect: Roth conversion income does not count when determining MAGI for purposes of determining whether a person can make an annual Roth IRA contribution.

In-Plan Roth Conversions

The Economic and Growth Tax Relief Reconciliation Act of 2001 first introduced the concept of a Roth 401(k). See Section 402A as originally enacted on page 66 of this file.

It was not until 2010 that the Small Business Jobs Act of 2010 introduced the concept of an “in-plan Roth conversion” i.e., converting an amount in a traditional 401(k) to a Roth 401(k) in a taxable transaction akin to a Roth IRA conversion. See page 63 of this file.

So the question emerges: If we exclude Roth IRA conversion income from the annual Roth IRA contribution definition, do we also exclude in-plan Roth conversion income from the definition?

Relevant Authorities

Section 408A established the Roth IRA in 1997, first effective in 1998. In that law, Congress defined MAGI for Roth IRA annual contribution eligibility purposes as MAGI as defined by Section 219(g)(3) except that any income created by a taxable Roth IRA conversion is not included in MAGI. See Section 408A(c)(3)(B)(i).

A Roth IRA conversion is taxable under Section 408A(d)(3)(A)(i).

In 1999, the IRS and Treasury published final regulations governing Roth IRAs.

Treas. Reg. Section 1.408A-3 Q&A 5 states that:

[M]odified AGI is the same as adjusted gross income under section 219(g)(3)(A) (used to determine the amount of deductible contributions that can be made to a traditional IRA by an individual who is an active participant in an employer-sponsored retirement plan), except that any conversion is disregarded in determining modified AGI. (emphasis added)

It’s not immediately clear what this regulation means by “conversion.” To determine what “conversion” means as used in Treas. Reg. Section 1.408A-3, we need to look to Treas. Reg. Section 1.408A-8(b)(2), which defines “conversion” for purposes of the Roth IRA regulations. That definition states:

The term conversion means a transaction satisfying the requirements of § 1.408A-4 A-1.

Now we have to look at Treas. Reg. Section 1.408A-4 Q&A 1. It defines a conversion as a transfer from a traditional IRA to a Roth IRA. Note that this regulation has never been updated for the 2006 law change allowing Roth IRA conversions from qualified plans such as traditional 401(k)s directly to Roth IRAs.

Section 402A, enacted in 2001, first created the Roth 401(k).

In 2006, the Pension Protection Act allowed Roth IRA conversions directly from qualified plans such as traditional 401(k)s. See Section 824 of the Pension Protection Act of 2006.

Congress enacted Section 402A(c)(4)(A), which allows for taxable in-plan Roth conversions, in 2010.

Notably, nothing in the Small Business Jobs Act of 2010 changed Section 408A, the statute governing Roth IRAs, including the MAGI limit on the ability to make annual Roth IRA contributions.

Today, IRS Publication 590-A has Worksheet 2-1, which computes MAGI for Roth IRA annual contribution purposes. Line 2 of that subtracts from “adjusted gross income” any Roth IRA conversion coming from an IRA and any Roth IRA conversion coming from a qualified retirement plan (such as a traditional 401(k). Nothing in that worksheet subtracts in-plan Roth conversion from adjusted gross income. It is important to note that IRS Publications are not authority binding on the IRS and/or taxpayers and cannot be cited as authority.

In-Plan Roth Conversions and the Roth IRA Annual Contribution MAGI Limit

My view is that income created by in-plan Roth conversions should be included in MAGI for purposes of determining whether a person can make an annual Roth IRA contribution.

In 1997, Congress said to use the IRA MAGI definition (Section 219(g)(3)) but kick out income created under Section 408(d)(3), which is Roth IRA conversion income. See Section 408A(c)(3)(B)(i). Income created by an in-plan Roth conversion is not created by Section 408(d)(3) but rather it is created by Section 402A(c)(4)(A).

In-plan Roth conversion income could not have been kicked out of the 1997 MAGI definition because it did not exist in 1997 to be kicked out of the MAGI definition!

No subsequent development kicks out in-plan Roth conversion income, or any other income, from the Roth IRA MAGI definition. The 1999 final regulations do not do so.Those regulations define the conversion income to be kicked out as income created by a transfer to a Roth IRA. Thus, the 1999 final regulations do not kick in-plan Roth conversion income out of the definition of MAGI for annual Roth IRA eligibility determination purposes.

In 2010, Congress created a new type of income: in-plan Roth conversion income. That income is part of all AGI and MAGI determinations unless Congress decides to exclude it from MAGI for any particular purpose. If Congress did not want that new type of income to count as MAGI for annual Roth IRA contribution purposes, it could have concurrently amended the Roth IRA statute in 2010. Congress chose not to.

Further, there is no compelling reason to kick out in-plan Roth conversion income from the definition of MAGI for annual Roth IRA contribution limitation purposes. Remember, there are essentially two reasons Roth IRA conversion income was kicked out in 1997.

First, in 1997 Congress decided to economize when it came to Section 408A MAGI definitions. It could have created two new MAGI definitions (one for testing annual contributions and one for testing Roth IRA conversions) but it took the economical path and simply created a single definition.

Second, Congress did not want to create a circular calculation definition. As applied to Roth IRA conversions, it would be highly problematic to test Roth conversions against themselves.

When we combine these two reasons, we see why Roth IRA conversion income is kicked out of MAGI for purposes of determining Roth IRA annual contribution eligibility. Neither of these two reasons (separate or together) apply when considering whether in-plan Roth conversion income needs to be excluded from MAGI to determine Roth IRA annual contribution eligibility.

Planning

The in-plan Roth conversion issue rarely comes up when considering annual Roth IRA contribution MAGI. Why?

As I discussed on an episode of the ChooseFI podcast, our working years tend to be a bad time to do taxable Roth conversions! Having a full time job tends to be a great indicator that a taxable Roth conversion is not advantageous. Note that a “backdoor” Roth conversion is entirely distinct from a “taxable Roth conversion” and something I tend to favor if the profile is right and the cash flow is adequate.

Thus, the issue addressed in this blog should not hit most workers’ planning radar. But I also know that not everyone agrees with me on the advantageousness of taxable Roth conversions during one’s working career. So the issue will arise from time to time.

Conclusion

My view is that in-plan Roth conversion income, unlike Roth IRA conversion income, is not kicked out of MAGI for purposes of determining eligibility to make an annual Roth IRA contribution. Of course, this post is simply one practitioner’s view. It is not advice for you, your situation, or anyone else.

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on LinkedIn at @SeanWMullaney

The Roth Conversion Windfall Problem

People worry about taxes on traditional retirement accounts.

During the owner’s lifetime, those worries are largely unfounded. On my YouTube channel I’ve demonstrated that even those with surprisingly large traditional IRAs are likely to pay modest effective tax rates during their own retirements.

Spreadsheets tell us the chances we will pay high taxes on our own traditional retirement accounts are rather low.

Inherited Traditional IRA Tax Concern

Spreadsheets also tell us that in many, though certainly not all, cases, our heirs are likely to pay a higher tax rate on our retirement accounts than we will.

Picture an 80 year old retired married couple. In order for a dollar of their required minimum distribution (RMD) to be subject to a 24% federal income tax rate, their taxable income in 2026 would need to be at least $211,401. In order for a dollar of their RMD to be subject to a 32% federal income tax rate, their taxable income would need to be at least $403,551.

In a world with a high standard deduction, an additional standard deduction, a senior deduction, and qualified charitable distributions, these levels of taxable income are relatively uncommon for married retirees.

During the owner’s life, RMDs go on top of Social Security income and investment income such as interest income. RMD percentages are quite modest. For those 75, the required distribution is only approximately 4.07 percent of the prior year-end account balance. It rises to 4.95 percent at age 80 and 6.25 percent at age 85.

For those inheriting traditional IRAs (beneficiaries), high levels of taxable income are more common. With inherited IRA distributions over the 10 year window on top of W-2 salary and bonuses, it is very possible Junior will pay tax rates on Mom and Dad’s IRAs in excess of the tax rates Mom & Dad paid on their RMDs.

For the beneficiary, in most years the inherited IRA distribution is likely to be 10 percent or more of the inherited IRA starting balance to smooth out the taxes paid over the 10 year window.

