The FI Tax Guy

Traditional 401(k) Contributions Are Fine for Most Americans (Really!)

Yesterday I posted Time to Stop 401(k) Contributions?, arguing that as applied to many in the FI community, traditional deductible 401(k) contributions are fine.

Today two very interesting pieces of content hit my radar. First, one of my favorite personal finance content creators, Clark Howard, is advocating for Roth contributions instead of traditional contributions for most Americans.

Second, UBS and Credit Suisse issued their Global Wealth Report for 2023. Allow me to call your attention to page 16. The median American adult has personal wealth just a bit under $108,000. This means almost half of American adults have less than $100K of wealth, and the majority of American adults do not have $200K of wealth. For most Americans, deferred taxation is not the problem! Sufficiency is the problem!

For me this report cracks the case. If the median American adult does not have close to sufficient wealth to comfortably retire, why are they worried about taxes in retirement?

Assuming this report is anywhere near close to a correct measure of adult American wealth, I believe I am correct and personal finance legends Ed Slott and Clark Howard are wrong when it comes to the traditional 401(k) versus Roth 401(k) debate.

The best way for working Americans to address sufficiency problems is by contributing to traditional, deductible retirement accounts. As demonstrated below, one employing this sort of deduct, deduct, deduct strategy would need to be successful well beyond what most Americans accomplish in order to create a tax problem.

When one has insufficient resources for retirement, the traditional, deductible 401(k) makes the most sense. He or she needs to build up assets, not worry about future taxes! With relatively little in the way of resources, future taxes are not likely to be a problem (especially in retirement when compared to one’s working years). Further, by contributing to a traditional, deductible 401(k) instead of a Roth 401(k), one behind in retirement saving takes home more money to invest in additional saving mechanisms such as Roth IRAs and taxable brokerage accounts.

Let’s Break Down Some Retirement Numbers

I believe we need some numbers to figure out who’s right.

Example 1: I start with Single Sally, who is 75 years old. Since she is somewhat like the median American, but older, let’s assume she has $250,000 of wealth and receives $30,000 a year in Social Security. Assume further that all $250K is in a traditional IRA and Sally, age 75, wants to live for today: she isn’t constrained by the 4% rule but rather decides to withdraw 10 percent per year ($25,000). On that $55,000 annual gross income, Single Sally pays just over $2,000 in federal income taxes (an effective rate less than 4%).

Why would Sally pass on a 10%, 12%, or 22% deduction from a traditional 401(k) contribution during her working years? Why would Single Sally put the money in a Roth 401(k) so as to avoid a less than 4% federal income tax in retirement? And how different is Sally’s situation from that of many Americans?

Update 8/17/2023: Single Sally is in the Tax Torpedo, an interesting tax phenomenon with a modest impact on her total tax liability. I added a spreadsheet to look at this in more detail.

Example 2: But Sean, I’m reading your blog. I’m not shooting for just $250K in retirement wealth! Okay, let’s start testing it by considering wealth significantly above the mean and median adult Americans. Single Sarah is 75 years old. She receives $30,000 a year in Social Security. But now she also has a $1M traditional IRA and takes an RMD ($40,650) based on her age. Single Sarah also has some taxable accounts and thus has $4,000 of qualified dividend income and $1,000 of interest income. On that approximate $76,000 annual gross income, Single Sarah pays just over $7,200 in federal income taxes (an effective rate of a bit more than 9.5%).

In order to grow a $1M traditional IRA (likely rolled over from workplace 401(k)s), she almost certainly was in the 22% or greater federal marginal tax bracket while working. Why would Single Sarah switch from taking a 22% tax deduction (the traditional 401(k) contribution) to a Roth 401(k) contribution to avoid a 9.5% effective federal tax rate in retirement?

Example 3: Example 3 is Single Sarah at age 80. Her investments are doing so well her traditional IRA is still worth $1M, causing her to be required to take a $49,505 RMD. This causes her federal income tax to increase to $9,175, for an effective federal income tax rate of almost 11%.

How many Americans will get to age 80 with $1M or more in tax deferred accounts? Even if they do, how bad is the tax problem? If Single Sarah’s effective tax rate is 11%, a 50% tax hike gets her to about 16.5%. Will she enjoy paying that tax? No. Is it crippling? Hardly!

Still worried about contributing to a traditional 401(k)? I’ve got a video for you!

Conclusion

The next time you hear “30 or 40% of your 401(k) belongs to the government” you should consider my examples. For many Americans, “10%” will be much closer to the mark than 30% or 40%.

It’s time to step back and ask whether prioritizing Roth 401(k) contributions during one’s working career is the best advice for the majority of Americans. As demonstrated above, a tax increase of 50 percent (highly unlikely) would result in most Americans having an effective tax rate below 20% in retirement.

I believe for many Americans, the optimal retirement savings path combines deductible workplace 401(k) contributions with Roth IRA contributions at home.

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

Follow me on Twitter at @SeanMoneyandTax

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, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.

Time to Stop 401(k) Contributions?

Ed Slott believes most Americans should not contribute to traditional 401(k)s. His recent essay on the subject is a great opportunity for the FI community to reassess its love for the traditional 401(k).

My conclusion is that for many in the FI community, traditional deductible 401(k) contributions are still the most logical path when it comes to workplace retirement saving. Below I explain my thinking.

It is important to note it is impossible to make a blanket statement as applied to the entire FI community.

Why the Traditional 401(k) Is Good for the FI Community

Many in the FI community have the very reasonable hope that in retirement they will have years, possibly decades, where their effective tax rate will be lower than their marginal tax rate in their working years.

The above is true of many Americans, but it is particularly true if one retires early by conventional standards. The idea is deduct, deduct, deduct into the 401(k) during one’s working years (particularly the high earning years) and then retire early by conventional standards. Prior to collecting Social Security and/or required minimum distributions (“RMDs”), most retirees look artificially poor on their tax return. This opens up the door to affirmatively convert money from traditional retirement accounts to Roth accounts and pay tax at the lowest federal income tax brackets (currently 10% and 12%). For those who deducted contributions into the 401(k) at a 24% or greater marginal federal tax rate, this is great tax rate arbitrage planning.

Minor litigation risks aside, this strategy just got even easier for those born in 1960 and later, who don’t have to take RMDs under SECURE 2.0 until age 75. With the new delayed RMD beginning date, even those retiring as late as age 65 will have a full decade prior to being required to take RMDs to do tax-efficient Roth conversions at low marginal tax rates. For some in the FI community, this opportunity window might not be a decade long but rather a quarter-century long (if they retire at age 50).

How Bad is the Retiree Tax Problem?

As wonderful as FI tax rate arbitrate planning might be, Ed Slott’s concern that retiree taxes will increase is not entirely unwarranted. It is obvious that the government is not fiscally responsible, and it is obvious that tax increases could be coming in the future.

Let’s assess the situation by looking at just how bad the problem of taxes is in retirement.

We begin with a baseline case. David and Hannah are in their 70s. They never did Roth conversions in early retirement and have the bulk of their financial assets in traditional IRAs and traditional 401(k)s. During most of their working years, David and Hannah maxed out 401(k)s and got deductions in the 24% bracket or greater. For 2023, they have taxable RMDs of $160,000, Social Security of $40,000, $4,000 of qualified dividends and $1,000 of interest income. How bad is their federal income tax situation?

Federal Income Tax Return
RMDs	$ 160,000
Social Security	$ 40,000
15% Social Security Exclusion	$ (6,000)
Interest	$ 1,000
Qualified Dividends	$ 4,000
Adjusted Gross Income (“AGI”)	$ 199,000
Standard Deduction	$ (27,700)
Additional SD Age 65+	$ (3,000)
Federal Taxable Income	$ 168,300
Federal Income Tax (Estimated)	$ 27,361
Effective Tax Rate on AGI	13.75%
Marginal Federal Income Tax Rate	22%

Under today’s rules, David and Hannah, who did no tax planning other than “deduct, deduct, deduct” are doing great. Their federal effective tax rate, even with $200K of RMDs and Social Security, is just 13.75%. They incur such a low effective tax rate because their RMDs go against the 10% tax bracket, the 12% bracket, and the 22% bracket.

While I do think David and Hannah would be in a better position had they done some tax efficient Roth conversion planning earlier in retirement, their unbridled enthusiasm for traditional retirement accounts served them well.

Note: David and Hannah are borderline IRMAA candidates: a $199K 2023 AGI might cost them approximately $2,000 in IRMAA surcharges in 2025 (but it is possible that inflation adjustments for 2025 will prevent that from happening). This is another reason to consider pre-RMD Roth conversions at lower marginal tax rates.

Update 8/19/2023: But what about the widow’s tax trap? If David or Hannah die, won’t the survivor get crushed by tax increases? Check out this estimate. Assuming the survivor loses the lower-earning spouse’s Social Security benefits of at least $10,000, the survivor’s marginal federal income tax rate would climb from 22% all the way up to . . . 24%!

But what about future tax increases? Okay, let’s add four tax increases to the picture and see just how bad it looks:

Eliminate the TCJA increase to the standard deduction (the law reverts to pre-2018 lower standard deduction and personal exemptions). This would reduce David and Hannah’s deductions by roughly $2,740, costing them approximately $602.80 in additional federal income tax (at today’s 22% marginal tax rate).
Eliminate the TCJA decrease in the 15% tax bracket to 12%. This would cost David and Hannah $2,023.50 in additional federal income tax. I’m highly skeptical that either of these two tax increases will actually occur, but as written in today’s laws they are scheduled to happen in 2026.
Increase the 15% long term capital gains and qualified dividend income rate to 25%. While I believe that the real risk is an increase in the 20% long term capital gains and qualified dividend income rate, let’s stress test things and consider a large increase in the 15% rate. In David and Hannah’s case, this costs them $400 in additional federal income tax.
Increase the 22% tax rate to 33%. Ed Slott is worried about large tax rate increases, so let’s consider one that I believe is politically infeasible, a 50% increase in the 22% tax bracket. This type of tax rate increase would hit millions of voters in a major way. But it’s helpful to consider what could be a worst case scenario. In this case, this tax rate increase costs David and Hannah an additional $8,233.50 in federal income tax.
There’s one more tax hike to consider: the combination of tax increases numbers 1 and 4. If both occurred together, combined they would cost David and Hannah an additional $301.40 in federal income tax.

Here’s what David and Hannah’s federal tax picture looks like if all of the above tax increases occur:

Federal Income Tax Return
RMDs	$ 160,000
Social Security	$ 40,000
15% Social Security Exclusion	$ (6,000)
Interest	$ 1,000
Qualified Dividends	$ 4,000
Adjusted Gross Income (“AGI”)	$ 199,000
Standard Deduction	$ (15,240)
Additional SD Age 65+	$ (3,000)
Personal Exemptions	$ (9,720)
Federal Taxable Income	$ 171,040
Federal Income Tax (Estimated)	$ 38,922
Effective Tax Rate on AGI	19.56%
Marginal Federal Income Tax Rate	33%

Significant tax increases hurt David and Hannah, but how much? By my math, very significant tax increases, including a 50% increase in the 22% bracket, cost them about 6% of their income. Not nothing, but wow, they’re still doing very well.

Yes, on the margin, the last dollars David and Hannah contributed to the traditional 401(k) were not ideal since they faced a 33% marginal federal tax rate in retirement. But let’s remember (i) their overall effective rate is still more than 4 percentage points lower than their working years’ marginal rate (at which they deducted their 401(k) contributions), (ii) they have income significantly above what most Americans will have in their 70s, and (iii) in my scenario they face four separate tax hikes and still pay a federal effective tax rate less than 20 percent.

Future Retirees’ Tax Risk

Do future tax hikes pose no threat to future retirees? Absolutely not! But my stress test shows that many Americans with substantial RMDs will not get walloped even if Congress enacts unpopular tax increases. Considering many in the FI community will have modest RMDs due to pre-RMD Roth conversions, the threat of future tax hikes is even less perilous for the FI community.

Further, many Americans, particularly those in the FI community, have a great tool that can mitigate this risk: Roth conversions during retirement! With RMDs now delayed to age 75 for those born in 1960 and later, many Americans will have years if not decades where money can be moved in a tax-efficient manner from old traditional accounts to Roth accounts.

Further, many Americans can claim deductions at work and then at home contribute to a regular Roth IRA or a Backdoor Roth IRA. This too mitigates the risk of having all of one’s retirement eggs in the traditional basket.

