Tag Archives: 401(k)

2023 Retirement Tax Reform

An Open Letter to the Members of the 118th Congress

Dear Senators and Congressmen,

Congratulations on your victories in the Senate and House elections. I write with respect to one aspect of your legislative endeavors in the 118th Congress: reforming our tax-advantaged retirement savings system. As you will see, much of it is antiquated and in need of reform.

Before I discuss the problems, allow me to briefly recite my qualifications to write you this letter. My primary qualifications are that I am an American citizen and taxpayer. My secondary qualifications include:

I am a financial planner and advise clients on retirement planning and saving.
I am the author of a book on one of the tax-advantaged retirement savings accounts, Solo 401(k): The Solopreneur’s Retirement Account.
I am a CPA (licensed in California and Virginia) and I have a Juris Doctor degree and a LLM in Taxation degree. My background is on my LinkedIn page.
I write a four year-old blog (fitaxguy.com) focused on tax planning for individuals, particularly the use of retirement accounts.

The views expressed in this open letter are mine only. I have not been compensated for writing this letter and my views are not necessarily the views of any of the clients of my financial planning firm.

Problems with the Current Retirement Savings System

Limits Are Unequal and Unfair

There’s a myth that Congress and IRS inflation adjustments determine the retirement plan contribution limits every year. If one looks at the Internal Revenue Code and the IRS website, they’d walk away with that belief.

But is that really true? It turns out that one’s employer often defines just how much an employee can get into tax-advantaged retirement accounts every year. In practice, the current system disproportionately benefits a privileged few.

Here are two examples (using 2023 limits) that prove my point in a stark fashion. Josh is a 50 year-old employee of a large Fortune 500 company with a $300,000 salary. Josh maxes out contributions to his traditional 401(k) at work and maxes out his Backdoor Roth IRA and Mega Backdoor Roth (available through his employer’s 401(k)). Further, Josh receives a 3% match in his employer 401(k). Here are what his annual retirement savings contributions look like:

401(k) Employee Deferral: $30,000

401(k) Employer Match: $9,000

401(k) Mega Backdoor Roth: $34,500

Backdoor Roth IRA: $7,500

Total traditional deductible contributions: $39,000. Total Roth contributions: $42,000. Total contributions: $81,000.

Sarah, single, is a 50 year-old non-profit executive director with a $150,000 annual salary and no workplace retirement plan. Under today’s rules, Sarah can only contribute a maximum of $7,500 to a deductible traditional IRA. That’s it! She may be able to make a partial Roth IRA contribution or a Backdoor Roth IRA contribution, but if she does, it reduces her maximum allowed deductible traditional IRA contribution. Thus, her total contributions are, at a maximum, just $7,500 for the year.

Sadly, there are many more workers in the latter situation than in the former situation.

Because of their choice in employers, Josh gets to put more than 10 times the amount Sarah can into tax-advantaged retirement accounts.

Yes, that is today’s reality. It makes absolutely no sense. Long term, a system that disproportionately rewards workers at some employers and barely covers workers at other employers is not sustainable.

Where you work should not increase your tax-advantaged retirement account contributions by more than 10 times!

Many retirement provisions benefit a very select few. Most of the time, those select few are among the people who need the least amount of help in achieving a successful retirement. Retirement tax advantages should have broad applicability and should not disproportionately reward any particular subgroup, particularly very small subgroups.

Goals for Retirement Account Reform

Here are the goals I believe the 118th Congress should have in enacting retirement account reform.

Reduce complexity and confusion. Simplify the mechanisms of retirement savings. “Backdoors” should be eliminated because retirement savings should occur through direct, simple transactions.
Increase retirement savings, particularly among Americans who have struggled economically over the past three years.
Effective yet modest changes. While it is tempting to throw out all the rules, a complete rewrite of the rules would create tremendous confusion and likely reduce, rather than increase, tax-advantaged retirement savings.
Democratize retirement account contributions while acknowledging the role employers can play in offering retirement savings for employees. That said, there should be at least some shift of dollars away from contributions to employer plans towards contributions to individual retirement accounts.
Reform cannot simply be a massive tax cut. The federal budget cannot afford a massive tax cut.
Special advantages available to very limited groups should be reduced and eliminated.
Remove punitive rules and traps for the unwary.
There are too many penalties in the retirement account system that are too high, too punitive, and too confusing. My proposal attempts to reduce the number of penalties, give the IRS and taxpayers more common sense tools to mitigate them, and make the rules simpler and fairer.
Reduce the competition between funding expenses attendant to having a child and funding retirement savings.
Avoid slogans. Our tax rules are now far too complicated to say “everyone gets a tax cut” or “no one below X income will have a tax increase.” Besides, slogans belong to the politics of the 80s and 90s.