The Inherited Traditional IRA Concern Remedy

The potential remedy for the inherited IRA concern is easy: Roth conversions during the owners’ lifetimes.

On a spreadsheet we can easily justify this remedy. Perhaps Mom and Dad would pay a 22 percent marginal statutory federal rate on Roth conversions. Such conversions might reduce their senior deduction, increasing the effective federal income tax on the conversions from 22 percent to 24.64.

The potential 2.64 percent “surtax” is created by every dollar of Roth conversion reducing the senior deduction by 12 cents on the dollar. Multiplying 12 cents on the dollar by a 22 percent statutory rate gets us to 2.64 percent.

Imagine Mom and Dad’s adult children all pay a marginal tax rate of 32 percent. Mom and Dad doing Roth conversions at a 24.64 percent effective tax rate would, intergenerationally, save the family 7.36 cents on the dollar in federal income taxes (32 minus 24.64).

Thus, assuming relatively high income beneficiaries, the spreadsheet says “Yes” when it comes to owner Roth conversions for the beneficiary’s benefit.

The Windfall Problem with Roth Conversions

Spreadsheets are great. But they should be ignored if following them disregards common sense.

Those using spreadsheets to argue Roth conversions are necessary to avoid higher beneficiary taxes on inherited IRAs argue that retirees not experiencing a financial windfall should pay more in taxes to benefit future beneficiaries experiencing a financial windfall.

Spreadsheets matter in financial planning.

Personal profiles matter much more.

Financial planning should ask “who benefits?” and, generally speaking, steer benefits to those in the family in most need of them. Adult children beneficiaries enjoying a financial windfall tend to need much less in financial benefits than those not enjoying a financial windfall.

Retirees funding their living expenses from their IRAs and 401(k)s are living off their own assets. Retirement accounts are not a windfall to them. Rather, those accounts are their deferred career earnings and growth thereon.

Inherited retirement accounts are a financial windfall for beneficiaries. They stack on top of other resources, including W-2 income and the beneficiary’s own accumulated financial wealth.

Why should someone not enjoying a financial windfall do financial planning for the benefit of someone enjoying a financial windfall?

Why should retirees pay additional taxes for the future benefit of their adult children who will receive a financial windfall?

This is not to say wealthy, elderly parents should not do Roth conversions to benefit their adult children as future retirement account beneficiaries. It is to say Roth conversions for the benefit of adult children who will experience a financial windfall are not necessary.

I am not opposed to some wealthy retirees making a value judgment that intergenerational tax arbitrage is desirable. For those making such a value judgment who can afford to pay the taxes, great, do Roth conversions for the benefit of the next generation.

But to say such planning is necessary ignores the reality that Roth conversions done for the benefit of the next generation require sacrifice by those not enjoying a financial windfall for the benefit of those who will enjoy a financial windfall.

Extra Note: You might be asking, “But Sean, what about my ne’er-do-well adult child? Shouldn’t I do Roth conversions for their benefit? They will need my retirement account.” The odds are very good that the ne’er-do-well beneficiary would pay a low tax on the retirement account, since they have little other income. A parent’s Roth conversion might hurt the beneficiary by increasing rather than decreasing the effective tax rate on the parent’s retirement account and reducing the amount of taxable assets the ne’er-do-well beneficiary inherits, since some of the parents’ taxable assets are used to pay the income taxes on what might ultimately be inefficient Roth conversions from an intergenerational perspective.

Conclusion

Those arguing Roth conversions to reduce taxes on inherited traditional retirement accounts are desirable ignore the Roth conversion windfall problem. It is illogical to say that those not enjoying a financial windfall need to pay more tax for the benefit of those enjoying a financial windfall.

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on LinkedIn at @SeanWMullaney

Roth IRA Distributions in Early Retirement

I recently presented “Back to the Future: Is Your FI Journey Stuck in 2017” for the ChooseFI Los Angeles chapter–coming soon to the San Diego ChooseFI chapter!

It struck me that back in 2017, most in the Financial Independence community would have said “let that Roth IRA grow tax free for as long as possible!”

Is that wise in 2026?

I believe that for some early retirees, spending Roth IRAs in early retirement may be the optimal path. Cody Garrett explored this in our recent book, Tax Planning To and Through Early Retirement.

I figure it is good to explore this topic in additional depth on my blog. An example will illustrate just how powerful Roth IRA withdrawals can be for some early retirees.

Funding Year-End Expenses in Early Retirement

Picture Linus and Sally. Both turn 58 in 2026. They are retired, live in San Diego, California, and have no dependents. Linus and Sally are on the “Second Lowest Cost Silver Plan” all year as their ACA medical insurance.

Through November 2026 they fund their living expenses by selling mutual funds in their taxable account. These sales, through November, have triggered $70,000 of capital gains. They also estimate that by the end of the year they will have $10,000 of total interest and dividend income.

Linus and Sally need $10,000 to fund their December living expenses. They are considering two options for getting that $10,000 from their portfolio.

Option 1 is selling $10,000 of mutual funds taxable accounts. This sale would trigger a $6,000 long-term capital gain.

Option 2 is withdrawing $10,000 from one of their Roth IRAs. Due to having previously made annual contributions to Roth IRAs (and/or having done the Backdoor Roth IRA), they have plenty of accessible Roth IRA basis such that the $10,000 withdrawal would be entirely tax and penalty free.

Which option should Linus and Sally choose to fund their December expenses?

The Premium Tax Credit

Linus and Sally are subject to three “taxes” that function like an income tax. They are:

Federal income tax
California state income tax
Premium Tax Credit

To be clear, the Premium Tax Credit is not a tax. Rather, it is a mechanism to run a personal expense (medical insurance premiums) through the Internal Revenue Code.

As a result, the Premium Tax Credit behaves very much like an income tax.

However, there is one feature of the Premium Tax Credit that we must consider in additional detail: the 400% of federal poverty level cliff.

For Americans with income from 138 percent of the federal poverty level up to and through 400% of the federal poverty level, the Premium Tax Credit functions largely like an income tax. As income rises, the Premium Tax Credit is ratably and progressively reduced. However, the second one has income a dollar more than 400 percent of the federal poverty level, the Premium Tax Credit plunges (goes off the cliff) to $0.

For a married couple, this could easily mean the loss of over $10,000 of Premium Tax Credits.

The 2026 return of the 400% of federal poverty level cliff means that Roth IRA withdrawals in early retirement are more important than ever!

Roth IRA Distributions and the Premium Tax Credit

Let’s explore the results when Linus and Sally pursue Option 1. This funds their December expenses with the sale of $10,000 of brokerage account mutual funds. It trips a capital gain of $6,000.

After this capital gain, Linus and Sally have an adjusted gross income (and MAGI) of $86,000, consisting of $70,000 of prior capital gains, $10,000 of interest and dividends, and the December capital gain of $6,000.

At $86,000 of MAGI, Linus and Sally qualify for no Premium Tax Credit, as their MAGI is 407 percent of the federal poverty level.

If, instead, Linus and Sally fund their December living expenses with a $10,000 Roth IRA distribution, their adjusted gross income and their MAGI is $80,000 ($70,000 of capital gains plus $10,000 of interest and dividends). This leaves their income at 378 percent of the federal poverty level.

At this level of income, Linus and Sally qualify for a $15,469 Premium Tax Credit.

Roth Distribution Optimization

Option 2 is a Roth Distribution optimization play.

In Linus and Sally’s 70s and 80s, it may be the case that a Roth distribution avoids a 24% or 32% federal income tax. That’s a good Roth distribution outcome.

But the $10,000 December Roth IRA distribution in 2026 avoids an effective federal tax of 257.82 percent!

Isn’t that the best time to take a Roth distribution?

Maximizing Premium Tax Credits with Roth IRA Distributions

It’s time to start thinking about ways to optimize Roth distributions. Enrollment in an ACA medical insurance plan may be the time to optimize Roth IRA distributions. ACA enrollees are subject to potential federal and state income taxes and potential diminution of the Premium Tax Credit.