Last, do we really believe that Congress is just itching to raise taxes on future retirees? Sure, it’s possible. But to my mind taxes are more likely to be raised on (i) those in higher ordinary income tax brackets and/or (ii) long term capital gains and/or qualified dividends (particularly the current 20% bracket). If anything, the most Congress is likely to do to retirees is slightly increase their taxes so as to mitigate the political risk involved in raising taxes on retirees who tend to vote.

The Risks of Not Having Money in Traditional Retirement Accounts

Risk isn’t a one-way street. There are some risks to not having money in traditional retirement accounts. I identify three below.

Qualification for Premium Tax Credits

Picture it: Joe, age 55, retires with the following assets: (i) a paid off car, (ii) a paid off house, (iii) a $40,000 emergency fund in an on-line savings account, and (iv), $2 million in Roth 401(k)s and Roth IRAs. He heard that Roth is the best, so he only ever contributed to Roth IRAs and Roth 401(k)s, including having all employer contributions directed to a Roth 401(k). Having fallen into the Rothification Trap, in retirement Joe must work in order to generate sufficient taxable income to qualify for any ACA Premium Tax Credit.

For at least some early retirees, the ability to create modified adjusted gross income by doing Roth conversions will be the way they guarantee qualifying for significant Premium Tax Credits to offset ACA medical insurance premiums.

Charitable Contributions

Many Americans are at least somewhat charitably inclined. Starting at age 70 ½, Americans can transfer money directly from a traditional IRA to a charity, exclude the distribution from taxable income, and still claim the standard deduction. Essentially, if you’re charitably inclined, at a minimum you would want to go into age 70 ½ with enough in your traditional IRAs (likely through contributions to traditional 401(k)s that are later transferred to an IRA) to fund your charitable contributions from 70 ½ until death.

Why ever pay tax on that money (i.e., by making contributions to a Roth 401(k) that are later withdrawn to be donated) if the money is ultimately going to charity anyway?

Unused Standard Deductions

Currently, the government tells married couples, hey, you get to make $27,700 a year income tax free! Why not take advantage of that exclusion every year, especially prior to collecting Social Security (which, in many cases will eat up most, if not all, of the standard deduction).

Why be retired at age 55 with only Roth accounts? By having at least some money in traditional retirement accounts going into retirement, you ensure you can turn traditional money into Roth money tax-free simply by converting (at any time) or even distributing (usually after age 59 1/2) the traditional retirement account against the standard deduction.

Deduct at Work, Roth at Home

I think for many it makes sense to max out traditional 401(k)s at work and contribute to Roth IRAs or Backdoor Roth IRAs at home. Why? As discussed above, traditional 401(k)s can set up tax rate arbitrage in retirement, help early retirees qualify for Premium Tax Credits, and make charitable giving after age 70 ½ very tax efficient. At home, many working Americans do not qualify to deduct IRA contributions, so why not contribute to a Roth IRA or Backdoor Roth IRA, since (i) you aren’t giving up a tax deduction in order to do so and (ii) you establish assets growing tax free for the future.

In this post I discuss why deduct at work, Roth at home can often make sense and I provide examples where Roth 401(k) contributions are likely to be better than traditional 401(k) contributions.

Conclusion

I believe that for many in the FI community, a retirement savings plan that combines (i) traditional deductible 401(k) contributions during one’s working years and (ii) Roth conversions prior to collecting RMDs is likely to be a better path than simply making all workplace retirement contributions Roth contributions.

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

Follow me on Twitter at @SeanMoneyandTax

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 Taxation of Roth IRA Distributions

Roth IRAs allow tax-free distributions to fund retirement. However, to help secure retirement savings and avoid premature raiding of Roth IRAs, Congress did not give them blanket exemption from taxes and penalties. Thus, there are times where distributions from Roth IRAs are subject to either or both ordinary income tax and/or the 10% early withdrawal penalty. The IRS and Treasury have issued regulations governing the rules of the road for Roth IRAs, which interpret the rules Congress wrote in IRC Section 408A.

A Few Introductory Notes Before We Get Started

The below post is different from many posts on FITaxGuy.com in two respects. First, my posts tend to be planning focused, though they often dive into tax rules, as a good understanding of the rules helps with planning. This post is almost entirely rules focused rather than planning focused.

Second, the primary audience for this post is tax and financial advisors (though I welcome both laymen and professionals reading and questioning the post). I have recently observed that professionals seem to be confused about the Roth IRA distribution rules. It’s time to lay out the rules with citations to the relevant governing regulations!

Below I lay out my breakdown of the rules with extensive citation to the regulations so you can see where I’m getting my assertions from. You get to be the judge and jury as to whether I have properly presented the relevant rule.

Now, back to the show. Per Treas. Reg. Section 1.408A-6 Q&A 1(a) “[t]he taxability of a distribution from a Roth IRA generally depends on whether or not the distribution is a qualified distribution.”

Roth IRA Qualified Distributions

A qualified distribution is not included in the Roth IRA’s owner’s gross income (Treas. Reg. Section 1.408A-6 Q&A 1(b)) and is thus tax free and penalty free (see Treas. Reg. Section 1.408A-6 Q&A 5(a)).

The way most distributions from a Roth IRA qualify as a “qualified distribution” is by satisfying the requirements that the owner (1) is age 59 ½ or older (see Treas. Reg. Section 1.408A-6 Q&A 1(b)(2)) and (2) has owned a Roth IRA for at least 5 years (see Treas. Reg. Section 1.408A-6 Q&A 1(b)(1)).

Once one qualifies for a qualified distribution by satisfying both the age 59 ½ requirement and the 5 year requirement, he or she no longer has any need to consider either of the two Roth IRA 5-year rules (the so-called 5-Year Conversion Clock and the so-called 5-Year Earnings Clock).

Roth IRA Nonqualified Distributions

Now we turn to the taxation of distributions that do not qualify as qualified distributions (what I colloquially refer to as “nonqualified distributions”). As a very general matter, the taxation of these distributions is mostly governed by Treas. Reg. Section 1.408A-6 Q&As 1, 4, 5, 8, and 9.

Ordering Rule

Treas. Reg. Section 1.408A-6 Q&A 8 provides an ordering rule for distributions from a Roth IRA. This creates three layers. Each layer must be fully withdrawn prior to a subsequent layer being accessed. See Treas. Reg. Section 1.408A-6 Q&A 8(a).

First, all annual contributions are withdrawn. Second, all previous Roth conversions are withdrawn (first in, first out). Third, earnings (growth) in the Roth IRA are withdrawn.

Tax Free Withdrawal of Owner Contributions (Both Annual Contributions and Roth Conversions)

Annual contributions and Roth conversions are “contributions” that are always withdrawn income tax free. See Treas. Reg. Section 1.408A-6 Q&A 1(b) (contributions always are withdrawn tax free), Q&A 8(a) (annual contributions and Roth conversions are both “contributions”).

Roth IRA annual contributions can be withdrawn at any time for any reason tax and penalty free! See Treas. Reg. Section 1.408A-6 Q&A 1(b) and Q&A 5(a).

5 Year Clock on Roth Conversions

However, the withdrawal of taxable Roth conversions can be subject to the 10% early withdrawal penalty. See Treas. Reg. Section 1.408A-6 Q&A 5(b) (see also IRC Section 408A(d)(3)(F)). This is only true if the Roth conversion is withdrawn within 5 years. See Treas. Reg. Section 1.408A-6 Q&A 5(b) (the 5-Year Conversion Clock).

Per Treas. Reg. Section 1.408A-6 Q&A 5(b), the exceptions to the 10% early withdrawal penalty also apply. The most prominent such exception is having attained the age of 59 ½. Thus, a distribution from a Roth IRA received by an owner at least 59 ½ years old will never be subject to the 10% early withdrawal penalty.

Roth Earnings

Nonqualified distributions of earnings are subject to ordinary income tax (see Treas. Reg. Section 1.408A-6 Q&A 4) and potentially the 10% early withdrawal penalty (see Treas. Reg. Section 1.408A-6 Q&A 5(a)). Generally speaking, if one is either under age 59 ½ years old (see Treas. Reg. Section 1.408A-6 Q&A 1(b)(2)) or if the owner has not owned a Roth IRA for at least 5 years (see Treas. Reg. Section 1.408A-6 Q&A 1(b)(1), the 5-Year Earnings Clock), any withdrawal of earnings will be subject to ordinary income tax. Further, if one receives a distribution of earnings prior to age 59 ½, they are generally subject to the 10% early withdrawal penalty, unless they qualify for another exception.

Note that as a practical matter, distributions of earnings received prior to turning age 59 ½ are rare since all previous annual contributions and Roth conversions must be withdrawn prior to a distribution being considered a distribution of earnings.

A Quick Note on Roth IRA Aggregation

For purposes of assessing the taxation of a distribution from a Roth IRA, one aggregates all of their Roth IRAs and treats them together as a single Roth IRA. See IRC Section 408A(d)(4), Treas. Reg. Section 1.408A-6 Q&A 9(a) and (b), and my YouTube video on the subject.

UPDATE October 30, 2023: I appreciate Andy Ives’s post on IRAHelp.com. He lays out very simply the Roth IRA Distribution rules at the end of this short post. His analysis agrees with mine.

Application to Fact Patterns

Having now covered the universe of the taxation of Roth IRA distributions (both qualified distributions and nonqualified distributions), let’s apply the rules to four examples.

Example 1: Jorge celebrates his 65th birthday in the year 2023. After his birthday party, he converted $40,000 of his traditional 401(k) to a Roth IRA. The conversion is fully taxable. This is the first time Jorge has owned any Roth IRA. On January 1, 2024, Jorge withdrew $25,000 from his Roth IRA. On January 1, 2025, Jorge withdrew $25,000 from his Roth IRA.

What results in 2024 and 2025?

Jorge, as of both 2024 and 2025, does not meet the criteria for taking a qualified distribution because he has not owned a Roth IRA for at least 5 years. Thus, he has a nonqualified distribution in both years.

In 2024, the $25,000 withdrawal of Roth conversions is income tax free (see Treas. Reg. Section 1.408A-6 Q&A 1(b)) and is penalty free because Jorge is older than age 59 ½. This demonstrates that the 5-Year Conversion Clock is irrelevant once one turns age 59 ½. Check out Jorge’s 2024 Form 8606 Part III here (pardon the use of the 2022 version, it’s the latest one available as of this writing).

In 2025, the first $15,000 of Jorge’s withdrawal is a return of Roth conversions and thus not subject to ordinary income tax. Further, this withdrawal is not subject to the 10% early withdrawal penalty. The second $10,000 Jorge withdrew is a nonqualified distribution of earnings. Jorge must pay ordinary income tax on those $10,000 (see Treas. Reg. Section 1.408A-6 Q&A 4). This withdrawal of earnings violates the 5-Year Earnings Clock and is thus subject to ordinary income tax. However, this withdrawal of earnings is not subject to the 10% early withdrawal penalty as Jorge is older than age 59 ½. Check out Jorge’s 2025 Form 8606 Part III here.

Example 2: Samantha celebrates her 45th birthday in the year 2023. After her birthday party, she converted $60,000 of her old traditional 401(k) to a Roth IRA. The conversion is fully taxable. This is the first time Samantha has owned any Roth IRA. On January 1, 2024, Samantha withdrew $25,000 from her Roth IRA. On January 1, 2025, Samantha withdrew $40,000 from her Roth IRA.

What results in 2024 and 2025?

Samantha, as of both 2024 and 2025, does not meet the criteria for taking a qualified distribution because she has not owned a Roth IRA for at least 5 years. Thus, she has a nonqualified distribution in both years.

In 2024, Samantha’s withdrawal is a return of Roth conversions and thus not subject to ordinary income tax. However, because the withdrawal is from Roth conversions younger than 5 years old, and Samantha is under age 59 ½, Samantha must pay the 10% early withdrawal penalty ($2,500) on the distribution (she violates the 5-Year Conversion Clock), unless an exception applies.

In 2025, the first $35,000 of Samantha’s withdrawal is a return of Roth conversions and thus not subject to ordinary income tax. However, because the withdrawal is from Roth conversions younger than 5 years old, Samantha must pay the 10% early withdrawal penalty ($3,500) on the distribution (she violates the 5-Year Conversion Clock), unless an exception applies.

The second $5,000 Samantha withdrew in 2025 is a nonqualified distribution of earnings. Samantha must pay ordinary income tax on those $5,000 (see Treas. Reg. Section 1.408A-6 Q&A 4) and generally must pay the 10% early withdrawal penalty ($500) on that $5,000 distribution of earnings, unless an exception applies.