While my primary audience is the members of the 118th Congress, please allow me to direct a quick word to my fellow American taxpayers who might lose out on an opportunity described below and thus might oppose these proposals. I ask potential opponents of this proposal this question: how sustainable is a retirement system that gives a select few Americans 10 times the tax-advantaged savings capacity as other Americans?

Why fight to preserve your special tax break when the myriad special tax breaks make the entire system less and less sustainable? Does my proposal make everything entirely fair? Surely not, but, as you will see below, it makes the system much fairer and simpler. I believe that will make the system more sustainable over the long run, which is good for everyone.

Lastly, retirement savings are far from the only component of the U.S. tax system needing legislative change. But, as you can see from my secondary qualifications above, retirement savings are of particular interest to me, so I’ll mostly limit my commentary here to tax law changes on retirement savings.

Retirement Tax Reform Proposals

Expanded Universal Roth IRAs and Closing Backdoors

1. Eliminate the MAGI Limitation on annual Roth IRA contributions. Why is there an income limit on contributing to a Roth IRA, which does not produce a tax deduction? Further, removing the income limitation will align the United States Roth account rules with Canadian tax-free savings account rules. Canada does not have an income limit on the ability to contribute. Why should the United States? This proposal also ends the Backdoor Roth IRA.

2. Increase annual IRA contribution limit (traditional and Roth) to $10,000, then index annually. It is time to shift retirement savings towards individuals. This will help expand individual and spousal contributions to retirement accounts, particularly Roth IRAs, and give individuals more control over their own retirement savings. This proposal makes individuals less reliant on their employer to offer a good retirement savings plan.

In the 10 year budget window, proposals 1 and 2 will cost some money, but I suspect not a whole lot. In fact, this expansion of Roth IRAs might make Roths more attractive and cause some taxpayers to direct what would have been traditional, deductible 401(k) contributions to their Roth IRA, increasing tax revenue in the early years.

3. Eliminate nondeductible contributions to IRAs and qualified plans, effective January 1, 2024. This ends Mega Backdoor Roth IRAs as of January 1, 2024. The Mega Backdoor Roth benefits only those few whose employers offer it and can afford to make after-tax contributions. The Mega Backdoor Roth, which only came to prominence starting in 2014, turbocharges the unfair advantages the retirement account system currently confers on a select few Americans (such as Josh in the example above).

As a result of eliminating the Mega Backdoor Roth, most of these contributions will be diverted to taxable accounts, which is not a horrible outcome for those currently taking advantage of the Mega Backdoor Roth. Further, those losing the Mega Backdoor Roth under this proposal gain expanded access to Roth IRAs under proposals 1, 2, and 4.

4. Increase age 50 or older IRA (traditional and Roth) annual catch-up contribution from $1,000 to $2,000, index for inflation annually. The current $1,000 annual catch-up contribution limit is not enough move the needle in terms of likelihood of financial success in retirement.

Eliminate Traditional Retirement Account Basis

5. Eliminate IRA Basis / after-tax 401(k) basis, effective January 1, 2027. The Pro-Rata Rule is an unnecessarily complicated rule for retirement account withdrawals. It has even created litigation. Basis record keeping is challenging and creates confusion. Enough already!

This proposal eliminates retirement account basis recovery as of January 1, 2027. To be fair to those with retirement account basis, this proposal allows elective withdrawal of basis amounts from traditional retirement accounts (including inherited traditional retirement accounts) to taxable accounts during the 2024, 2025, and 2026 tax years. Any elective withdrawals of basis for the year would not count towards RMDs and could not be converted to Roth accounts. Regular withdrawals, RMDs, and Roth conversions in the year of an elective withdrawal of basis could not access existing basis.

Eliminating basis eliminates page 1 of the Form 8606. This simplifies traditional retirement account withdrawals, inheriting traditional retirement accounts, and Roth conversions. In turn, this makes the retirement account provisions easier for the IRS to administer and easier for taxpayers to understand.