What makes the diminution of the Premium Tax Credit issue particularly compelling in 2026 and beyond is the return of the 400 percent of federal poverty level cliff for Premium Tax Credits.

For many of those retired prior to age 65, controlling income to avoid the 400 percent of federal poverty level cliff has become a compelling planning objective. Going off the cliff can easily cost a married retired couple $10,000 or more in Premium Tax Credits.

Having a tax free source to draw upon for living expenses in the early stages of an early retirement might be much more important than having a tax free source to draw upon later in retirement, as Linus and Sally’s example illustrates.

Additional Resources

The taxation of “early” Roth IRA distributions tends to be very favorable. I blogged about the tax treatment of Roth IRA distributions in these two articles.

Roth IRA Withdrawals

The Taxation of Roth IRA Distributions

Conclusion

Who doesn’t love a large tax free balance in a Roth IRA? Nevertheless, it is important to remember that balance exists to support retirees.

For many retirees, particularly those on an ACA medical insurance plan, the Roth IRA may best support them in the early part of their early retirement.

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on LinkedIn at @SeanWMullaney

Can You Find the Hidden Roth IRA?

Perhaps you have a Hidden Roth IRA.

You might be thinking “No way. I did not lose track of a Roth IRA!”

The Hidden Roth IRA is not a lost retirement account.

Rather, the Hidden Roth IRA is a Roth IRA that hides inside traditional IRAs and traditional 401(k)s.

How can a Roth IRA hide in a traditional retirement account? It turns out tax free distributions (essentially, a Roth IRA) from traditional retirement accounts occur more often than you would think.

This article searches for Hidden Roth IRAs. You’ll be surprised how often retirees can benefit from the Hidden Roth IRA.

The Standard Deduction and the Hidden Roth IRA

We live in an era of a rapidly growing standard deduction.

The standard deduction is to the Hidden Roth IRA what the flux capacitor is to time travel.

The standard deduction makes the Hidden Roth IRA possible!

Increasing the standard deduction, as the One Big Beautiful Bill did, greatly expanded the Hidden Roth IRA.

It gets even better. Through 2028, the senior deduction expands the Hidden Roth IRA for many age 65 and older. The new nonitemizers’ charitable deduction effectively increases the standard deduction by $1,000 per person for Americans with some charitable inclinations.

Senator Cory Booker has recently proposed a significant increase in the standard deduction which would help many retirees enjoy the benefits of the Hidden Roth IRA.

Golden Years Hidden Roth IRAs

The “prime time” of the Hidden Roth IRA is one’s mid-to-late 60s, particularly the 66th through 69th birthday years.

In today’s environment, a married couple in their mid-to-late 60s could take more than $45,000 annually from traditional IRAs and have the “taxable” income fully offset by the available standard deduction, additional standard deduction, senior deduction, and potentially the nonitemizers’ charitable deduction.

During the Golden Years, there are no required minimum distributions (RMDs). There’s no Premium Tax Credit on the table, so controlling income for PTC optimization is not a consideration. Further, Social Security can be delayed until age 70, resulting in increased annual payments, potentially reducing volatility in one’s 70s and 80s.

Yes, the Golden Years Hidden Roth IRA mostly or fully goes away once the couple claims Social Security. Social Security benefits are ordinary income that soak up the standard deduction and senior deduction, reducing or fully eliminating their ability to shield traditional IRA/401(k) distributions from federal income taxation. Nevertheless, for multiple years of one’s retirement well into five figures can come out of traditional IRAs as a tax free Hidden Roth IRA.

The Golden Years Hidden Roth IRA is the best Hidden Roth IRA, in my opinion. But it’s not the only Hidden Roth IRA.

72(t) Payment Plans and the Hidden Roth IRA

Some retirees will get a jump start on the Hidden Roth IRA. Early retirees starting a 72(t) payment plan naturally tend to get the benefit of the Hidden Roth IRA.

Prior to the One Big Beautiful Bill, I did a YouTube video about this concept using the then-current 2025 numbers. Even prior to the OBBB expansion of the standard deduction, a married couple on a 72(t) payment plan could have more than $25,000 a year in a Hidden Roth IRA.

72(t) payment planning naturally marries with the Hidden Roth IRA. In most cases, I strongly favor mostly or fully spending down taxable account assets prior to initiating a 72(t) payment plan. Having spent down the taxable assets, it’s difficult for early retirees to incur significant income other than the 72(t) payment itself.

This naturally clears the path for the 72(t) payment to enjoy the benefit of the Hidden Roth IRA. Those benefits can last for the better part of two decades in an extreme case such as the one posited in this YouTube video.

Married Couples Taking RMDs

In today’s environment, many taking RMDs will enjoy the Hidden Roth IRA. Why?

Most 70-something and 80-something’s main sources of income are Social Security and retirement account distributions.

Let’s consider average and median wealth and income statistics. The average monthly Social Security benefit, as of January 2026, is $2,071. Multiply that by 12 months and 2 spouses and you get $49,704 in Social Security per year.

Median retirement account balances for those 75 and older as of 2022 was just $130,000.

Let’s round up those numbers for an 80 year old couple, Sal and Sophia. Assume $70,000 in total Social Security, $2,000 of interest from an online savings account, and $24,752 in RMDs from $500,000 in traditional IRAs. That’s a retired couple well above Social Security average benefits and median retirement account balances.

Does this above-the-median married couple enjoy the benefits of the Hidden Roth IRA while taking RMDs?

You betcha!

How much?

Of that $24,752 RMD, $24,410 is a Hidden Roth IRA!

This YouTube video demonstrates how Sal and Sophia, with a half million traditional IRA, can have all or almost all of their RMD be tax free. That demonstrates the power of the Hidden Roth IRA.

I’ve found that it’s possible that a married couple taking RMDs on a $1 million traditional IRA could enjoy the benefit of a Hidden Roth IRA to a small degree in 2026. See this YouTube video for some numbers.

The Hidden Roth IRA is a real phenomenon for many Americans taking RMDs. Based on the Social Security and retirement account statistics, it is very possible the majority of married couples taking RMDs can benefit from the Hidden Roth IRA.

Singles and Widows Taking RMDs

The benefits of the Hidden Roth IRA are not reserved only for married retirees. Singles and widows can also benefit. This is true even for many single/widowed retirees with above average Social Security income and above median retirement account balances.

On my YouTube channel I discussed an 80 year old single person with a half million traditional IRA and $40,000 of annual Social Security income. She enjoyed the benefit of an $8,660 Hidden Roth IRA.

Yes, singles and widows tend to enjoy much less when it comes to the Hidden Roth IRA. But even those widows with above average Social Security and above median retirement account balances can enjoy a degree of Hidden Roth IRA benefits.

Inherited Traditional IRAs and the Hidden Roth IRA

One thing people fear is the taxes on inherited IRAs. The 10 year payout rule is viewed as a detriment to leaving heirs traditional IRAs. At first blush, taxing a large traditional IRA within 10 years seems to create a huge tax problem.

But will it really be a problem?

Consider many inheritors of large traditional IRAs. They themselves might already be retired or might decide to retire because of the large inheritance.

I ran through one such scenario on my YouTube channel. It may be the case that even a $2 million inherited traditional IRA could enjoy significant Hidden Roth IRA benefits for some or all of the 10 year payout window.

Implications of the Hidden Roth IRA

The Hidden Roth IRA has several important implications for financial planning.

All of the below tactics and considerations are offered as educational insights. They are not offered as advice for you or any other individual’s situation. There are times when retirees would wisely want to avoid the below tactics.

But, if all else is equal, in a general sense the Hidden Roth IRA makes the below tactics more appealing.

Spend Down Taxable Accounts First

The first is that spending down taxable accounts first in retirement is very attractive, particularly for the early retiree. Part of the reason the Hidden Roth IRA can be so significant is the lack of other income hitting one’s annual tax return.

Spending down taxable assets first has several advantages, including potentially setting up years of enjoying the Hidden Roth IRA later in retirement.

Limit Ordinary Income in Retirement

A second implication is it is desirable to limit ordinary income hitting tax returns in retirement. There are various ways to achieve this. For example, holding bonds in traditional retirement accounts takes bond interest income off our tax returns. Consideration should be given to rolling pensions into IRAs to reduce annual ordinary income payouts earlier in retirement.