Example 3: Ed celebrates his 65th birthday in the year 2023. After his birthday party, he converted $40,000 of his old traditional 401(k) to a Roth IRA. The conversion is fully taxable. Ed has owned a Roth IRA since 1998. On January 1, 2024, Ed withdrew $25,000 from his Roth IRA. On January 1, 2025, Ed withdrew $25,000 from his Roth IRA.

What results in 2024 and 2025?

Unlike Examples 1 & 2, we finally have a qualified distribution! Why? Ed has (i) owned a Roth IRA since 1998 (more than 5 years) and (ii) is over age 59 ½. Thus, the only type of distribution Ed can take from his Roth IRA is a qualified distribution. Per Treas. Reg. Section 1.408A-6 Q&A 1(b), a qualified distribution is tax free. Further, Ed cannot pay the early withdrawal penalty on a distribution from his Roth IRA as he is in his 60s (see also Treas. Reg. Section 1.408A-6 Q&A 5(a)). Thus, there is no tax and no penalty on either the 2024 distribution or the 2025 distribution.

Example 4: This example is based on my conversation with Brad Barrett on a recent episode of the ChooseFI podcast. Jonathan turns age 57 on July 1, 2023. He’s never had a Roth IRA. On July 1, 2023, he converted $50,000 from a traditional IRA to a Roth IRA. The conversion is fully taxable.

What withdrawal constraints does Jonathan have on his Roth IRA?

If Jonathan withdraws up to $50,000 from his Roth IRA prior to turning age 59 ½ on January 1, 2026, Jonathan will have to pay the 10% early withdrawal penalty as he violates the 5-Year Conversion Clock (unless an exception applies).

If Jonathan cumulatively withdraws amounts in excess of $50,000 from his Roth IRA prior to turning age 59 ½, he will pay ordinary income tax on the withdrawal of those earnings (as he violates the 5-Year Earnings Clock) and he will pay the 10% early withdrawal penalty (unless an exception applies).

From January 1, 2026 through December 31, 2027, if Jonathan cumulatively withdraws amounts in excess of $50,000 from his Roth IRA, he will pay ordinary income tax on the withdrawal of those earnings (as he violates the 5-Year Earnings Clock). However, Jonathan will not pay the 10% early withdrawal penalty. Starting on January 1, 2028, Jonathan satisfies the 5-Year Earnings Clock (see Treas. Reg. Section 1.408A-6 Q&A 2) and is now permanently able to take a qualified distribution from his Roth IRA going forward.

Example 5: Denzel celebrates his 35th birthday in the year 2023. After his birthday party, he contributed $6,500 to a traditional IRA on July 1, 2023. He cannot deduct the contribution based on his income level. On August 2, 2023, at a time the traditional IRA was worth $6,502, he converted the entire traditional IRA to a Roth IRA, completing a Backdoor Roth IRA. This is the first time Denzel has owned any Roth IRA. He owned no traditional IRAs, SEP IRAs, and/or SIMPLE IRAs on December 31, 2023. Denzel reported $2 of taxable income on his 2023 tax return due to the Backdoor Roth IRA.

On January 16, 2024, Denzel withdrew $3,000 from his Roth IRA and made no contributions to his Roth IRA during 2024.

What results in 2024?

Denzel, as of 2024, does not meet the criteria for taking a qualified distribution because he has not owned a Roth IRA for at least 5 years. Thus, he has a nonqualified distribution in 2024.

Pursuant to Treas. Reg. Section 1.408A-6 Q&A 8(b), the taxable portion of the Roth conversion ($2 out of $6,502) comes out first. That $2 is subject to the 10% early withdrawal penalty (a $0.20 penalty which rounds down to $0) since he violates the 5-Year Conversion Clock, unless an exception applies. This $2 constitutes what I colloquially refer to as a micro layer inside the Roth IRA: for 5 years it is subject to the 10% early withdrawal penalty if withdrawn (unless an exception applies).

However, the $2 recovery of the taxable Roth conversion is not subject to ordinary income tax. See Treas. Reg. Section 1.408A-6 Q&A 1(b).

Second, the $2,998 nontaxable portion of the Roth conversion is distributed out. This nonqualified distribution is subject to neither ordinary income tax nor the 10% early withdrawal penalty. See Treas. Reg. Section 1.408A-6 Q&A 1(b), 5(a), and 5(b). Check out Denzel’s 2024 Form 8606 Part III here.

There is some confusion on this latter result. Treas. Reg. Section 1.408A-6 Q&A 4 provides that only once all of the owner’s previous “contributions” have been withdrawn are nonqualified Roth IRA distributions subject to ordinary income tax. For this purpose, it is clear from reading Treas. Reg. Section 1.408A-6 Q&A 8(a) that “contributions” include both “annual contributions” and “Roth conversions.” See also Treas. Reg. Section 1.408A-6 Q&A 5(b) providing that the 10% early withdrawal penalty does not hit withdrawals of nontaxable converted amounts (“For purposes of applying the tax, only the amount of the conversion contribution includible in gross income as a result of the conversion is taken into account.”). Thus, the nontaxable portion of a Backdoor Roth IRA can be recovered tax and penalty free at any time for any reason.

Other than the minor potential Backdoor Roth IRA micro layer issue, a Backdoor Roth IRA could, in theory, serve as an emergency fund (though generally we want to plan for long term Roth IRA tax-free growth).

Roth IRA Distributions Summary Chart

Type of Distribution	Ordinary Income Tax	10% Early Withdrawal Penalty	Notes
Qualified Distribution	Never	Never	Main way to qualify: attain age 59 ½ and own Roth IRA for 5 years.
NQ Return of Annual Contributions	Never	Never	Comes out prior to returns of conversions and earnings.
NQ Return of Roth Conversions	Never	Can apply. Applies if the taxable conversion is less than 5 years old and the owner is under age 59 ½ (though exceptions can apply).	Come out “FIFO” (first-in, first out).
NQ Distribution of Earnings	Always	Yes, if the owner is under age 59 ½ (though exceptions can apply).	Come out only if all prior annual contributions and conversions have been withdrawn.

NQ stands for nonqualified

Exceptions to the 59 ½ Year Age Requirement

It is possible to qualify for a qualified distribution if one is younger than 59 ½ years of age. It happens if (1) the 5-Year Earnings Clock is satisfied and (2) the Roth IRA owner (i) is using the money for a first-time home purchase (limit of $10,000), or (ii) is disabled, or (iii) has died. See Treas. Reg. Section 1.408A-6 Q&A 1(b)(2). Outside of the owner’s death, these situations are rare.

Resources

Notice this post cites the to regulation and occasionally the Internal Revenue Code. That’s because they are the law of land! The Code is the primary law of the land, but it tends to be written in a manner inaccessible to most laymen and difficult for many professionals to understand. The regulations interpret the Code. While not an elementary school level read, Treas. Reg. Section 1.408A-6 is much more comprehensible than the Code. The regulation’s question and answer format makes it much easier to digest.

IRS Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs), is an IRS publication. As such it is (i) informative and (ii) not binding authority on either the IRS or on taxpayers. Please understand both when using an IRS publication. I will note that Publication 590-B has an excellent flowchart (Figure 2-1) which can be used to help determine if a distribution from a Roth IRA is a qualified distribution.

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

Follow me on Twitter at @SeanMoneyandTax

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.

How I Learned to Stop Worrying About the Roth IRA 5 Year Rules

You know what gets too much attention in the personal finance space? The two five-year Roth IRA rules.

Why do I say that? Because the odds are extremely low that either rule will ever impact most Roth IRA owners. While the rules theoretically have wide effect, in practice, discussed further below, they rarely impact the taxation of Roth IRA distributions.

Before I get started, below is a summary table of the two five-year rules (or five-year clocks, use whichever terminology you prefer). The table is not comprehensive, but rather intended to cover the vast majority of situations. I hope you find this table to be a useful reference regarding the two five-year rules.

Rule	Tax Bite	Age	Code Section	Regulation
First Five-Year Rule	Ordinary income tax on withdrawal of earnings from Roth IRA only	Generally bites only if owner is over 59 ½ years old	408A(d)(2)(B)	1.408A-6 Q&A 2
Second Five-Year Rule	10% early withdrawal penalty on withdrawal of taxable converted amounts from Roth IRA only	Only bites if owner is under age 59 ½	408A(d)(3)(F)	1.408A-6 Q&A 5(b)

First Five-Year Rule: Earnings Cannot Be Withdrawn Income Tax Free From a Roth IRA Unless the Account Holder has Owned a Roth IRA for Five Full Tax Years

At first, this rule seems daunting. As written, it applies to anyone owning a Roth IRA. But in practice, it rarely has any bite. First, the rule only serves to disqualify a distribution from being a “qualified distribution.”

Here’s the thing: outside of rare circumstances (see “Two Uncommon Situations” below), anyone under age 59 ½ cannot receive a “qualified distribution” from their own Roth IRA regardless of the first five-year rule.

Thus, as a general matter, the first five-year rule is a rule that only applies to those age 59 ½ and older.

For those doubting me, I’ll prove it with two examples:

Example 1: Ernestine turns age 25 in the year 2023. In March, she made a $6,500 annual contribution to a Roth IRA for the year 2023. This is her only ever Roth IRA contribution. In 2026, when the Roth IRA is worth $8,000 and Ernestine turns age 28, Ernestine withdraws all $8,000 from the Roth IRA. The first $6,500 is a nontaxable return of the $6,500 contribution, and the remaining $1,500 is a taxable distribution of earnings subject to both ordinary income tax and the 10 percent early withdrawal penalty.

Example 2: Hortense turns age 25 in the year 2023. In March, she made a $6,500 annual contribution to a Roth IRA for the year 2023. This is her only ever Roth IRA contribution. In 2030, when the Roth IRA is worth $8,000 and Hortense turns age 32, Hortense withdraws all $8,000 from the Roth IRA. The first $6,500 is a nontaxable return of the $6,500 contribution, and the remaining $1,500 is a taxable distribution of earnings subject to both ordinary income tax and the 10 percent early withdrawal penalty.

Ernestine did not satisfy the first five-year rule, Hortense did. Notice that it did not matter! Both must pay ordinary income tax and the 10% early withdrawal penalty on the $1,500 of earnings they each received from their Roth IRA. The first five-year rule had absolutely no impact on the taxation of the withdrawal because both Roth IRA owners are under age 59 ½. This proves that outside unusual circumstances, the first five-year rule has no impact on those under age 59 ½.

I’ve said it before and I’ll say it again: Previous annual contributions to a Roth IRA can be withdrawn from a Roth IRA tax and penalty free at any time for any reason! The first five-year rule has nothing to do with withdrawals of previously made contributions. See Treas. Reg. Sec. 1.408A-6 Q&A 1(b) (previous contributions are withdrawn tax free) and Q&A 5(a) (tax free withdrawals of previous regular annual contributions are not subject to the 10% early withdrawal penalty).

So when the heck does the first five-year rule matter? Here are two examples to help us figure it out.

Example 3: Ernie turns age 58 in the year 2023. In March, he made a $7,500 annual contribution to a Roth IRA for the year 2023. This is his only ever Roth IRA contribution. In 2026, when the Roth IRA is worth $10,000 and Ernie turns age 61, Ernie withdraws all $10,000 from the Roth IRA. The first $7,500 is a nontaxable return of the $7,500 contribution, and the remaining $2,500 is a taxable distribution of earnings subject to ordinary income tax. Ernie does not pay the 10 percent early withdrawal penalty because he is over age 59 ½ when he receives the earnings.

Example 4: Harry turns age 58 in the year 2023. In March, he made a $7,500 annual contribution to a Roth IRA for the year 2023. This is his only ever Roth IRA contribution. In 2030, when the Roth IRA is worth $10,000 and Harry turns age 65, Harry withdraws all $10,000 from the Roth IRA. As Harry satisfies both the first five-year rule and is over age 59 ½, the entire $10,000 distribution is a qualified distribution and thus entirely tax and penalty free.

We’ve found where the first five-year rule matters! Generally speaking, the first-five year rule only bites when applied to a distribution of earnings if the recipient is over the age of 59 ½. Further, it only applies to subject the earnings to ordinary income tax, not the 10% early withdrawal penalty (as being age 59 ½ or older is always a valid exception to the early withdrawal penalty).

Remember, though, in most cases it is difficult to access Roth IRA earnings. Why? Because earnings come out of a Roth IRA last. Ernie’s fact pattern is rare. Many Roth IRA owners will have years of contributions and/or conversions inside their Roth IRA. As I have previously discussed, nonqualified distributions from Roth IRAs first access Roth IRA contributions and then access Roth IRA conversions before they can access a penny of earnings. See also Treas. Reg. Sec. 1.408A-6 Q&A 8 and Natalie B. Choate’s Life and Death Benefits for Retirement Planning (8th Ed. 2019), page 328.