Simplify and Rationalize Retirement Account Rules

6. Unify Roth account nonqualified withdrawal treatment such that the current Roth IRA nonqualified distribution rules apply to nonqualified Roth 401(k) distributions. The rules for Roth 401(k) nonqualified distributions are confusing, and can be avoided by rolling into a Roth IRA. Why not make them consistent?

7. Change the age for HSA catch-up contributions to age 50. Catch-up contributions to all accounts should kick-in at one, and only one, age. Make it age 50 for all accounts by changing the HSA catch-up contribution kick-in age from 55 to 50. Unifying the HSA/IRA/401(k) catch-up contribution age at age 50 makes the rules simpler.

8. Unify rules for taking RMDs from traditional retirement accounts. Under this proposal, so long as the total required is taken during the year, it doesn’t matter which account (401(k), 403(b), IRA) or accounts the distributions come from.

9. Eliminate NUA tax treatment. Net Unrealized Appreciation allows for employer stock in a 401(k) to get preferential tax treatment. As workers are already heavily economically tied to their employer (because of their salary and benefits), NUA treatment encourages something that probably should be discouraged (investing significantly in the stock of one’s own employer). Further, the NUA rules are complex. Removing them simplifies the tax code.

10. Simplify treatment when spouses inherit a retirement account. Currently, there are three options and planning choices to be made when a spouse inherits a retirement account. The death of a spouse is challenging enough without having to make a complicated tax planning decision. New rule to simplify this: all retirement accounts inherited by spouses are deemed to be the inheriting spouse’s own retirement account as of the first spouse’s death. To prevent any early withdrawal penalties to surviving spouses under age 59 ½ due to this change, add a new 10% early withdrawal penalty exception: being widowed prior to age 59 ½. This new penalty exception applies to all widows and widowers for all pre-age 59 ½ retirement account distributions regardless of whether the widow/widower inherited a retirement account.

11. Clarify the SECURE Act to provide that if the 10 year rule applies to an inherited account, RMDs do not apply to the account, other than in the final year of the 10 year window. The IRS came out with overly complicated proposed regulations requiring RMDs for many inherited accounts even though the 10 year rule applies to them. This clarification repeals the needlessly complicated proposed regulations, and the government’s interests are already adequately protected by the 10 year rule.

12. Adopt a supercharged version of SECURE 2.0 Section 321. Allow the self-employed (generally those reporting self-employment income on Schedule C or through partnerships) to both establish a Solo 401(k) after year-end and make employee contributions to their Solo 401(k) before the tax return deadline for the taxable year. This eliminates the election required under Treas. Reg. Sec. 1.401(k)-1(a)(6)(iii). There’s no reason for a self-employed individual to have to make an election with themselves to make a retirement account contribution. This change would make the contribution deadline rules for self-employed employee contributions the exact same as the contribution deadline rules for self-employed employer contributions for every year (not just for the first year as Section 321 proposed to do).

Combat Mega Retirement Accounts and Limit Benefits for the Very Rich

13. Eliminate (as of enactment) new tax-advantaged retirement account investments in private equity, venture capital, and companies 10% or more owned (by vote or value) by the account owner. These investments have allowed a very select few to accumulate hundreds of millions of dollars in IRAs. IRAs and qualified plans are best when they provide growth and capital preservation from diversified assets to fund retirement. They were never intended to create 9 figure-plus hoards of wealth sheltered from taxation.

14. Required Accumulation Distribution (RAD) of 20 percent of the amount over $5M anytime all traditional accounts (IRAs and qualified plans) exceed $5M (indexed for inflation) at year-end for the following year prior to age 72. RAD of 20 percent of the amount over $5M anytime all Roth accounts (IRAs and qualified plans) exceed $5M (indexed for inflation) at year-end for the following year. Under this proposal, there would be no penalty on any RAD. RADs from Roths are treated as qualified distributions. This is much simpler than the Build Back Better proposals on mega retirement accounts. RADs from traditional accounts cannot be converted to Roth accounts.

The hope is that after a while, there will be few, if any RADs. In a world without private equity and venture capital type investments in retirement accounts it will be quite difficult to accumulate in excess of $5M (adjusted for inflation) in either type of retirement account. The RAD rules do not need to apply to traditional retirement accounts at 72 and beyond, since the owner is already subject to the RMD rules. Inherited retirement accounts would be exempt from the RAD rules.