Delay Social Security

Delaying claiming Social Security increases future monthly benefits. It also keeps Social Security income off one’s tax returns in their 60s, increasing the runway available to the Hidden Roth IRA.

RMDs are Not Harmful for Many Retirees

Consider Sal and Sophia. They are required to take a $24,752 RMD, almost all of which is tax free. A forced tax free distribution in one’s 70s or 80s is not harmful. Many Americans will enjoy the benefit of the Hidden Roth IRA on a portion of their RMDs.

Yes, many affluent retirees taking RMDs will not get the benefit of the Hidden Roth IRA. Even for them, RMDs tend not to be all that harmful.

Why would a couple like Sal and Sophia ever do a Roth conversion if most, if not all, of their RMDs while they are both alive benefit from the Hidden Roth IRA?

Resource

I’m aware of only one book that discusses the phenomenon of the Hidden Roth IRA. In Tax Planning To and Through Early Retirement, Cody Garrett and I discuss the Hidden Roth IRA in the context of drawdown planning.

Conclusion

Do you like Roths? If so, one of the best ways to have a Roth is to contribute to a traditional 401(k) at work. In retirement, some of that account may be distributed tax free as a Hidden Roth IRA.

Many Americans will enjoy the benefit of the Hidden Roth IRA. The Hidden Roth IRA hides inside “taxable” traditional retirement accounts such as IRAs and 401(k)s.

Planning such as spending taxable accounts first in retirement and reducing ordinary income hitting one’s tax return can increase the benefits of the Hidden Roth IRA.

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on LinkedIn: @SeanWMullaney

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.

Roth 401(k) vs Roth IRA

Many ask the question: should I contribute to a Roth 401(k) or contribute to a Roth IRA? Below I discuss why, in the vast majority of cases, I strongly favor Roth IRA contributions over Roth 401(k) contributions.

Roth Accounts

Who does not love tax free accounts? The Roth, properly distributed, can create tax free income.

The Roth is becoming particularly attractive for the early retiree trying to optimize Premium Tax Credits. Yes, you can potentially fund pre-65 retirement expenses from traditional retirement accounts or sales of taxable account assets. But (with uncommon exceptions) both trigger taxable income, increasing the possibility of going over the 400 percent of federal poverty level cliff.

Roth IRAs

Roth IRAs are an individual account and can be established at a plethora of financial institutions. Most working taxpayers qualify to make annual contributions to a Roth IRA. However, the ability to make an annual contribution to a Roth IRA phases out at certain income levels and is completely eliminated at $168,000 (single) or $252,000 (married filing joint) of modified adjusted gross income (2026 numbers).

The maximum annual contribution to a Roth IRA is $7,500 (if under age 50) or $8,600 (if age 50 or older) (2026 numbers).

Annual contributions can be withdrawn from the Roth IRA at any time for any reason tax and penalty free. Thus, Roth IRAs can perform double duty as both a retirement savings vehicle and as an emergency fund. This is an advantage of Roth IRAs over Roth 401(k)s.

Of course, considering their tax free growth, it is usually best to keep amounts in a Roth IRA for as long as possible, particularly during one’s working years.

Roth 401(k)s

Roth 401(k)s are a workplace retirement plan. Contributions can be made through payroll withholding.

The Roth 401(k) does enjoy some advantages when compared to its Roth IRA cousin. First, there is no income limit to worry about. Regardless of income level, an employee can contribute to a Roth 401(k). Second, the contribution limits are much higher than the contribution limits for Roth IRAs. As of 2026, the annual Roth 401(k) contribution limit is $24,500 (under age 50). Those aged 50 and older by year end qualify for additional catch-up contributions.

The Roth 401(k) is not a good account for emergency withdrawals. Withdrawals occurring prior to both the account holder turning 59 ½ years old and the account turning 5 years old generally pull out a mixture of previous contributions and taxable earnings.

Roth 401(k) vs Roth IRA

So which one should workers prioritize? Contributions to a Roth 401(k) or contributions to a Roth IRA?

To help us answer that question, let’s consider a young couple pursuing financial independence:

Stephen and Becky are both age 35, married (to each other), and pursuing financial independence. They both would like to retire at least somewhat early by conventional standards. They each have a W-2 salary of $110,000. They have approximately $2,000 of annual interest and dividend income. They claim the standard deduction of $32,200 in 2026. At this level of income, they have a 22 percent marginal federal income tax rate. Stephen and Becky each have access to a traditional 401(k) and a Roth 401(k) at work. They would like to maximize their retirement plan contributions.

How should Stephen and Becky allocate their retirement plan contributions? Should they contribute to a Roth 401(k) and/or to a Roth IRA?

To my mind, the best play here is to contribute to a Roth IRA ($7,500 each) and contribute to a traditional 401(k) ($24,500 each). Stephen and Becky should not contribute to a Roth 401(k).

There is a significant tax opportunity cost to making a Roth 401(k) contribution: the ability to deduct a traditional contribution to a 401(k). Remember, the Roth 401(k) shares the $24,500 annual contribution limit with the traditional 401(k). Every dollar contributed to a Roth 401(k) is a dollar that cannot be contributed to a traditional 401(k).

Contrast the significant tax opportunity cost of making a Roth 401(k) contribution to the tax opportunity cost of making a Roth IRA contribution: practically nothing.

Stephen and Becky have no ability to deduct a traditional IRA contribution because of their income level and the fact that they are covered by a workplace retirement plan. Thus, they aren’t losing much, from a tax perspective, by each making a $7,500 annual Roth IRA contribution.

For Stephen and Becky, the idea is to Pay Tax When You Pay Less Tax. As I’ve explored on my YouTube channel, it’s frequently the case that retirees are lightly taxed. The odds are that Stephen and Becky will pay the most tax when they are working. Thus, the better path is likely to be to take the tax deduction (the traditional 401(k) contribution) during their working years and then pay tax on traditional retirement accounts in retirement.

Trade Off Profile

The trade off profile of the traditional 401(k) versus Roth 401(k) tilts towards the traditional 401(k) contribution.

Every dollar contributed to a Roth 401(k) is a dollar that could not have been tax deducted into a traditional 401(k).

The opposite is true when it comes to IRAs. Every dollar contributed to a Roth IRA is not a dollar that could have been deducted into a traditional IRA in many cases due to the relatively low income limits many face on the ability to deduct a traditional IRA contribution.

If I’m going to do Roth, don’t I want to do the Roth that does not sacrifice a tax deduction?

Situations Where the Roth 401(k) Contributions Make Sense

Generally there are four situations where choosing to contribute to a Roth 401(k) makes sense. In these situations, the tax rate arbitrage play available to Stephen and Becky isn’t available.

In the first three situations below, a Roth 401(k) contribution is likely preferable to a traditional 401(k) contribution. As compared to a Roth IRA contribution, (a) the first contributions should generally be to the Roth 401(k) to secure the employer match, and then after that, (b) generally both the Roth 401(k) and the Roth IRA work well. To my mind, the emergency-type fund feature of the Roth IRA is probably the tiebreaker in favor of making the next contributions to a Roth IRA.

Transition Years

Think about a year one graduates college, graduate school, law school, or medical school. Usually, the person works for only the last half or last quarter of the year. Thus, they have an artificially low taxable income (since they only work for a small portion of the year). Why take a tax deduction for a contribution to a traditional 401(k) in such a year, when one’s marginal federal income tax rate might only be 10 percent?

End of career wind downs where one reduces workload, and thus, taxable income, can be a great time to switch to the Roth 401(k) for retirement contributions.

Transition years are a great time to make Roth 401(k) contributions instead of traditional 401(k) contributions.

Mini-Retirements

Taking a year-long mini-retirement beginning February 1st? January 401(k) contributions might be best made to the Roth 401(k) instead of the traditional 401(k).

No Hope

Picture a charismatic franchise NFL quarterback. He’s got a $50M plus annual NFL contact, endorsement deals, business ventures, and likely a long TV career after his playing days are done. For him, there is no hope ( 😉 ). He will probably be in the top federal income tax bracket the rest of his life. He might be well advised to “lock-in” today’s low (by historical standards) 37% federal income tax marginal tax rate by choosing to contribute to a Roth 401(k) instead of to a traditional 401(k).