Further, in today’s world, most (though not all) 59 ½ year old Roth IRA owners will satisfy the five-year rule. All Roth IRAs are aggregated for this purpose, so the funding (through a contribution or conversion) of any Roth IRA starts the five-year clock as of January 1st of the year for which the contribution was made. See Treas. Reg. Sec. 1.408A-6 Q&A 2.

Two Uncommon Situations: There are two uncommon situations in which a Roth IRA owner under age 59 ½ receiving a Roth IRA distribution could save the ordinary income tax by satisfying the first five-year rule. The first is the taking of an up-to $10,000 first-time home buyer distribution. See Choate, previously referenced, at page 612. The second is if the owner is disabled as defined by Section 72(m)(7). Both are rare situations. Further, in both such cases, satisfying the first five-year rule would be irrelevant if the distribution would have been a return of contributions, nontaxable conversions, and/or taxable conversions at least 5 years old.

Inherited Roth IRA Twist: The first five-year rule can affect distributions from an inherited Roth IRA. I’ve heard this referred to as the third Roth IRA five-year rule, but I view it as simply a continuation of the first five-year rule. A withdrawal of earnings by a beneficiary from an inherited Roth IRA made less than five tax years after the owner originally funded the Roth IRA is subject to ordinary income tax. See Treas. Reg. Sec. 1.408A-6 Q&A 7. These situations are quite rare.

If Anyone on Capitol Hill is Reading This . . .

The first five-year rule serves no compelling purpose, and is superfluous as applied to most taxpayers under the age of 59 ½.

Perhaps in 1997 Congress worried about quick withdrawals from Roth IRAs. Now that we fully understand that contributions and conversions come out of Roth IRAs first, and that being under age 59 ½ prevents a tax-free distribution of earnings in most cases, there’s no reason for the first five-year rule. Being age 59 ½ or older (or death, disability, or first-time home buyer) should be sufficient to receive a qualified distribution.

I recommend that Congress repeal the first five-year rule by removing Section 408A(d)(2)(B) from the Internal Revenue Code as part of retirement tax simplification.

Second Five-Year Rule: Taxable Conversions Are Subject to the Ten Percent Early Withdrawal Penalty if Withdrawn from the Roth IRA Within Five Taxable Years

This rule is much more logical than the first five-year rule. The reason has nothing to do with Roth IRAs. Rather, the reason is to protect the 10% early withdrawal penalty as applied to traditional IRAs and traditional workplace plans such as 401(k)s and 403(b)s. Without the second five-year rule, taxpayers would never pay the 10% early withdrawal penalty.

Rather, taxpayers under age 59 1/2 would simply convert any money they want to withdraw from a traditional retirement account to a Roth IRA, and then shortly thereafter withdraw the amount from the Roth IRA tax-free as a return of old contributions or of the conversion itself.

The second five-year rule prevents the total evisceration of the 10% early withdrawal penalty.

The second five-year rule applies separately to each taxable Roth conversion. Each Roth conversion that occurs during a year is deemed to occur January 1st of that year for purposes of the second five-year rule. See Treas. Reg. Sec. 1.408A-6 Q&A 5(c).

Note further that the second five-year rule has nothing to do with income tax: its bite only triggers the distribution being subject to the 10% early withdrawal penalty.

When Might the Second Roth IRA Five-Year Rule Apply

I am not too worried about the application of the second five-year rule. Here’s why.

First, the second five-year rule is not likely to apply while one is working. During the accumulation phase, many are looking to contribute to, not withdraw from, Roth IRAs.

Second, for those retiring after age 59 ½, the second five-year rule will have practically no impact, as (i) they are not likely to take pre-retirement distributions from their Roth IRA, and (ii) distributions taken from the Roth IRA by the owner after turning age 59 ½ are never subject to the 10% early withdrawal penalty.

Third, many early retirees will choose to live off taxable assets first in early retirement. As a result, many will not access Roth accounts until age 59 ½ or later, and thus the second five-year rule will not be relevant.

However, some will choose to employ a Roth Conversion Ladder strategy with respect to an early retirement. Here the second five-year rule might bite. Let’s consider a quick example:

Example 5: Josh is considering retiring in 2024 when he turns age 50. In his 30s, he qualified to make an annual Roth IRA contribution and maxed out his Roth IRA each year. In his 40s, he made income in excess of the annual MAGI limits on Roth IRA contributions, so he maxed out the Backdoor Roth IRA for each year. He plans on living on taxable assets for the first five years of retirement and then living off Roth conversion ladders from age 55 through age 59 ½. Josh has never previously taken a distribution from a Roth IRA.

Here is Josh’s Roth IRA history in table form. Thanks to Investopedia for the historic annual contribution maximums.

Year	Age	Roth IRA Contribution	Backdoor Roth IRA	Taxable Amount
2004	30	$3,000
2005	31	$4,000
2006	32	$4,000
2007	33	$4,000
2008	34	$5,000
2009	35	$5,000
2010	36	$5,000
2011	37	$5,000
2012	38	$5,000
2013	39	$5,500
2014	40		$5,502	$2
2015	41		$5,503	$3
2016	42		$5,501	$1
2017	43		$5,502	$2
2018	44		$5,501	$1
2019	45		$6,001	$1
2020	46		$6,002	$2
2021	47		$6,002	$2
2022	48		$6,001	$1
2023	49		$6,004	$4

If Josh started withdrawing from his Roth IRA in 2024, he would first withdraw all $45,500 of previous annual contributions (all tax and penalty free) and then withdraw all $33,510 of his 2014 through 2019 Backdoor Roth IRAs (all tax and penalty free) before he could take a distribution with respect to which the second five-year rule could bite.

Note that for withdrawals of up to $79,010, it is irrelevant that Josh does not satisfy the second five-year rule with respect to the 2020 through 2023 Backdoor Roth IRAs. Josh can withdraw up to $79,010 entirely tax and penalty free in 2024. Perhaps the second five-year rule’s bark is worse than its bite . . .

If, in 2024, Josh withdraws both of the above listed amounts from his Roth IRA, then yes, the next $2 of withdrawals in 2024 would be from the $2 taxable amount of his 2020 Backdoor Roth IRA, which would be subject to the 10% early withdrawal penalty ($0.20) under the second five-year rule.

In Josh’s extreme example, the second five-year rule bites, but, as you can see, it barely bites!

As an aside, assuming Josh continues to withdraw money from his Roth IRA in 2024, the next $6,000 is a tax and penalty free return of the non-taxable portion of his 2020 Backdoor Roth IRA! See Treas. Reg. Sec. 1.408A-6 Q&A 8. The generosity of the Roth IRA nonqualified distribution rules is, by itself, a reason not to sweat the two Roth IRA five-year clocks too much.

Assuming Josh follows through with his plan and waits until age 55 (the year 2029) to start withdrawing from his Roth IRA, he can access all of his 30s Roth IRA annual contributions ($45,500), all of his 40s Backdoor Roth IRAs ($57,519), and whatever amount he converted to his Roth IRA in 2024 tax and penalty free in 2029! After that, however, the second five-year rule will bite ten cents on the dollar for amounts additionally distributed in 2029, since amounts converted in 2025 or later would still be subject to the second five-year rule if distributed in 2029.

In Josh’s early retirement example, assuming Josh takes no distributions from his Roth IRA until age 55, the second five-year rule can only possibly bite from age 55 to 59 ½, and even then, the combination of years of built up Roth basis and affirmative planning make that possibility at least somewhat remote.

Don’t over think it: If the owner of a Roth IRA is 59 1/2 years old or older, and has owned a Roth IRA for at least 5 years, all distributions they receive from a Roth IRA are qualified distributions and thus fully tax and penalty free. In such circumstances, the 5-year clocks are entirely irrelevant.

Conclusion

It’s perfectly cromulent to proceed with financial planning without too much worry about the two Roth IRA five-year rules. For personal finance nerds (myself included), the two Roth IRA five-year clocks can be fun to dive into. But from a practical standpoint, they rarely impact the taxation of distributions from Roth IRAs. The two five-year clocks are best understood as sporadically applicable exceptions to the general rule that most nonqualified distributions from Roth IRAs are tax and penalty free.

Medicare Resources

You know what doesn’t get enough coverage in the personal finance space: Medicare! It’s complicated, and frankly, I have neither the time nor the mental bandwidth to become a Medicare expert.

However, recently I have seen some excellent YouTube Videos on the topic. I believe all the links provided below are worthy of consideration. That consideration should, of course, include critical analysis: these videos are great, but they didn’t come down the mountain with Moses (neither did any of my blog posts or YouTube videos).

Further, none of the videos should be relied upon as advice for any particular person. They are all educational resources.

Sarasota Tim on Medicare Basics and Enrolling: https://www.youtube.com/watch?v=FNCk7x26i_M

Clark Howard Shares His Concerns with Medicare Advantage (Medicare Part C): https://youtu.be/QUSdn7nGXvQ?t=192

Danielle Kunkle Roberts on Medigap Part G: https://www.youtube.com/watch?v=XtqfO22-Tss

Danielle Kunkle Roberts on Medigap High Deductible Part G: https://www.youtube.com/watch?v=s2aRGN7pR1Q

MedicareSchool on Medigap Part G Versus Medigap Part N: https://www.youtube.com/watch?v=tYXvKvMPbpI

MedicareSchool on Medicare Part D (Prescription Drugs): https://www.youtube.com/watch?v=rSLx-lFr-DM

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

Follow me on Twitter at @SeanMoneyandTax

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, investment, and tax matters. Please also refer to the Disclaimer & Warning section found here.

Saving Social Security and Medicare

America has a retirement savings problem. To varying degrees, Social Security and Medicare support retirees. Other than for the very wealthy, a significant diminution in either program would materially hurt retirees.

Most can agree with a simple proposition: over the long term, there are fiscal holes in Social Security and Medicare.

I have seven proposals to address the problem. These proposals won’t solve funding problems for all time, but will move the needle significantly towards securing Social Security and Medicare. All the tax related proposals tax those who have benefited the most from the American economy and a very favorable investment tax climate.

Before I get started, I would like to encourage the reader to endeavor to reduce his or her dependence on these programs by building up their own retirement assets and/or income streams. That said, as a practical matter both Social Security and Medicare are very important to the retirements of the vast majority of Americans.

Who Pays to Save Social Security and Medicare?

PROPOSAL ONE: No changes to the Social Security and Medicare eligibility ages.

Some propose to increase the eligibility age for Medicare and/or Social Security full retirement age.

I believe that to be a horrible idea, for a myriad of reasons. Over the long term, there are fiscal holes in Social Security and Medicare. By definition, someone in the world must pay for those holes. If we eliminate more outlandish possibilities such as billing invading extraterrestrials and foreign plunder, most of the cost must be made up by some cohort or cohorts of Americans. Raising the eligibility ages to fix the holes simply decides that Americans in their mid-to-late 60s of all income and wealth levels are the cohort of Americans who must pay for those holes.

But why? Are 60-somethings particularly well off compared to other cohorts? I don’t believe they are, and many in their mid-to-late 60s are far worse off than the average American citizen.

I’m not the only commentator to oppose increasing Social Security eligibility ages.

My three tax proposals below are hardly perfect. But at least they put the onus on filling the holes on those who (i) have benefited most from the recent American economy and (ii) have most benefited from America’s very favorable investment and endowment tax environment. Why shouldn’t the people who have benefited the most, and would be harmed by tax increases the least, fix the Social Security and Medicare holes?

Further, my three tax proposals have a significant advantage over delaying eligibility ages. Delaying eligibility ages is a delayed fix! If enacted in 2023, my three proposals go to work (in full!) on January 1, 2024.

Any delay of the eligibility age will likely be at least somewhat delayed. No politician is going to vote to raise a 66 year old’s Social Security full retirement age overnight from age 67 to age 70. There’s zero chance of that. That’s demonstrated by this proposal, which proposes to increase Social Security eligibility ages by 3 years and admits that the proposal would not save money for at least 10 years!

Would you be happy if you called a plumber to fix a leak in your sink and he responded, “Sure, happy to help, I’ll swing on by in 10 years.” No!

Further, I am not going to advocate for a politically untenable solution, and I wouldn’t recommend any politician do so either. There are plenty of solutions that can be implemented short of solutions that are guaranteed to be wildly unpopular with the electorate.