Examples: Joe, age 65 in 2024, has $4.9 million in all traditional retirement accounts (401(k)s, IRAs, etc.) on December 31, 2023. He also has $4.9 million in all Roth retirement accounts (401(k)s, IRAs, etc.) on December 31, 2023. His 2024 RAD from traditional retirement accounts is $0, and his 2024 RAD from Roth retirement accounts is $0.

Sally, age 65 in 2024, has $7 million in all traditional retirement accounts (401(k)s, IRAs, etc.) on December 31, 2023. She also has $4 million in all Roth retirement accounts (401(k)s, IRAs, etc.) on December 31, 2023. Her 2024 RAD from traditional retirement accounts is $400,000 ($7M minus $5M times 20%), and her 2024 RAD from Roth retirement accounts is $0.

John, age 75 in 2024, has $7 million in all traditional retirement accounts (401(k)s, IRAs, etc.) on December 31, 2023. He also has $7 million in all Roth retirement accounts (401(k)s, IRAs, etc.) on December 31, 2023. His 2024 RAD from traditional retirement accounts is $0 (since he is 72 or older), and his 2024 RAD from Roth retirement accounts is $400,000. Under the existing rules (unchanged by this proposal), John is subject to RMDs in 2024 totalling $284,553 ($7M divided by 24.6) from his traditional retirement accounts (though see proposal 8 giving John more flexibility in terms of which account(s) he can take the RMDs from).

15. Cap at $25,000 the maximum annual amount that can be deferred by those with salaries (W-2, self-employment income) of $400K or more per year (indexed for inflation) under a Section 409A nonqualified deferred compensation plan. This rule change is logical considering (i) the tax law’s benefits for retirement saving have been too skewed towards helping a very affluent few who need the least amount of saving help, (ii) most of the beneficiaries of nonqualified deferred compensation plans are the ones doing best economically, and (iii) the need to provide more benefits of tax-advantaged retirement savings to a larger swath of Americans. Further, those losing a tax benefit because of this rule gain a significant benefit in the removal of income limits on Roth IRA contributions and the increased contribution limits.

For administrative convenience, the new rule would not apply to any amount deferred at any time during one year and paid out at any time during the immediately following tax year.

Proposals 13, 14, and 15 raise revenue to expand the amounts that every worker can save in Roth IRAs, and some Americans will get increased deductible traditional IRA contributions because of proposals 2 and 4.

Penalty Reform

16. New 20% penalty on all missed RADs and reduce the missed RMD penalty to 20%. The current 50% penalty on missed RMDs is unnecessarily punitive.

17. Unify the exceptions to the 10 percent early withdrawal penalty so there is no difference between qualified plans and IRAs. It makes no sense that under current law there are some penalty exceptions only applicable to IRAs and some penalty exceptions applicable only to qualified plans. After this change, the only “plan only” exception would be the exception applicable to nonqualified 457(b) plans.

18. Change the Rule of 55 “separation from service” qualified plan penalty exception to be a broader, fairer age 55 need-based exception. Currently a 56 year-old CEO can leave their job and qualify for the penalty exception from their 401(k) but a 57 year-old teacher cannot qualify for the exception from an IRA. How does that make sense?

New exception: Starting in the year one turns age 55, if AGI other than the taxpayer’s and/or their spouse’s potential Rule of 55 distribution(s) is less than $70K single, $110K MFJ (indexed for inflation), then the distribution (a “Rule of 55 distribution”) from the qualified plan or IRA is penalty free. Each person would have a $70K annual maximum (indexed for inflation) that could be accessed penalty free under this new, more rational Rule of 55 exception. In between $70K and $90K ($110K to $145K MFJ) of AGI (other than the potential Rule of 55 distributions), the $70K limitation per person is ratably reduced.

The new Rule of 55 exception would be a Rule of 50 exception for public safety employees subject to the AGI limits described immediately above.

Eliminate Loopholes Benefitting Very Few

19. Age 15 requirement for IRA (traditional and Roth) contributions. Today a very few advantaged families can fund a retirement account for young children. Sometimes this takes the form of paying an infant a salary, which is at best questionable. Even with the elimination of this loophole, the family’s total annual Roth IRA contributions may be greater under this proposal. Instead of $6,500 per person ($19,500 total for family of 3), each parent can contribute $10,000 into a Roth IRA ($20,000 total). Of note, Canada requires being at least age 18 to make contributions to a tax-free savings account.