High Earners’ Catch-Up Contributions

This isn’t a question of “traditional versus Roth” preference. It’s a question of the tax law.

Starting in 2026, those making more than $150,000 in prior-year W-2 wages from an employer cannot make catch-up contributions to a traditional 401(k). Their catch-up contributions must be made to the Roth 401(k).

Sure, this rule takes away a valuable tax deduction. But having Roth money going into retirement is not a bad thing. Those high earners with cash flow sufficient to make Roth catch-up contributions should consider doing so.

Additional Resource

Cody Garrett and I did a deep dive on all things retirement planning, including Roth retirement accounts, in Tax Planning To and Through Early Retirement, available on Amazon and many other online sources.

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on LinkedIn: @SeanWMullaney

This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.

California Umbrella Insurance

Live in California? Do you wonder “how much personal liability umbrella insurance should I have?”

In this article, I cover the basics of personal liability umbrella insurance and then discuss five principles I believe to be most relevant in deciding how much personal liability umbrella insurance California residents should have.

Insurance for Personal Liabilities

Living our lives generates the possibility of liabilities to others. Accidents happen. It’s part of the human experience.

Most Californians have two primary insurances to guard against personal liability to others.

The first is homeowners insurance. For those who rent, this is renter’s insurance. This insurance can cover things like slip-and-fall accidents inside one’s home or one’s stoop.

The second is auto insurance, specifically liability insurance to third parties.

Often homeowners and auto insurance have limits on the amount of liabilities it will pay to third parties. These could be $300,000 or $500,000 per accident, for example.

In today’s environment, particularly in California, it is very possible that our liabilities to third parties through auto accidents or in-home accidents can exceed these liability caps. Thus, many can and should obtain additional insurance coverage in the form of personal liability umbrella insurance, often referred to as “umbrella insurance.”

Personal Liability Umbrella Insurance

An umbrella policy sits on top of, not “instead of” or “in addition to” primary insurance. Umbrella insurance is generally secondary coverage.

Here is an example of how that works in practice. Oscar has a car and has a $500,000 auto insurance liability policy. Further, Oscar has a $2 million personal liability umbrella policy. Dollars $1 through $500,000 of Oscar’s potential auto liability to third parties would be paid out by the auto policy. Dollars $500,001 through $2 million of liability would be paid out by the umbrella policy

It is not the case that Oscar now has $2.5 million worth of auto liability coverage. Oscar’s $2 million umbrella is not added to his primary auto insurance coverage. Rather, the umbrella fills in coverage up to its limit, in this case $2 million.

You can see that with respect to Oscar, the most likely insurance to pay out is his auto insurance. Say Oscar rear-ends another car and causes $25,000 worth of damage. His auto insurance policy would pay out $25,000 and his umbrella policy would pay $0.

Since umbrella insurance is generally a secondary policy, it tends to be somewhat affordable. That said, in California my experience has been that even umbrella insurance premiums are rising fast as of 2026.

Oftentimes it is logical to bundle home, auto, and umbrella. Carriers often give discounts when consumers bundle.

Umbrella carriers generally require minimum levels for home and auto protection. They don’t want consumers using an umbrella policy as a backdoor home and/or auto policy, so it is quite common for an umbrella carrier to require certain minimum coverage amounts with respect to home and auto policies.

Umbrella insurance is generally offered in million dollar increments. In most cases, insurance companies will issue up to $5 million of umbrella insurance as long as the insured (a) has sufficient minimum home and auto coverage and (b) can write the check. Beyond $5 million generally requires additional underwriting.

Protected Assets and Umbrella Insurance

In theory, if all of one’s wealth was in protected assets in certain states, there’s not much need for any umbrella coverage. The person could be sued, but if every significant asset was protected, at least in theory there would be little to nothing to collect in litigation.

Depending on the state, creditor protected assets often include 401(k) and other ERISA protected retirement accounts. States also offer varying degrees of protection for one’s primary residence. In Florida, the entirety of one’s primary residence value is a protected asset.

Retirement account protection depends on both federal and state law.

IRAs have been subject to relatively weak California law creditor protection, though they do qualify for decent federal protection in bankruptcy. A relatively new California law, AB 2837, has placed distributions from 401(k)s and other ERISA protected accounts at some risk. It remains to be seen how courts implement new AB 2837.

Ultimately, the amount of retirement account wealth that will be protected in litigation in California is subjective and dependent on all the facts and circumstances, including whether bankruptcy has been declared. Limited retirement account protection is a risk of living in California.

The amounts protected by California’s homestead exemption vary by county and may not fully cover the value of one’s primary residence.

For Californians, residents of what is generally perceived as a litigious state, the question arises, how much umbrella insurance coverage should I have?

California Umbrella Insurance Principles

I don’t have the silver bullet formula for exactly how much personal liability umbrella insurance you or anyone else should have.

But I have some principles that I believe can be helpful in making that determination. Of course, these five principles are not the only potential considerations one has when determining umbrella insurance coverage level. But I do believe they can be helpful for many Californians.

The Most Important Million is the First Million

In my opinion, the most important million in umbrella coverage is the first million.

Why?

First, a $1 million personal liability umbrella insurance policy covers a significant swath of the liability probability curve.

Generally speaking, the liability probability curve is at its highest at lower levels of monetary liability and slopes down. The greater the amount of monetary liability, the lower the likelihood of incurring it.

Further, consider the practicalities of settlements, as discussed in the second principle. The potential to settle a liability claim at $1 million is very valuable.

Second, it is helpful to have a deep pocket in one’s corner if one has a liability event. The umbrella insurance company is on the hook for a significant amount of money if the insured has a liability event (such as a car accident) and thus has incentive to work through their legal team to limit the ultimate settlement amount. Obviously this is beneficial to the insured.

I look at umbrella insurance coverage level like an elementary school spelling test. When I went to Catholic elementary school, in second grade we had 20 word spelling tests on Friday mornings. Each word was worth 5 points.

For many Californians, having no personal liability umbrella insurance is like getting a 0 on the spelling test, while having $1 million of personal liability umbrella insurance is like getting a 100 on the spelling test.

For some more well-to-do Californians, the $1 million umbrella policy is like getting an 80, 85 or 90 on the spelling test. Increasing umbrella coverage to $2 million, $3 million, $4 million, or $5 million (depending on the circumstances) would get these well-to-do Californians to a 100 score on the test.

Consider Potential Exposure

Perhaps the most important question to ask is “how much could someone sue me for?”

In this regard, Dr. Jim Dahle, known online as The White Coat Investor, makes a very helpful assertion: most people are very willing to walk away for a $1 million settlement. Thus, Dr. Dahle argues that for most people a $1 million personal liability umbrella insurance policy can be sufficient.

For this reason I believe even the extremely wealthy rarely need more than $5 million worth of personal liability umbrella insurance, even in a litigious state like California.

One can never precisely predict the ultimate outcome of a future dispute. But settlement practicalities, including both sides’ desire to avoid a lengthy and costly legal process, do help define, to a certain degree, potential exposure.

Consider Unprotected Assets

I believe Californians should look at things like taxable accounts, HSAs, high housing values, rental real estate, etc. and consider protecting them with umbrella insurance. As discussed above, the extent to which retirement accounts are protected will depend on various facts and circumstances, including but not limited to whether bankruptcy has been declared.

The extent to which Californians should protect retirement accounts with umbrella insurance is highly subjective and should be considered, in today’s environment, very much in conjunction with the other principles mentioned here.

If In Doubt, Round Up in California

California is a challenging environment when it comes to cost of living, asset protection, litigation, and the like. No one precisely knows exactly how much personal liability umbrella insurance is optimal. Why not round up, not down, on umbrella insurance coverage level if in any doubt?

Frequently Revisit Umbrella Insurance Coverage Levels

I believe Californians should frequently revisit coverage levels. People’s circumstances change. California law changes. The frequently evolving landscape both legally and personally strongly suggests Californians should frequently revisit umbrella insurance coverage levels.