One piece of evidence demonstrates just how unpopular cutting Social Security and Medicare are. A recent Axios-Ipsos poll (see the bottom of page 9) found that Americans generally oppose Social Security and Medicare cuts by a 7 to 2 margin. Any highly unpopular solution will ultimately be counterproductive.

A group of Republican Congressmen argue Social Security eligibility ages should be increased in the future to account for increased life expectancy (see the bottom of page 88 of this file). I believe their argument is mistaken for two reasons. First, some increases in life expectancy are attributable to diminished infant mortality instead of increased lifespan in old age. Second, in 2020 and 2021, American life expectancy decreased.

PROPOSAL TWO: No Increase to the FICA Tax Rates (Employee and Employer)

Historically, there have been many payroll tax increases to fund Social Security and Medicare. I believe, in today’s economy, a simple payroll tax rate increase would be unfair and would hurt many Americans who have not benefited from the surge in financial markets the way the affluent have. In a world where working class workers have not experienced real significant salary increases in decades, while the stock market has soared over several decades, we can’t simply increase payroll taxes on everyone and call it fair.

Further, it might be tempting to only increase the payroll tax rates paid by employers. But this runs into two big problems. First, it’s a tax on job creation. I, for one, want employers of all sizes creating more jobs in the United States. Increasing the tax rates employers pay for Social Security and Medicare increases incentives to offshore jobs and shifts towards automation. Count me against that.

Second, increasing employer tax rates is a tax hike on the self-employed. The self-employed face many challenges. They are not a cohort that should shoulder the burden of closing the fiscal holes in Social Security and Medicare.

Tax Increases to Save Social Security and Medicare

PROPOSAL THREE: Increase the additional Medicare tax on earned income from 0.9% to 2.0% Use half the tax (1.0%) fund Medicare and half the tax (1.0%) fund Social Security.

PROPOSAL FOUR: Increase the Medicare surtax on net investment income from 3.8% to 5.0%. Use the increase (1.2%) to fund Social Security.

These two proposals have several advantages. They incrementally increase taxes on the most successful in America in order to close the shortfalls in Social Security and Medicare. They are not taxes on employers hiring more employees, so they do not discourage hiring. Further, these two tax proposals leverage off existing taxes such that implementation of the proposals should be relatively easy.

PROPOSAL FIVE: Impose a new 25% excise tax on net investment income of college endowments with $1 billion or more in assets as of year end.

This new tax would replace the tiny 1.4% excise tax on some college endowments enacted as part of the Tax Cuts and Jobs Act (TCJA) in 2018.

Congress can allocate tax collections between Social Security and Medicare as they best see fit.

Once subject to the tax, a college endowment would be subject to it going forward until the endowment can demonstrate its year-end assets have been under $750 million for three consecutive years.

Net investment income for this purpose would be the endowment’s Section 1411(c)(1)(A) income, less the following limited expenses: salaries and benefits for employees primarily working for the endowment (limited to $20,000 per month per employee), endowment tax return preparation fees, endowment legal fees, office supplies and equipment (printers, copiers, scanners, etc.) for the endowment, and computer software for the endowment (limited to $1 million per year). Capital gains and capital losses would be netted and no net capital loss could be taken, though any net capital loss would carry forward without limit to subsequent years.

As the excise tax taxes endowments of financial assets, dorms, classrooms, and other buildings used by the university in their educational mission would not be endowment assets for purposes of the new excise tax.

Estimated payments would be due the same dates as individual estimates are due (and the same underpayment penalties would apply), and the net investment income of any controlled endowment entity (domestic or foreign) would also be included in the endowment’s net investment income.

These tax-free hoards have enjoyed incredibly favored treatment long enough. Some of these endowments now exceed $1 million per student, more than enough to fund many students without collecting a dollar of tuition.

Most colleges do not pay income tax on tuition and donations received. I don’t propose to change that, but it’s time these colleges, which mostly serve a select privileged few, pay a significant tax on their investment income. Considering these endowments are worth vast sums of money, that tax should be equal to the rate paid by highest income individuals on long term capital gains, 25% (20% long term capital gain rate plus 5% net investment income tax under my proposal).

You might think this is unfair to colleges. But let’s imagine we were tasked with creating the entire U.S. federal tax system from scratch. If I proposed to subject waiters and factory workers to both income taxes and payroll taxes on their entire salary, while exempting colleges from taxation on tuition collected and donations received, and then added a 25% net investment income tax on large endowments, you’d probably say “Wow, you’re being unfair to waiters and factory workers and too generous to colleges.”

I don’t propose a revolution in tax policy, but rather a fair, equitable, and incremental tax change that increases the tax burden on those most able to bear it in order to combat funding shortfalls in Social Security and Medicare.

Stabilizing The Federal Government’s Finances

PROPOSAL SIX: Significant reductions in military and foreign spending

Practically all Americans reading this are owed Social Security and/or Medicare benefits! That makes you a creditor of the U.S. government.

Your creditor’s financial health matters to you. It’s time your creditor got its house in order. Your creditor’s house is not in order for many reasons, including spending that is consistent with neither the founding nor the history of our great republic.

Incredibly enough, the United States has nearly three times as many foreign military bases as it has embassies. It’s time to ditch the bases and bring the troops home for many reasons. Having so many military and other government personnel overseas is contrary to the great history of our republic. As John Quincy Adams said, “America does not go abroad in search of monsters to destroy.” Today’s historically out-of-whack military and foreign spending is destabilizing the government’s finances. It’s time to cut military and foreign spending significantly and redeploy that money to reduce the deficit and secure the financial stability of the federal government.

A financially stable government is much more likely to be able to successfully meet its Social Security and Medicare obligations.

Some might argue that neither our current level of military spending nor Social Security and Medicare are consistent with the founding and history of our country, so shouldn’t both be cut? Jeffrey Sachs has observed that there is some popular support for cutting America’s foreign military involvement. On the other hand, there is very little appetite among the electorate for reductions to Social Security and Medicare. There’s no reason to consider wildly unpopular options when there are much more popular options on the table.

Self-Help

PROPOSAL SEVEN: Change Your Health

Not every change to improve the Social Security and Medicare system needs to come from Congress.

Over the years I have become more and more convinced that almost everything we learned about health and nutrition is wrong. It is time for each of us to radically take charge of our own healthcare. We need to do this regardless of the fiscal state of Social Security and Medicare. But my hope is this shift will reduce spending on Medicare.

I have seen my health improve by focusing on eating high quality animal fats and proteins, avoiding seed oils (which are very new in human history), and dramatically reducing sugar consumption. One reason I continue with that focus is that, as discussed by Doctors Ken Berry and Lisa Wiedeman, sugar feeds cancer! See also Dr. Ken Berry discussing this further. Avoiding certain foods can dramatically improve health outcomes and reduce medical spending (including Medicare spending).

My hope is that more and more Americans will become aware of the role of diet in health, and that will, over time, reduce long term medical expenses, including the expenses paid for by Medicare. Eventually, this renewed health will hopefully lead to longer life spans and increase future Social Security payments. If this happens, it hurts Social Security many years in the future. That much delayed good problem to have will hopefully be more than compensated for by earlier (and hopefully permanent) reductions in Medicare costs.

Conclusion

As the federal government racks up more and more debt, and the clock ticks towards financial peril for both Social Security and Medicare, it’s time to take action to preserve and protect these programs.

Follow me on Twitter at @SeanMoneyandTax

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

The above does not represent the opinion of anyone other than the author, Sean W. Mullaney. The author was not compensated by any individual or entity for writing this blog post, and this blog post does not necessarily reflect the views of any current or former employer of Sean W. Mullaney.

Sean on the Catching Up to FI Podcast

Listen as I talk tax with Becky Heptig and Bill Yount on the Catching Up to FI podcast.

You can access the podcast on Apple Podcasts.

We discuss tax planning for financial independence, particularly planning for those catching up later in their careers.

The show notes include references to the following FI Tax Guy blog posts.

The Advantages of Living on Taxable Assets First in Early Retirement

TikTok Tax Advice

Early Retirement and Social Security

HSAs and Las Vegas

This post, and the above mentioned podcast episode, are for entertainment and educational purposes only. They do 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.

Inherited Health Savings Accounts

Folks love health savings accounts, and why not? A tax deduction or exclusion on the way in, tax-free growth, and then tax-free withdrawals when used for qualified medical expenses or reimbursements of qualified medical expenses.

Tastes great and less filling!

Considering the HSA is less than 20 years old (as of this writing) and contribution limits are relatively modest, inherited HSAs have not been much of an issue in the personal finance world. I suspect that will soon change, as HSAs and their account owners age and HSA balances grow.

HSA Planning

There is something very fundamental one must keep in mind: planning for traditional retirement accounts and Roth retirement accounts is two sided. There is planning that owners should do for those retirement accounts prior to death and there is planning that inheriting beneficiaries should do after the owner’s death.

HSA planning, as you will see below, is mostly prior to the owner’s death. Other than a spouse, anyone else inheriting an HSA has relatively few planning opportunities.

Spousal Beneficiaries

The tax rules generally favor spousal beneficiaries, and the world of HSAs is no different. Section 223(f)(8)(A) has a very specific rule that changes the HSA account owner to the spouse as of death. This means the continuation of HSA account status, and thus continued tax free growth and future tax free withdrawals for payments of qualified medical expenses and for payments of previously unreimbursed qualified medical expenses (what I refer to as PUQME, pronounced “puck-me”).

As Notice 2004-50 Q&A 39 makes clear, there is no time limit on PUQME reimbursement. Thus, inheriting spouses should, generally speaking, be able to reimburse themselves for built up PUQME unaffected by their spouse’s death. For example, the surviving spouse should be able to reimburse him/herself tax and penalty free from the HSA for medical expenses of the decedent spouse incurred on their deathbed.

Obviously, HSA tax-free carryover treatment is very favorable. It is difficult to imagine circumstances where a married HSA owner would want to name anyone other than their spouse as the 100 percent primary beneficiary of their HSA. In theory, leaving an HSA to a charity at the first spouse’s death could be neutral when compared to leaving to the surviving spouse, if the couple is both very affluent and charitably inclined. Even then, it’s hard to see much of a drawback to naming the spouse as the primary beneficiary.

Other Individuals

Section 223(f)(8)(B) has some bad news for an individual, other than the surviving spouse, inheriting an HSA. Sure, they get the assets in the HSA. But, (i) the account loses its status as an HSA, and (ii) even worse, the entire amount of the HSA is included in the recipient’s taxable income in the year of the original owner’s death.

This is the hidden HSA death tax. As the HSA is under 20 years old, and frequently owed by younger people, the issue of the hidden HSA death tax has not come to the forefront of the personal finance space. To my mind, this is a lurking issue that many aren’t aware of.

The tax hit from an HSA inheritance could be quite significant. Here is one theoretical example.

Jack and Meghan are married, both age 51 in 2023, file joint, and claim the standard deduction. Planning on having an AGI of approximately $155K for 2023, they each contributed $7,500 to a Roth IRA for 2023 on January 2, 2023. They have one child in college and thus plan on getting a $2,500 AOTC tax credit for tuition paid.

On September 2, 2023, Meghan’s widowed father died and left his HSA, worth $75K, to Meghan. As a result, their AGI increases by $75K. On March 1, 2024, informed by their tax return preparer they did not qualify to make the Roth IRA contributions, they withdrew the contributions and the earnings attributable to the contributions ($750 each based on 10 percent growth). They also lose the ability to claim a credit for the college tuition they paid.

Here’s the tax consequences of Meghan inheriting the HSA.

Item	W/o HSA Inheritance	With HSA Inheritance
Ordinary Income (Initial)	$153,000	$153,000
Qualified Dividend Income	$2,000	$2,000
AGI (Initial)	$155,000	$155,000
HSA Inheritance	$0	$75,000
Roth IRA Earnings	$0	$1,500
AGI	$155,000	$231,500
Standard Deduction	$27,700	$27,700
Taxable Income	$127,300	$203,800
Tentative Tax	$18,481	$35,572
AOTC	$2,500	$0
Federal Income Tax	$15,981	$35,572
Federal Tax Increase	$0	$19,591
Effective Rate on AGI	10.31%	15.37%

The tax hit on inheriting the HSA is almost $20,000! Jack and Meghan pay more federal income tax on inheriting the HSA than they do on the rest of their income! Further, because tax benefits such as being able to contribute to a Roth IRA and AOTC qualification are based on MAGI, and inherited HSA income increases MAGI, Jack and Meghan (i) lost their 2023 AOTC and (ii) had to withdraw $15,000 in 2023 Roth IRA contributions and the related earnings.