Consider Driving Less

Risk mitigation is certainly not limited to personal liability umbrella insurance.

What’s the highest risk personal activity most Californians engage in? It’s easily driving.

Living in California usually requires time behind the wheel. But is every last mile behind the wheel necessary?

A personal anecdote: This Fall I am speaking at and attending a three day financial planner conference in San Diego. My original plan was to drive down from Los Angeles. The problem with that plan is it required 150 miles each way fighting Southern California traffic. That’s 300 miles for me to get into an accident, only to have my car sit in a hotel garage for three days incurring parking fees.

So I chose a different path: I’m taking the Amtrak Pacific Surfliner to and from the conference. I even upgraded (for just $20 each way) to Business Class. Instead of fighting traffic and risking an accident, I’m relaxing in Business Class drinking free coffee, catching up on work and/or listening to the Hindley Street Country Club.

Consideration should be given to taking an Uber or Lyft to the airport instead of driving and parking there. There are marginal tactics like these available that can reduce the miles we drive.

Conclusion

Asset protection is a significant financial planning consideration in California. Personal liability umbrella insurance is one of the best available tools to provide financial protection in the event of an accident. Californians often benefit from having personal liability umbrella insurance. There’s no precise science for determining exactly how much coverage to have. But I hope the five principles I provided in this article are helpful as Californians consider the appropriate level of coverage they should have.

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on LinkedIn: @SeanWMullaney

Roth IRA Withdrawals

The Roth IRA is 28 years old as of 2026 (its birthday was January 1st). Yet there is still confusion about the rules applicable whenever someone withdraws money from a Roth IRA prior to turning 59 ½. This blog post attempts to correct some misconceptions on the taxation of nonqualified Roth IRA withdrawals.

Roth IRA withdrawals are becoming more important for early retirees facing the 400 percent of federal poverty level cliff which can eliminate thousands of dollars of Premium Tax Credits. Keep reading to find out how tactical Roth withdrawals in early retirement can help enhance Premium Tax Credits.

Roth IRAs: The Basics

A Roth IRA is a tax-advantaged account that generally offers tax-free growth for invested amounts. Taxpayers receive no upfront tax deduction for putting money into a Roth IRA. If properly executed, taxpayers can withdraw money from a Roth IRA entirely tax and penalty free, and can enjoy years of tax-free growth on the amounts invested in a Roth IRA.

Roth IRA Funding

How does one move money into a Roth IRA? There are three ways.

Annual Contributions

Generally speaking, if your income is below certain limits, you can contribute up to the lesser of $7,500 or your earned income (2026 limits) to a Roth IRA. If you are aged 50 or older, the limits are the lesser of $8,600 or earned income (2026 limits).

Conversions

Amounts can be converted from traditional retirement accounts into a Roth IRA. Any taxpayer can convert amounts from a traditional retirement account to a Roth IRA. There are no restrictions based on level of income and/or having had earned income.

Conversions are taxable in the year of the conversion.

There are several reasons you might want to do a Roth IRA conversion. One might be the anticipation of paying tax at a higher rate in the future. The planning concept is to “lock in” the lower tax rate in the year of the conversion rather than tomorrow’s (anticipated) higher tax rate, and to get all of the earnings on the contribution out of income taxation.

Unlimited Roth IRA conversions form the backbone of the Backdoor Roth IRA planning concept.

Note that inherited traditional IRAs cannot be converted to Roth IRAs.

Transfers from Workplace Retirement Accounts

A third way to get money into a Roth IRA is by using workplace retirement accounts. Amounts in Roth 401(k)s and other workplace Roth accounts can be transferred into a Roth IRA. Generally, it is best to use direct “trustee-to-trustee” transfers to accomplish this.

Further, after-tax contributions in workplace retirement plans can be directly transferred to Roth IRAs, as discussed in Notice 2014-54.

The ability to transfer after-tax contributions into a Roth IRA has facilitated the use of the Mega Backdoor Roth IRA planning technique.

Roth IRA Withdrawals: The Confusion

You may have heard that you cannot take money out of a Roth IRA if the account is not 5 years old without paying tax and a penalty. Not true!

There are not one, but two, five (5) year rules applicable to Roth IRAs. But neither one of them prohibit you from taking money out of a Roth IRA you have previously contributed through annual contributions. First, I will illustrate the default Roth IRA withdrawal rules, and then I will discuss the two 5 year rules.

Quick Thought: Most of this blog post addresses situations where the taxpayer does not qualify for a qualified distribution. Generally, a taxpayer fails to qualify for a qualified distribution if he or she has not attained the age of 59 ½, and/or if he or she has not owned a Roth IRA for 5 years. The advantage of a qualified distribution is that it is automatically tax and penalty free.

Roth IRA Withdrawals: The Layers

Here is the default order of distributions that come out of a Roth IRA. These are the rules that apply in cases where the taxpayer does not qualify for a qualified distribution. All Roth IRAs (other than inherited Roth IRAs) the taxpayer owns are aggregated for purposes of determining his or her Roth IRA layers.

First Layer: Tax-free return of Roth IRA contributions

Second Layer: Roth IRA conversions (first-in, first-out)

Third Layer: Roth IRA earnings

Each layer must come out entirely before the subsequent layer is accessed.

Here’s a brief example:

Example 1: Samantha opened her only Roth IRA in 2018. Samantha has made three prior $5,000 contributions to her Roth IRA (one for each of 2018, 2019, and 2020). She also made a $5,000 conversion from a traditional IRA to a Roth IRA in 2018. In 2021, at a time when her Roth IRA is worth $30,000 and Samantha is 50 years old, she takes a $10,000 withdrawal from her Roth IRA. All $10,000 will be a recovery of her previous contributions (leaving her with $5,000 remaining of previous contributions). Thus, the entire $10,000 distribution from the Roth IRA will be tax and penalty free.

The Roth IRA contributions come out tax and penalty free at any time for any reason! The 5 year rules have nothing to do with whether a taxpayer can recover their previous Roth IRA contributions tax and penalty free!

For those wanting to dig deeper into the tax law, please refer to this blog post and this technical slide deck discussing why the Roth IRA contributions are distributed tax and penalty free regardless of the 5 year rules.

Note that aggregation rules always apply. In making an analysis like the one provided in Example 1, one must account for all their Roth IRAs and treat all of their Roth IRAs as a single Roth IRA to determine their own Roth IRA layers. Roth 401(k)s and inherited Roth IRAs are not included in the analysis.

5 Year Rule for Roth IRA Earnings

The first five-year rule for Roth IRAs applies only to a withdrawal of earnings from a Roth IRA. If the account owner has not owned a Roth IRA for at least 5 years, the earnings withdrawn from the account are subject to ordinary income tax (and possibly a penalty).

Example 2: Joe is 62 years old in 2024. He has owned a Roth IRA since 2021. In 2024, after having made $14,000 in prior annual contributions to his Roth IRA, he withdrew $17,000 from the Roth IRA. Because Joe has not owned a Roth IRA for 5 years, the withdrawal is not a qualified distribution. Joe recovers his first $14,000 tax free as a return of contributions. The next $3,000 of earnings is taxable to Joe as ordinary income (because of the first five-year rule). Because Joe is over age 59 ½, he does not owe the ten percent penalty on the distribution. If Joe had not attained the age of 59 ½, he would owe the 10 percent penalty on the $3,000 of earnings he received.

5 Year Rule for Roth IRA Conversions

There is a five-year rule applicable to taxable money converted from a traditional retirement account to a Roth IRA (what I will colloquially refer to as the “second five-year rule”). The idea behind the second five-year rule is to protect the 10% early withdrawal penalty applicable when someone has a traditional retirement account. Here is an illustrative example.

Example 3: Milton has $100,000 in a traditional IRA, no basis in any IRA, and is age 50. If he were to withdraw $1,000 from his traditional IRA (assuming no penalty exception applies), he would owe (in addition to ordinary income tax) a $100 penalty (ten percent) on the withdrawal.

Okay, but what if Milton first converts that money from a traditional IRA to a Roth IRA (assume Milton has no other balance in a Roth IRA)? Would that get him out of the 10 percent penalty? No, it won’t, because of the second five-year rule.

Example 4: Milton has $100,000 in a traditional IRA, no basis in any IRA, has no Roth IRAs, and is age 50. In September 2024, he converts $1,000 to a Roth IRA. In October 2024, he withdraws $1,000 from that Roth IRA. Because of the five-year rule applicable to Roth IRA conversions, Milton will still owe the $100 penalty on the withdrawal from the Roth IRA.

Had Milton waited until 2029 or later, he would not have owed the penalty on the withdrawal of that $1,000.

The 5 Year Rule for Roth IRA Conversions and the Backdoor Roth IRA

The Backdoor Roth IRA is subject to the second five-year rule, but the penalty effect turns out to be very minor (or non-existent) if the Backdoor Roth IRA has been properly executed.

Conversions, the second layer of the Roth IRA stack, come out first-in, first out. Further, the taxable amount (potentially subject to the 10 percent penalty upon withdrawal) of any one particular Roth IRA conversion comes out first within the conversion amount. Thus, the second layer (the conversion layer) can be composed of several mini-layers.

Here is a quick example:

Example 5: Denzel made $6,000 nondeductible traditional IRA contributions on January 1, 2019 and January 1, 2020. On February 2, 2019 and February 2, 2020, Denzel converted the entire balance of the traditional IRA ($6,010 each time) to a Roth IRA. As of December 31, 2019 and December 31, 2020, Denzel had $0 balances in all traditional IRAs, SEP IRAs, and SIMPLE IRAs.

In 2021, at a time when Denzel is 35 years old and has made no other contributions or conversions to a Roth IRA, he withdraws $3,000 from his Roth IRA. The first $10 of the withdrawal will be from the taxable amount of his 2019 Roth conversion, and thus, will be subject to the 10 percent penalty as it violates the second five-year rule (Denzel will owe $1 in penalties). The next $2,990 is attributable to the non-taxable portion of his 2019 Roth conversion, and as such, will not be subject to the 10 percent penalty. None of the $3,000 will be subject to ordinary income tax.

Penalty Exceptions

From time to time you will hear things such as “you can withdraw only $10,000 from a Roth IRA for a first-time home purchase.” Does that mean everything else discussed above does not apply?

Fortunately, the answer is no!

So what is the $10,000 rule getting at? It is getting at amounts withdrawn from a Roth IRA that would otherwise be subject to the penalty (and possibly income taxes — see The Super Exceptions below).

There are several penalty exceptions applicable to taxable converted amounts and earnings that are withdrawn from a Roth IRA in a nonqualified distribution. But the penalty exception rules generally apply on top of the usual layering rules, not instead of the usual Roth IRA layering rules.

In a discussion on social media, I used a version of the following example.

Example 6: Jane Taxpayer, age 30, has had a Roth IRA since 2017. In 2020, she withdraws $30,000 from her Roth IRA to acquire her first home, and has never used traditional IRA and/or Roth IRA money for such a purchase. She has previously made $20,000 in annual contributions to the Roth IRA. The first $20,000 of the withdrawal is a tax-free return of those contributions (see the layers above). The next $10,000 is out of earnings (see the layers above). This $10,000 is taxable to her as ordinary income. But, because of the $10,000 “qualified first-time homebuyer distribution” exception, she does not owe the 10 percent penalty on the withdrawal of those earnings.

In this case, withdrawals used to fund certain home purchases can qualify for a penalty exception (the first-time homebuyer exception is subject to a $10,000 cap). Please visit this website for a list of the possible penalty exceptions applicable to withdrawals from a traditional IRA and a Roth IRA.

The Super Exceptions

If the taxpayer is relying on the disability, age 59 ½, death, or qualified first-time home purchase penalty exceptions, the earnings also come out income tax free so long as the taxpayer has owned a Roth IRA for five years. See slide 5 of the above referenced technical slide deck.

As applied to Jane Taxpayer in Example 6 above, if she had owned a Roth IRA since any time in 2015 or earlier, the distribution of $10,000 of earnings would not only have been penalty free, it would have also been income tax free.

60 Day Rollovers

A taxpayer might take money out of a Roth IRA and then reconsider. Perhaps he or she wants the money to grow tax-free. Or perhaps the taxpayer dipped into earnings and the distribution is not a qualified distribution, meaning that it will likely be subject to ordinary income tax and possibly the ten percent penalty.

He or she might be able to roll the money back into the Roth IRA. However, the tax rules allow only one 60 day rollover every 12 months. The IRS has a website here discussing some of the issues.

Because of the one-rollover-per-year rule, I generally advise against doing 60 day rollovers unless you need to. Generally, it is best to avoid them, and then have the option available as a life raft if money somehow comes out of a Roth IRA (or other IRA) when it should not have. Note that Roth conversions are excepted from the once-every-12-months rule. Those wanting to do so could do a Roth conversion every day if they were so inclined.

Required Minimum Distributions

There are no required minimum distributions from a Roth IRA during the owner’s lifetime.

Early Retirement Tax Planning

Starting in 2026, the dreaded 400 percent of federal poverty level cliff is back when it comes to claiming Premium Tax Credits against ACA medical insurance premiums. The cliff can easily cost a retired married couple over $10,000 a year in early retirement.

This greatly increases the desirability of reducing income in early retirement. But early retirees still need to live.

Wouldn’t it be great if there was a source of funds for living expenses that is entirely tax free? Roth IRAs can be that source!

The Roth IRA withdrawal ordering rules are so favorable that it is likely many early retirees can access thousands of dollars from their Roth IRA to fund their retirement and keep income very low.

For those retirees younger than age 59 ½, their Roth basis (in a general sense, the combination of their historic annual contributions and their taxable Roth conversions that at least 5 years old less any previous withdrawals) can be withdrawn tax and penalty free to fund living expenses in a manner that does not increase income for Premium Tax Credit determinations.

For those retirees who are both 59 ½ and have held any Roth IRA for at least 5 years, the only thing they can take from a Roth IRA is a qualified distribution which is always entirely tax free.

Many retirees on ACA medical insurance plans will want to consider tactically taking Roth IRA withdrawals to limit their modified adjusted gross income (MAGI) and increase their Premium Tax Credit.

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on LinkedIn: @SeanWMullaney

Spreadsheets Don’t Answer Every Personal Finance Question

There’s a temptation to boil personal finance down to calculators and spreadsheets.

Can I retire?

Should I do Roth conversions?

When should I take Social Security?

Many say “find the right retirement calculator” or “put together a spreadsheet” and use that to make the decision.

I’ve thought about this issue often during my career as a financial planner and personal finance content creator. In 2024 I discussed this issue during my CampFI presentation.

In the past week, two pieces of content have put this issue back on my radar.

First is Pete Adeney’s article The Shockingly Simple Math Behind Social Security. Mr. Adeney is more commonly known online as “Mr. Money Mustache” or “MMM.” In this article, MMM argues that the question of “when to claim Social Security?” is resolved by a net present value calculation.

Second is Rory Sutherland’s Doorman Fallacy.

I believe we can properly assess MMM’s argument by unpacking the Doorman Fallacy.

The Doorman Fallacy

Here’s my rough version of the Doorman Fallacy:

Picture a 5 star luxury hotel with a doorman. It actually has six doormen. Three Monday to Friday doormen, each working an eight hour shift and each collecting salary and benefits. The hotel also has three weekend doormen who occasionally also substitute for the weekday doormen. These three doormen collect an hourly wage.

Consultants can put their annual costs and the cost of installing an automatic door into a spreadsheet.

The spreadsheet tells us that in less than 8 months, the hotel breaks even from laying off the doormen and installing an automatic door. The automatic door needs to be replaced every 7 years. Thus, guided by the consultants and their spreadsheet, the hotel lays off the doormen and installs the automatic door.

In a couple of months, the hotel finds their average TripAdvisor rating fell from 4.8 stars to 4.4 stars. They notice that they have to lower room rates by 15 percent most nights to sell out the hotel when previously they had only a few nights that were not sold out. They also notice that now they occasionally get guest complaints about suspicious people hanging out in the lobby.