Deduction Planning: Yes, Jack and Meghan could potentially tax loss harvest (getting a current deduction of up to $3,000) and/or increase contributions to charities and/or donor advised funds to itemize their deductions in a year they are now in the 24% bracket. This planning is only marginally helpful (particularly in a high standard deduction world) and does not lower their MAGI sufficient to still qualify for the AOTC and to make most of the annual Roth IRA contributions. Further, if Meghan inherited the HSA late in the year, there may not be enough time to execute such planning.

Inherited HSA Tax Exception

There is a narrow exception to full income inclusion. The inheriting non-spouse beneficiary can reduce the inherited HSA income inclusion by the amount of medical expenses incurred by the original owner prior to death and paid by the inheriting beneficiary in the year after the death.

The Estate

In theory, an HSA could be left to the estate of the HSA owner if (i) the owner elected such treatment on the beneficiary designation form or (ii) they failed to file a beneficiary designation form with the HSA provider.

The original owner’s final income tax return must include the fair market value of the HSA in taxable income if the HSA is left to the estate. See IRS Publication 969, page 10.

Obviously, this is not a great result. In theory, if the owner is low income and the ultimate intended beneficiary is high income, one might want to name their estate as the beneficiary of the HSA. Considering that the are planning alternatives that can avoid anyone paying income tax on an HSA, this is not likely to be a good “go-to” planning option.

Charitable Beneficiaries

Many HSA owners are at least somewhat charitably inclined. The inherited HSA rules present a planning opportunity: leave HSA balances to charity if the HSA owner is not married. Charities pay no income tax when inheriting an HSA.

As discussed above, the optimal planning for a charitably inclined married couple is likely to be to name the spouse as the primary beneficiary. Only after the death of the first spouse would the primary beneficiary be changed to the charity.

Note that HSA owners should discuss naming a charity or charities as a primary or secondary beneficiary with their HSA account provider.

Later In Life HSA Planning

What could Meghan’s widowed father have done to avoid costing his daughter and son-in-law almost $20,000 in federal income taxes?

First, strong consideration should be given to bailing out HSAs during old age, particularly if the HSA owner is not married. HSAs will not be too difficult to deplete tax and penalty free. Reimbursements of PUQME can access thousands of dollars of old qualified medical expenses, and the elderly will have plenty of new qualified medical expenses, including final medical expenses of deceased spouses. Further, Medicare Parts B and D premiums qualify as qualified medical expenses, so even the healthy elderly should be able to reimburse themselves tax-free from their HSA annually for some qualified medical expenses.

Had Meghan’s father reimbursed himself tax-free for PUQME instead of leaving the money inside the HSA, Meghan could have inherited the money (now in a taxable account) income tax free.

Second, Meghan’s widowed father could have named a charity as the primary beneficiary on the HSA, and left taxable brokerage accounts, Roth retirement accounts, and even traditional retirement accounts to Meghan. Even the traditional retirement accounts would not have either created no taxable income to Meghan in 2023, or, at worst, would have required Meghan to take the RMD her father was required to take in 2023 (if her father died before taking it).

I recently wrote about strategic planning in this regard. If one is not married, accounts such as Roth IRAs and taxable brokerage accounts are great to leave to individual beneficiaries. HSAs are great for unmarried people to leave to a charity if one is charitably inclined.

Conclusion

HSAs are arguably the most tax favored accounts during one’s lifetime. This remains true when passing an HSA to a spouse. However, the tax advantage of an HSA can turn into a tax bomb if left to a non-spouse. I refer to this as the hidden HSA death tax.

Planning to avoid the hidden HSA death tax includes taking reimbursements of PUQME from the HSA later in life and/or naming a charity as the primary beneficiary on an HSA if the owner is not married.

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

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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.

Inherited Roth IRAs

Inherit a Roth IRA in 2023 or later? Thinking about leaving a Roth IRA to heirs at your death? Then this article is for you. Note that it is an educational resource. It is not advice for any individual’s particular situation. Further, this article does not address situations where a person inherited a Roth IRA prior to the year 2023.

Inheriting a Roth IRA is great, since distributions are always penalty free and tax-free 99.99% of the time. The only time a distribution from a non-spousal inherited Roth IRA could be subject to income tax is if the distribution is a distribution earnings from the Roth IRA prior to the passage of 5 years from January 1st of the year the original owner first contributed to a Roth IRA. See Treas. Reg. Section 1.408A-6 Q&A 1(b). As a practical matter, few distributions from inherited Roth IRAs will be both (i) earnings of the inherited Roth IRA and (ii) made prior to the end of the five year clock.

Said differently, both the original owner and the beneficiary would have to be incredibly unlucky in order for a beneficiary to pay federal income tax on an inherited Roth IRA distribution.

In theory, a spouse inheriting a Roth IRA could pay tax and/or a penalty on distributions from an inherited Roth IRA the spouse treated as their own, but even that occurrence is likely to be rare, as discussed in more detail below.

Terminology and Titling

One inheriting a Roth IRA is a beneficiary. Yes, that inherited Roth IRA is now your property, but you are not the “owner” from a tax perspective. The original owner is the owner. You, the inheritor, are the beneficiary. If you die, the person inheriting the Roth IRA you inherited is a successor beneficiary.

Upon the owner’s death, the beneficiary should work with the Roth IRA’s financial institution to retitle the Roth IRA. The titling should indicate that the beneficiary is a beneficiary and should reference the owner.

The above two paragraphs are not the case as applied to spouses who choose to treat an inherited Roth IRA as their own. In that case, the inheriting spouse becomes the owner, not the beneficiary.

Types of Beneficiaries

To my mind, there are generally seven types of Roth IRA beneficiaries. Below, I use my own colloquialisms for each. You will not find the term “10-year beneficiary” in the Internal Revenue Code or the IRS website, for example. Rather, it is simply a term I colloquially use to refer to a particular type of inherited Roth IRA beneficiary.

To understand what happens when one inherits a Roth IRA, one must first understand what type of beneficiary they are among the below seven categories.

Watch me discuss Inherited Roth IRAs on YouTube.

Spouses

Spouses are generally favored inherited Roth IRA beneficiaries from a tax planning perspective. Married individuals should think long and hard prior to naming someone other than their spouse as their Roth IRA primary beneficiary for many reasons, including tax planning.

There are three options a spouse has when inheriting a Roth IRA. Two of those options entail the inherited IRA being treated as the inheriting spouse’s own Roth IRA. This is usually advantageous for several reasons, including the fact that an owner is never subject to required minimum distributions (“RMDs”) with respect to their own Roth IRA. Practically speaking, this is how most inherited Roth IRAs are handled by spouses.

SECURE 2.0 added a new fourth option for spouses to be treated as the deceased spouse when inheriting a retirement account. This change appears to matter as applied to RMDs, which the Roth IRA never has for an owner. Thus, I do not believe this change impacts spouses inheriting Roth IRAs to any significant degree.

The inheriting spouse could treat the inherited Roth IRA as an inherited account (i.e., become a beneficiary instead of being the owner). Practically speaking, an inheriting spouse would only consider this if they are under 59 ½ years old and they believe it is likely they would need to access earnings in their Roth IRAs (including the inherited accounts) prior to age 59 ½.

Considering a spouse treating an inherited Roth IRA as their own can recover their own and their decedent spouse’s Roth IRA contributions and 5 year-old conversions tax and penalty free at any time and recovers these amounts before Roth earnings are ever accessed, most inheriting spouses will not need to elect inherited Roth IRA (i.e., beneficiary) treatment. This may be true even in situations where the inheriting spouse is under 59 ½ years old and needs access to some of the inherited Roth IRA funds prior to age 59 ½. Further, treating the inherited Roth IRA as one’s own Roth IRA instead of keeping it as an inherited IRA will generally be advantageous from a creditor protection standpoint.

One potential planning option for the spouse is to roll the decedent spouse’s Roth IRA to an inherited Roth IRA and later (presumably at age 59 ½) roll it into their own Roth IRA. See Choate, referenced below, page 225. This offers the inheriting spouse protection as it allows him or her to access Roth earnings tax-free prior to the spouse turning age 59 ½ and then later avoids RMDs to the spouse (see discussion of that possibility below).

In Proposal 10 of my retirement tax reform proposal, I offer suggestions to simplify the treatment when spouses inherit retirement accounts.

RMD Beneficiaries

The SECURE Act set up a new standard to be an RMD beneficiary (what the SECURE Act termed an “eligible designated beneficiary”). Some practitioners use the term “EDB” for these beneficiaries, but I prefer the term “RMD beneficiary” because these are the beneficiaries that are allowed to (i) avoid the new 10-year rule discussed below and (ii) withdraw from the inherited Roth IRA RMDs based on their own remaining life expectancy.

Who qualifies as an RMD beneficiary? These include:

A spouse electing to treat the inherited Roth IRA as an inherited Roth IRA
Any individual not more than 10 years younger than the owner (think parents and adult siblings, but it can be others)
Anyone chronically ill or disabled

An RMD beneficiary must start taking RMDs from the inherited IRA in the year after the owner died. He or she goes to the IRS Single Life Table and finds the factor for their age in the year following the owner’s death. The RMD for that first year is the prior-year end-of-year account balance divided by that factor. The following year’s RMD is the prior-year end-of-year account balance divided by the first year’s factor minus one. See Choate, referenced below, at pages 67-68 and 73-74. Here’s an example of how it works.

Jack died on December 1, 2023. He was 65 at his passing. He leaves his Roth IRA to his brother Jim. In 2024, Jim turns 62. Jim is an RMD beneficiary and should* take an RMD based on his IRS Single Life Table factor at age 62, 25.4. If the inherited Roth IRA balance on December 31, 2023 is $500,000, Jim’s 2024 inherited Roth IRA RMD is $19,685.04 ($500,000 divided by 25.4). If the balance in the inherited Roth IRA is $510,000 on December 31, 2024, Jim’s 2025 RMD is $20,901.65 ($510,000 divided by 24.4). Jim takes annual RMDs in a similar fashion in subsequent years.

As Natalie Choate notes in her treatise referenced below (see page 74), Jim only looks at the IRS Single Life Table once: for the first RMD year. After that, he simply subtracts 1 from the factor every year. Thus, those using the Single Life Table only look at it a single time.

*Note that an RMD beneficiary can, instead of taking RMDs, elect the 10-year rule discussed below. See Choate supplement, page 12, Andy Ives at IRAHelp.com, and Ian Berger at IRAHelp.com. In many cases, I suspect taking relatively modest tax-free RMDs will facilitate more tax-free growth than avoiding RMDs and emptying the inherited Roth IRA within 10 years. This is because taking RMDs allows a large portion of the inherited Roth IRA to survive well beyond 10 years in cases where the beneficiary is not themselves rather elderly. That said, the older the beneficiary is, the more likely electing into the 10-year rule is to be advantageous. It is not clear how the beneficiary makes the election (see Choate supplement, page 50), though presumably failing to take RMDs would do it.

Spouses electing beneficiary treatment (which is RMD beneficiary treatment in their case) are generally not required to take the annual RMD until the later of (i) the year after the decedent spouse’s death or (ii) the year the decedent spouse would have reached age 72. See Choate, referenced below, page 97, Prop. Reg. Section 1.401(a)(9)-3(d) on page 109 of this PDF file (also see Prop. Reg. Section 1.408-8(b)(2)(ii) on page 253 of the PDF file).

Successor Beneficiaries

Successor beneficiaries of RMD beneficiaries must, in most cases, empty the inherited Roth IRA by the end of the 10th calendar year following the RMD beneficiary’s death. See Natalie Choate supplement page 43 and Prop. Reg. Section 1.401(a)(9)-5(e)(3) on page 142 of this PDF file. Update August 4, 2023: In addition to being subject to the 10-year rule, the successor beneficiary must continue to take the annual RMDs the RMD beneficiary would have been required to take had they lived. See Natalie Choate supplement page 51.

Update July 10, 2023: Sarah Brenner of IRAHelp.com raises an interesting possibility. What if the RMD beneficiary elects the 10-year rule? If that happens, the successor beneficiary must empty the inherited Roth IRA by the end of the 10th year after the original owner’s death!

Minor Children of the Owner

If a minor child of the owner inherits a Roth IRA, he or she gets to take RMDs for all the years through the year he or she turns 21. Then the inherited Roth IRA must be emptied by the end of the 10th calendar year following the beneficiary turning age 21. See Prop. Reg. Section 1.401(a)(9)-5(e)(4) on pages 142-43 of this PDF file. Update September 11, 2023: the minor child starting the RMDs prior to turning age 21 triggers RMDs during the later 10-year period.