My very rough retelling illustrates that the Doorman Fallacy is a classic case of seeing the data but failing to recognize the pattern. Yes, spreadsheets can help us see the pattern.

Nevertheless, it is often the case that spreadsheets focus us on the data and obscure the pattern. The consultants’ spreadsheet focuses on one piece of data: the immediate cost saving from laying off the doormen and replacing it with an automatic door.

But doormen in the case of a 5 star hotel are much more than what the spreadsheet can easily capture–their salary and benefits. It turns out that for a 5 star hotel, the doorman is part of a pattern that is much more dynamic than what a spreadsheet can tell you.

Social Security and Spreadsheets

It’s tempting to boil Social Security down to a spreadsheet. Do a net present value calculation and make your claiming decision.

MMM’s recent article advises us to do that. He argues:

Because when it comes to deciding on how Social Security fits into your retirement strategy, it really boils down to only one number:

The Net Present Value of your future lifetime stream of Social Security payments.

Generally speaking, we compute net present value on a spreadsheet.

As much as I appreciate MMM (see below), I strongly disagree with the conclusion of his recent article. Why?

MMM’s take misses Social Security’s role in the pattern of investing and drawdown in retirement. Let’s dig into the pattern.

Volatility

First and foremost is volatility. Social Security, generally speaking, is the least volatile financial asset retirees have. Social Security is adjusted for inflation. Delays in claiming Social Security increase annual collected benefits under an established formula.

Compare and contrast Social Security with the other financial assets retirees rely on. For most, these are stocks, bonds, and cash. Stocks, bonds, and cash are good to have. But they are more volatile than Social Security, in my opinion.

You say cash isn’t volatile. I say its value can be eroded away by potentially unpredictable inflation. Bonds are subject to volatility due to movements in interest rates, and we know stocks have all sorts of volatility.

Picture a 70 year old retiree who has achieved what some call their “FI number.” Do you want him or her to have more or less volatility in their lives?

When we’re working in our 30s and 40s and have years if not decades until retirement, volatility is our friend. Volatility tends to, over long periods, fuel portfolio growth. Further, those in their 30s and 40s have years to make up for portfolio declines.

In our 70s and 80s we’ve experienced much of the portfolio growth we need for financial success. Further, we generally can’t go back to lucrative work at this point, so we struggle to make up for losses. In retirement, volatility is mostly our enemy.

I believe (generally speaking) most financially successful retirees should look to reduce volatility in their 70s and 80s. What does that look like when it comes to Social Security claiming strategies?

Delay, delay, delay!

From this perspective, financially successful retirees should live off volatile assets entirely in their 60s and collect Social Security starting only at age 70. This has the effect of reducing reliance on the stocks, bonds, and cash (the volatile assets) in one’s 70s and 80s and increasing the amount of nonvolatile income, Social Security, in one’s 70s and 80s.

While it is theoretically possible to use backwards looking statistics to illustrate volatility on a spreadsheet, doing so creates complexity and potential confusion while only looking backwards. Why focus on backwards looking statistics when the relevant numbers are future unknown numbers? Thus, I don’t believe that spreadsheets are all that helpful in recognizing this part of the retirement drawdown pattern.

Those focused on Social Security net present value calculations while ignoring how Social Security claiming strategies interact with the rest of a retiree’s financial portfolio focus on a subset of data instead of recognizing the relevant pattern.

Claiming at age 62 to invest: Some in the FI community claim Social Security benefits at age 62 to invest them. The idea is to “do better” in the stock market. I disfavor this approach. Why? It increases volatility by increasing volatile portfolio assets while decreasing the monthly amount of Social Security collected in one’s 70s and 80s.

Tax Planning

Another important consideration in Social Security claiming decisions is tax planning. Claiming Social Security early tends to limit or foreclose some outstanding mid-to-late 60s tax planning opportunities, including Tailored Taxable Roth Conversions and the Hidden Roth IRA. I discussed both of these opportunities in detail during my 2025 Bogleheads Conference presentation.

Delaying claiming Social Security can also reduce the amount of Social Security income subject to income tax. The rules subject 0 to 85 percent of one’s Social Security to income tax based largely on one’s other income. If you have less other income in your 70s and 80s (since you spent down more of your portfolio assets in your 60s) you are at least somewhat more likely to have less of your Social Security income subject to income tax. Note that this potential benefit is usually nonexistent for very affluent retirees.

Tax planning rarely boils down to just spreadsheets. It’s about recognizing the pattern of where taxes on retirees are likely heading in the future and how tax rules on retirees relate to comprehensive drawdown strategies. Cody Garrett, CFP(R) and I discuss this in great detail in our recent book Tax Planning To and Through Early Retirement.

Social Security Probability Analysis

Another factor to consider is “what claiming strategy is most likely to produce the highest total present value benefits collected from Social Security?”

The best free resource in this regard I’m aware of is Mike Piper’s opensocialsecurity.com.

Note that this resource simply answers one relevant question. As we’ve already seen, there are other relevant factors. The Open Social Security calculator in no way measures tax planning benefits of delaying. It also does not measure the volatility benefits to the investor of having more of one’s overall portfolio in increased future Social Security payments in their 70s or 80s.

Other Factors

Volatility, tax planning, and probability analysis. All three factors are relevant and are part of the pattern that informs our Social Security claiming decision. But there are other factors that are important. How long do you expect to live? Are you married? Are you the higher earning spouse or the lower earning spouse?

None of this is to say that Social Security claiming decisions are to be agonized over. I believe the pattern often emerges with informed consideration of the relevant factors. Spreadsheets and calculators can be helpful but are certainly not the be-all-and-end-all in this regard.

Social Security claiming decisions do not boil down to a single spreadsheet calculation.

Social Security’s Future: But Sean, won’t Social Security benefits be reduced in the future? Allow me to respond with a question: Will future politicians cease to act in their own best interests? A pay cut for retirees is hardly in the politicians’ own best interests, considering that in 2024, 58 percent of the electorate was aged 50 or older. The most likely explanation of Social Security benefits over the next few decades is that retirees will collect 100 cents on the dollar or very close to it.

Spreadsheets Do Have an Important Role in Personal Finance

Spreadsheets play a role in personal finance. I ought to know. I’ve now spent hours of YouTube videos going through spreadsheets demonstrating how retirees using traditional retirement accounts are taxed when taking feared required minimum distributions (“RMDs”).

It turns out that there’s nothing to fear when it comes to RMDs. The spreadsheets uncover the truth that too much personal finance commentary omits.

Long before my YouTube videos, the one and only Mr. Money Mustache used a spreadsheet to recognize a pattern. The Shockingly Simple Math Behind Early Retirement is a classic article. He used a spreadsheet to roughly translate a savings rate into “Working Years Until Retirement.”

MMM’s spreadsheet wasn’t used for precision. Rather, it was used to illustrate a pattern. Retirement is very possible if one reduces expenses to increase investments. The spreadsheet put data together–in this case, combining annual expenses and savings rate–to produce the pattern. MMM’s spreadsheet illustrates retirement is sooner than most think if you can reduce annual expenses and invest the savings.

The above said, let’s not get carried away when it comes to spreadsheets and online calculators. Gary Gulman helpfully observes that $20 to most people is not the same as $20 is to Bill Gates. A spreadsheet says $20 equals $20.

Trying to boil down personal finance decisions to what a calculator or spreadsheet says reflects a problem in decision making: what is most appropriately done based on multiple factors and inputs is boiled down to a “high school maths” problem.

Conclusion

Social Security claiming decisions cannot be made in a vacuum. There is no single silver bullet.

Social Security claiming decisions have implications for investment allocation and tax planning. Patterns can be understood only after considering all the important relevant factors.

Thus, a one-off net present value calculation is not sufficient to make a Social Security claiming decision. Using a spreadsheet to determine a Social Security claiming decision is equivalent to a spreadsheet claiming it is “optimal” to lay off doormen and install a cheaper automatic door at a 5 star hotel.

Yes, spreadsheets can play a role in retirement drawdown and financial planning. Far more important, however, is recognizing patterns that account for all relevant factors including investment volatility, tax planning, and the unique characteristics of each retiree.

FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com

Follow me on LinkedIn at @SeanWMullaney