This treatment is quite favorable considering the relatively low RMDs during one’s youth, as the RMD is based on their relatively long life expectancy.

The only children qualifying for this treatment are the children of the owner. Grandchildren, nieces, nephews, etc. will not qualify, and in most cases will be 10-year beneficiaries. These children could qualify for RMD beneficiary treatment if they are chronically ill or disabled.

Note that technically minor children of the owner qualify as “eligible designated beneficiaries” but since the treatment they receive is, to my mind, quite different from the treatment RMD beneficiaries receive, I mentally carve them out as their own distinct category.

Successor Beneficiaries

Natalie Choate observes on page 43 of her supplement that in the case of a minor-child RMD beneficiary, the successor beneficiary must empty the account by the earlier of (i) the end of the 10th full year following the minor-child’s death or (ii) the end of the 10th full year following the former minor child turning age 21. Update August 4, 2023: If the minor-child beneficiary dies while collecting RMDs, it appears the successor beneficiary would also be subject to annual RMDs using the decedent minor-child’s life expectancy during the 10-year time frame.

10-year Beneficiaries

10-year beneficiaries are those individuals who are not spouses, minor children of the owner, and RMD beneficiaries. They are everyone else. From a practical perspective, most 10-year beneficiaries are the adult children of the owner.

10-year beneficiaries are not subject to RMDs. However, they must empty the inherited Roth IRA by the end of the 10th year following death. From a purely tax planning perspective, the beneficiary will want to leave the money inside the inherited Roth IRA and withdraw the money in December of the 10th full year following the owner’s death to get as much tax-free growth out of the inherited Roth IRA as possible. Of course, distributions prior to the end of the 10th year are permitted, and, as discussed above, should be tax-free in practically all cases.

Successor Beneficiaries

Successor beneficiaries of 10-year beneficiaries must empty the inherited Roth IRA by the end of the 10th calendar year following the owner’s death. See Prop. Reg. Section 1.401(a)(9)-5(e)(2) on page 142 of this PDF file. Thus, the death of a 10-year beneficiary does not extend the time to empty an inherited Roth IRA.

Estates

A pulse is worth at least 5 years of tax-free growth!

Roth IRAs can be left to one’s own estate, but generally speaking, they should not be. In order to qualify for the 10-year rule or better treatment (see the first four categories of beneficiaries), the beneficiary designation form must leave the Roth IRA to a human being. Estates can become the Roth IRA beneficiary if no beneficiary designation form is filed, or if the filed beneficiary designation form names the estate as the beneficiary. When an estate inherits a Roth IRA, the inherited Roth IRA is subject to a 5-year payout rule. See Choate, referenced below, pages 77 and 104.

If left to one’s estate, the Roth IRA must be paid out by the end of the fifth full calendar year following death. See Choate supplement page 100. This is true even if the estate will ultimately pay the money out to actual humans who could have, on their own, qualified as 10-year beneficiaries, RMD beneficiaries, and/or spousal beneficiaries.

Trusts

If you want to see some tax complexity, look at inherited retirement accounts and trusts. Trusts themselves often have human beneficiaries, but the trust mechanism is used to protect the beneficiary and/or the assets inside the trust. There are valid reasons to name a trust as a retirement account beneficiary (usually surrounding the nature of the potential beneficiaries), but naming a trust should not be done lightly.

The tax risk is that the inherited Roth IRA will be subject to the 5-year rule. Properly structured (including the provisions required by Treas. Reg. Sec. 1.401(a)(9)-4 Q&A 5(b)), the human beneficiaries of the trust can qualify for the applicable treatment offered by one of the first four categories of beneficiary. However, if the trust is not properly structured, the trust and the human beneficiaries of the trust will be subject to the 5-year rule and lose out on 5 or more years of tax-free growth.

Charities

A charity must take an inherited Roth IRA in 5 years, but it does not care, as it is not generally subject to income tax. From a planning perspective, Roth IRAs are the assets that are least advantageous to leave to charity. Your human heirs like to inherit Roth accounts and generally would prefer to inherit a Roth over an account such as a traditional IRA or a HSA. Here’s an example of how that could play out.

Walter, age 80, is a widow and has one adult son, Paul, age 50. Walter has the following assets:

*Asset Location*	*Amount*
Roth IRA	$100,000
Taxable Brokerage	$100,000
Traditional IRA	$50,000
HSA	$50,000
*Total*	*$300,000*

Walter intends on leaving two-thirds of his assets to Paul and one-third of his assets to his Catholic parish, a 501(c)(3) charitable organization. From Paul’s perspective, he’d prefer to inherit the $100,000 Roth IRA (10 more years of tax-free growth, no income tax and full step up in basis when the assets are distributed to him) and $100,000 taxable brokerage (no income tax and full step up in basis). Paul would prefer that the $100,000 left to the parish be the $50,000 traditional IRA (which would be taxable to Paul through RMDs and the 10-year rule) and the $50,000 HSA (which is immediately fully taxable to Paul in the year of Walter’s death if Paul inherits).

Why waste the Roth’s step-up in basis, tax-free treatment, and 10 years of additional tax-free growth on a charity when you can give the charity assets that are otherwise less favorable to the human beneficiary (the traditional IRA and the HSA)?

Planning

For Owners

Retirement account owners may want to think about inter-generational planning, for two reasons. First, if the owner is in a relatively low marginal tax bracket, and their beneficiaries (perhaps successful adult children) are in relatively high marginal tax brackets, they may want to think about Roth conversions during their lifetimes to move money from traditional retirement accounts to Roth IRAs. This can reduce the income tax paid with respect to the traditional retirement accounts. Second, it eliminates the chance that adult children could be subject to both the 10-year rule and to RMDs (see this article for more details).

Any planning in this regard should consider that tax planning for one’s adult children is a second order planning priority. The first planning priority should be the financial success of the retirement account owner. His or her financial success should be prioritized ahead of tax planning geared toward a better result for one’s adult children.

For Beneficiaries

Generally speaking, beneficiaries and successor beneficiaries will want to leave funds inside an inherited Roth IRA for as long as possible. For many in a SECURE Act world, that will be 10 years following the end of the year of death. Here’s a quick example of how that works: Joe dies on August 1, 2023. His 10-year beneficiary has until the end of the 10th year following his death, December 31, 2033, to empty the Roth IRA he inherits from Joe.

Of course, tax is just one consideration. If the money is needed sooner than that, at least the beneficiary knows that the distribution is tax-free in all but the rarest of situations.

As discussed above, beneficiaries should understand how long the owner had any Roth IRA. Once the beneficiary is sure 5 years have passed since January 1st of the year of the original owner’s first contribution, he or she can take Roth earnings out of the inherited Roth IRA and know that it is tax free. Even if the Roth IRA is less than 5 years old, the beneficiary can take old contributions and conversions tax free. Such amounts come out first under the ordering rules prior to the removal of any earnings.

SECURE 2.0 529-to-Roth IRA Rollovers

Below I’ll discuss the ins and outs of the new SECURE 2.0 529-to-Roth IRA rollover provision. While an understanding of the details is great, the more important issue is this: does this new rule fundamentally change financial decision making and planning?

UPDATE 1 March 1, 2024: There are now significant doubts as to the validity of SECURE 2.0, including the 529-to-Roth IRA rollover provision. See my YouTube video on a very important court decision that puts SECURE 2.0 on very shaky ground (though it is still the law of the land as of March 1, 2024).

UPDATE 2 March 1, 2024: As of now, the IRS and Treasury have not issued significant guidance on the 529-to-Roth IRA Rollover. Thus, many questions remain on how it works.

529-to-Roth IRA Rollover Introduction

SECURE 2.0 has a special rule (see Section 126 on page 2161), first effective in 2024, allowing a tax-free transfer of money inside a 529 to a Roth IRA. This provision has been met with some unbridled enthusiasm that, to my mind, should be scaled back.

Before we get started, it’s important to note that (i) this is a very new rule and (ii) at any time the IRS and Treasury could issue guidance concerning this new rule. For both those reasons, everything discussed in this post is subject to change.

The above said, let’s discuss the parameters of this new rule, adding in the context of the already existing Section 529 rules.

First, consider the statutory definition of a 529. From Section 529(b)(1)(A)(ii): an account which is established for the purpose of meeting the qualified higher education expenses of the designated beneficiary of the account.

Second, we must consider Section 529(b)(6):

(6)Prohibition on excess contributions

A program shall not be treated as a qualified tuition program unless it provides adequate safeguards to prevent contributions on behalf of a designated beneficiary in excess of those necessary to provide for the qualified higher education expenses of the beneficiary.

To my mind, the combination of these two rules* and how the IRS views them in a new environment where money can go tax-free from a 529 to a Roth IRA tamps down on any affirmative planning to stuff 529s with a primary purpose of getting money into Roth IRAs. I would not be surprised to see the IRS and Treasury come out with regulations more explicitly prohibiting stuffing 529s in this way.

*See also page 5 of the preamble of the never-finalized proposed 529 regulations stating that a 529 is “an account established exclusively for the purpose of meeting qualified higher education expenses of the designated beneficiary.”

What I believe is very much allowed is parents rounding up when funding a child’s 529. The above-cited Section 529 language should not be read to require parents to be conservative when funding 529s. Future higher education expenses are quite speculative. What will future college tuition be? Will the child go to grad school? Will the child graduate undergrad 3 years, 4 years, or 5 years? Will the child get scholarships?

529-to-Roth IRA Rollover Details

First, the rule provides that, in any year, the beneficiary of the 529 can be given up to the annual maximum allowed Roth IRA contribution as a Roth IRA contribution from the 529. If done, the contribution from the 529 becomes the beneficiary’s annual Roth IRA contribution for the year. Thus, this new rule does not create additional Roth IRA limits for the beneficiary.

One advantage is that the contribution is not subject to the Roth IRA MAGI limits. This advantage is not all that great, considering most young adult beneficiaries will not earn income exceeding the Roth IRA MAGI limits. Even if the beneficiary is very high income, he or she may be able to use the Backdoor Roth IRA to get around the MAGI limits.

Second, in order to execute this maneuver, the 529 must be at least 15 years old, and the amount contributed is limited to the amount of contributions (and earnings attributable to those contributions) occurring at least 5 years prior to the transfer to the Roth IRA. The 5 year rule defeats the idea of “oh, my daughter’s a senior in college, let me contribute $30K to her near-empty-529 and now have runway to make 5 annual Roth IRA contributions for her for her first 5 years after college graduation.”

Third, the total that can be transferred to the beneficiary’s Roth IRA is $35,000. The $35,000 is not adjusted for inflation, significantly limiting the benefit of this new rule.

As a planning tool, this technique is quite limited because the technique does not create any new Roth IRA contribution limitation. The new rule does not, generally speaking, increase Roth IRA contribution limits. Further, parents thinking of supporting young adult children can simply gift their adult children their annual Roth IRA contribution out of Mom and Dad’s bank account.

529 Rollovers as Roth Contributions and Roth Earnings

The new 529-to-Roth IRA maneuver preserves earnings in the 529 as “earnings” inside the Roth IRA. I refer to this as the “earnings-to-earnings rule.” This impacts how any future nonqualified withdrawals are made from the Roth IRA. From the now adult child’s perspective, a regular annual Roth IRA contribution is better than a 529-to-Roth rollover, because the 529-to-Roth rollover limits how much of the contribution is easily withdrawn as a return of prior contributions.

Here are two examples to illustrate the concept:

Example 1: Mark graduated college and started his first full time job in 2024. He contributes $6,500 to a Roth IRA for 2024. If Mark ever has an emergency, he can withdraw the $6,500 from the Roth IRA at any time for any reason tax and penalty free.

Example 2: Julile graduated from college and started her first full time job in 2024. Her father named her the beneficiary of a 529. Assuming the 15 year rule and the 5 year rule are satisfied, her father can direct $6,500* from the 529 to Julie’s Roth IRA for 2024. At the time of the transfer, the 529 consisted of $30,000, $15,000 of previous contributions and $15,000 of earnings. The $6,500 goes into the Roth IRA as $3,250 of contributions and $3,250 of earnings. Assuming Julie has made no other Roth IRA contributions, the most she can withdraw from the Roth IRA tax and penalty free for any reason prior to age 59 1/2 is $3,250.

*Note the 2024 Roth IRA contribution limits have not been published as of this writing. This uses the 2023 contribution limit as the 2024 contribution limit for illustrative purposes only.

The earnings-to-earnings rule makes sense to (somewhat) protect the 529 earnings rule. If 529 rollovers went into Roth IRAs entirely as contributions, the 529-to-Roth maneuver could be used to bail out 529 earnings by rolling to a Roth IRA and then immediately withdrawing, taking advantage of the Roth IRA nonqualified withdrawal rules to get the 529 earnings out tax free.

The above said, the hope for most receiving the benefit of the 529-to-Roth IRA rollover is that they do not make withdrawals from their Roth IRA for many years, making the new earnings-to-earnings rule mostly academic.

Sean’s Take

So how do I view the 529-to-Roth IRA rollover? I view this as a helpful, though quite limited, bailout technique for overfunded 529s. As a bailout technique, it’s a nice tool to have in the toolbox. The people who should be happy about it are those parents/grandparents with either a student in college today and/or a recent graduate and an overfunded 529.

The above said, the 529-to-Roth IRA is not a technique that provides much, if any, value from a planning perspective. I do not believe that this new maneuver significantly impacts financial planning for most parents, as I don’t believe it makes the 529 all that much more attractive.

Compare (i) 529s and this provision with (ii) simply investing money in taxable mutual funds and then using that money to fund a child’s college education and giving them $35K to be invested in Roth IRAs as a young adult. Yes, the 529 plus the 529-to-Roth is better than using taxable accounts, but not by enough for me to get very excited. Remember, in the FI community, the primary goal is not to optimize your child’s tax situation. Rather, for most parents, the primary goals are to secure Mom & Dad’s financial independence and be sure that Junior never has to worry about Mom & Dad’s financial security during Junior’s adulthood.

The availability of the 529-to-Roth rollover reduces concerns about overfunding a 529, but only modestly so. Even with this new rule, I believe two things are true. First, most young parents should focus on building up their own financial assets instead of funding 529s. The availability of this new rollover does not significantly change planning for young parents, in my opinion.

Second, those parents with extra money in 529s after a child graduates college should still consider changing beneficiaries to younger children or grandchildren primarily, and use the new 529-to-Roth IRA bailout technique as an alternative if no other beneficiary needing tuition assistance is readily available. To my mind, if there’s a successor beneficiary readily available, changing the beneficiary will usually be the preferable option, as it can be done instantaneously without worrying about limits and holding periods, and there’s no need to coordinate with the Roth IRA’s financial institution.

529 Seasoning

Some are discussing new parents opening a 529 at birth just to season the account so the account qualifies for the 529-to-Roth IRA maneuver sooner rather than later (before the child’s 16th birthday). As I believe young parents should be focused (financially) on securing their own financial future, I do not believe it should be a priority to do this. My (financial) hope for most young parents is that they first secure their own financial future during their child’s childhood.

If the parents’ financial future is secured by the time the child is in high school, the parents can start 529 funding to grab some state tax deductions or credits (if applicable). In such cases, when the funding occurs closer in time to college, it should be much easier for the parents to “right size” the 529 such that it is not overfunded for college. In those cases, any small remaining 529 balance can be bailed out by changing the beneficiary or using the 529-to-Roth IRA maneuver, even if it does take a few more years to satisfy the 15 year rule.

In addition, what’s the rush? So what if you have to wait 10 years until after Junior graduates college to execute the 529-to-Roth IRA rollover? In those 10 years you get tax free growth, and even if Junior has become the CEO you can still execute the maneuver, since the annual contribution MAGI limit has been eliminated for those doing the 529-to-Roth IRA rollover.

The downside of foregoing several years of pre-graduation seasoning is that additional time could cause growth such that the total in the 529 exceeds $35K by the time the 15 year clock is satisfied. I’d argue a 529 established much closer to the beginning of college is less likely to be significantly overfunded, mitigating this downside concern.

Multiple Beneficiaries

I think multiple beneficiary planning for the 529-to-Roth IRA maneuver is going to be very challenging. Consider the following situation:

Example 3: Dad owns a 529 and Son, age 21 is the beneficiary. Dad has paid for Son’s first three years of college through the 529. Daughter, age 25, is already a college graduate and in the workforce. If Dad’s 529 is now worth $100,000, in theory Dad could do a partial rollout of $30,000 to a 529 naming the Daughter as beneficiary with an eye towards the 529-to-Roth IRA rollover for Daughter’s benefit. However, remember the 15 year rule. The new 529 could not seed Daughter’s Roth IRA until Daughter is age 40. Further, if Daughter never uses any of the money for qualified educational expenses, the account is likely to run into issues being a valid 529.

529 plans cannot have multiple beneficiaries. This alone makes split-up planning for the 529-to-Roth IRA maneuver quite difficult. That said, if Daughter attended a year of graduate school at age 27 largely funded by this new 529, then Dad’s maneuver works, though remember that Daughter can only get the money into her own Roth IRA starting at age 40.

Starting with Owner as Beneficiary

Some might consider a parent opening a 529 before the child is born naming the parent as both owner and beneficiary. After 15 years, the parent can make annual 529 to Roth IRA rollovers to their own Roth IRA. Once the $35K maximum has been hit, the parent could then change the beneficiary to a child. Considering the 529 statutory language discussed above, I don’t believe that is a wise course of action. Such a course risks 529 account disqualification unless the IRS and Treasury come out with rules affirmatively blessing it. Further, all that’s been saved is tax on interest, dividends, and capital gains of $35,000 of Roth IRA contributions. Under today’s investment friendly tax rules, that will not be very much tax.

Don’t Plan on Using the 529-to-Roth IRA Maneuver if You Aren’t Going to College

The online world is full of scuttlebutt, and already I have seen social media posts inquiring as to whether adults should fund 529s for themselves with the idea of funding them today and starting 529-to-Roth IRAs rollovers 15 years later. I do not believe this is a wise course of action.

Based on the language in Section 529 quoted above, I am highly skeptical of planning to put money into the 529 looking to get it into a Roth IRA. Sorry to all those 40-somethings out there thinking about throwing $20,000 into a 529 to fund their Roth IRA annual contributions in their 50s and 60s.

Even if Congress were to change Section 529 tomorrow and explicitly allow 529 stuffing to get money into a Roth IRA, I don’t believe it makes much sense to affirmatively look to use a provision like this. It doesn’t increase the limit for Roth IRA contributions. If one is working 15 years from now, they will probably have the cash flow to fund their Roth IRA. Why do they need to invest through a 529 and get a very small tax break on the money for the 15+ years beforehand? Further, what if they aren’t working and don’t have compensation income in 15 years?

Without compensation income (or spousal compensation income), one cannot make a Roth IRA contribution (whether from their bank account or from a 529). At that point the money might be trapped inside the 529, and withdrawable only if the owner is willing to pay ordinary income tax and the 10 percent penalty on distributions of earnings.

Changing the Beneficiary to the Owner

Considering the language in Section 529 discussed above, I doubt the IRS will allow middle-age 529 owners whose schooling is far behind them to change the 529 beneficiary to themselves and then do the 529-to-Roth IRA maneuver. Yes, the IRS and Treasury may allow the successor beneficiary to step into the 15 year clock of the original beneficiary. But if the middle-age owner becomes the beneficiary, the 529 is no longer for the beneficiary to use for qualified educational expenses. At that point, it appears that there is a high risk the account may cease to be a good 529. If the owner then executes the rollover maneuver and their MAGI exceeds the annual Roth IRA contribution MAGI limit, they create an excess contribution to the Roth IRA.

It’s possible that the IRS will view this differently, but I would not count on it. Until the IRS and Treasury come out with more definitive guidance, I would expect that the benefit of this new rollover maneuver will largely be limited to those who completed their college education after the funding of a 529 for their benefit.

Changing the Beneficiary and the 15 Year Clock

Does changing the beneficiary on a 529 reset the 15 year clock?

My hope is that the IRS and Treasury allow a successor beneficiary to inherit the holding period the original beneficiary had. My view is that the IRS and Treasury are protected by the statutory language requiring 529s to be for the educational expenses of the beneficiary. If the successor beneficiary plans on using the 529 money only for their Roth IRA, the 529 can be disqualified. But if the successor beneficiary uses some of the money for education and then has leftover amounts, he or she should not need to wait until the passing of a new 15 year clock to get the money into a Roth IRA.

If the IRS and Treasury are worried about abuses here, one possible compromise would be to allow the successor beneficiary to inherit the original beneficiary’s clock only if (i) the successor beneficiary is no more than ten years older than the original beneficiary and (ii) the successor beneficiary is a member of the original beneficiary’s family.

A Critical Look at the 529

Watch me discuss on the 529 on YouTube

Conclusion

For those with an overfunded 529, the new 529-to-Roth IRA maneuver is very good news. That said, to my mind, it is just another tool in the tool box. In many cases, overfunded 529s are better used for another beneficiary, such as another child or a grandchild. But still, overfunded 529s are an issue, and it is good to have another bailout tool available, particularly if there is no successor beneficiary in the picture.

I generally do not view the 529-to-Roth IRA maneuver to be a great planning tool. Generally speaking, it does not increase the amount that can go into a Roth IRA. That alone significantly diminishes its value from a planning perspective. Of course, everyone needs to do their own analysis and planning considering the particulars of their own situation.

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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.

Let’s Break Down Some Retirement Numbers

Conclusion

Why the Traditional 401(k) Is Good for the FI Community

How Bad is the Retiree Tax Problem?

Future Retirees’ Tax Risk

The Risks of Not Having Money in Traditional Retirement Accounts

Qualification for Premium Tax Credits

Charitable Contributions

Unused Standard Deductions

Deduct at Work, Roth at Home

Conclusion

A Few Introductory Notes Before We Get Started

Roth IRA Qualified Distributions

Roth IRA Nonqualified Distributions

Ordering Rule

Tax Free Withdrawal of Owner Contributions (Both Annual Contributions and Roth Conversions)

5 Year Clock on Roth Conversions

Roth Earnings

A Quick Note on Roth IRA Aggregation

Application to Fact Patterns

Roth IRA Distributions Summary Chart

Exceptions to the 59 ½ Year Age Requirement

Resources

First Five-Year Rule: Earnings Cannot Be Withdrawn Income Tax Free From a Roth IRA Unless the Account Holder has Owned a Roth IRA for Five Full Tax Years

If Anyone on Capitol Hill is Reading This . . .

Second Five-Year Rule: Taxable Conversions Are Subject to the Ten Percent Early Withdrawal Penalty if Withdrawn from the Roth IRA Within Five Taxable Years

When Might the Second Roth IRA Five-Year Rule Apply

Conclusion

Further Reading

Who Pays to Save Social Security and Medicare?

PROPOSAL ONE: No changes to the Social Security and Medicare eligibility ages.

PROPOSAL TWO: No Increase to the FICA Tax Rates (Employee and Employer)

Tax Increases to Save Social Security and Medicare

PROPOSAL THREE: Increase the additional Medicare tax on earned income from 0.9% to 2.0% Use half the tax (1.0%) fund Medicare and half the tax (1.0%) fund Social Security.

PROPOSAL FOUR: Increase the Medicare surtax on net investment income from 3.8% to 5.0%. Use the increase (1.2%) to fund Social Security.

PROPOSAL FIVE: Impose a new 25% excise tax on net investment income of college endowments with $1 billion or more in assets as of year end.

Stabilizing The Federal Government’s Finances

PROPOSAL SIX: Significant reductions in military and foreign spending

Self-Help

PROPOSAL SEVEN: Change Your Health

Conclusion

HSA Planning

Spousal Beneficiaries

Other Individuals

Inherited HSA Tax Exception

The Estate

Charitable Beneficiaries

Later In Life HSA Planning

Conclusion

Terminology and Titling

Types of Beneficiaries

Spouses

RMD Beneficiaries

Successor Beneficiaries

Minor Children of the Owner

Successor Beneficiaries

10-year Beneficiaries

Successor Beneficiaries

Estates

Trusts

Charities

Planning

For Owners

For Beneficiaries

Further Reading

529-to-Roth IRA Rollover Introduction

529-to-Roth IRA Rollover Details

529 Rollovers as Roth Contributions and Roth Earnings

Sean’s Take

529 Seasoning

Multiple Beneficiaries

Starting with Owner as Beneficiary

Don’t Plan on Using the 529-to-Roth IRA Maneuver if You Aren’t Going to College

Changing the Beneficiary to the Owner

Changing the Beneficiary and the 15 Year Clock

A Critical Look at the 529

Conclusion