20. Eliminate the “super HSA” by deeming all persons covered by a HDHP other than the policyholder and their spouse to be a dependent of the policyholder for purposes of determining HSA contribution limits. The super HSA allows young adults covered by their parents’ high deductible health plans to put more into an HSA than most single HSA owners can. That’s not fair and illogical, and the super HSA is a loophole created not by Congressional intent but rather by the drafting technicalities used to create HSAs in IRC Section 223.

Reform, Expand, and Simplify Qualified Birth Distributions

21. Reform, expand, and simplify SECURE Act Qualified Birth Distributions. Repeal as written in the SECURE Act. Capped at only $5,000 and confusing in their details, the current qualified birth distribution rules are not effective for parents. The new qualified birth distribution and recontributions rules would be as follows:

For those under age 59 ½, up to $30,000 of distributions from qualified plans, SEP IRAs, SIMPLE IRAs, traditional IRAs, and Roth IRAs per parent distributed within 18 months (9 months before and 9 months after) surrounding a birth and/or an adoption are presumed to be a qualified birth distribution (QBD) and as such (i) are not treated as distributions in the year of the distribution (and not subject to tax withholding) and (ii) can be rolled back into the account by the end of the third year following the distribution. Amounts not repaid to the account are treated as distributions from the account at the end of that third year (including for estimated tax purposes), and are excused from the 10% early withdrawal penalty (if the penalty would otherwise apply to the deemed distribution). No mandatory reporting requirements for the parents (other than for any deemed distribution at the end of the third year), but the IRS is authorized to provide a voluntary reporting form reporting qualified birth distributions and qualified birth recontributions. The new law would authorize financial institutions and plan providers to rely on taxpayer representations for both distributions and recontributions in issuing Forms 1099-R and 5498 and accepting recontributions.

This is a good idea for several reasons. It means saving for retirement is not a hindrance to financial security when adults are considering whether to have children. Our country is facing a decline in births. This proposal helps parents use retirement accounts to help during pregnancy and after childbirth while not handicapping their retirement. People can invest in Roth IRAs, for example, knowing that the money can be available for both the initial expenses of childbirth and their future retirement.

Unfortunately, saving for birth and saving for retirement can compete. New, more robust and parent-friendly qualified birth distributions can reduce this competition and allow retirement savings to help during pregnancy and the first nine months after birth.

Here is an example of how it could work: Robert, age 30, is the father of Mark, born February 2, 2024. On December 1, 2023, Robert withdrew $30,000 from his Roth IRA. At the time of the distribution, Robert had previously made $23,000 of annual contributions to his Roth IRA. Robert’s recontribution deadline is December 31, 2026. On April 2, 2026, Robert recontributes $20,000 to the Roth IRA, and makes no other qualified birth recontributions. On December 31, 2026, the $10,000 Robert did not recontribute to the Roth IRA is deemed to be a distribution from the Roth IRA to Robert. Robert took no other distributions from his Roth IRA prior to December 31, 2026. Since Robert had $23,000 of previous Roth IRA contributions to his Roth IRA as of the end of 2023 and may have made further annual contributions to his Roth IRA after 2023, the deemed distribution of $10,000 is deemed to be return of old annual contributions (under the nonqualified distribution rules) on December 31, 2026 and thus not taxable to Robert. The deemed distribution reduces Robert’s previous annual Roth IRA contributions by $10,000 for purposes of the nonqualified distribution rules as applied to any future nonqualified distributions.

As a practical matter, the combination of this proposal and proposals 1 and 2 are likely to result in most QBDs coming from Roth IRAs. Thus, most QBDs not recontributed to the Roth IRA will simply be nontaxable deemed distributions of previous Roth IRA annual contributions.

The new QBD rules would include rules providing that retirement account direct trustee-to-trustee transfers, rollovers, and Roth conversions occurring during the QBD 18 month window are not considered QBDs so as to preserve each parent’s $30K limitation. For simplicity’s sake, each birth and adoption will be treated as a distinct event for QBD purposes. Under this simplicity convention, parents of twins can each take up to $60K of QBDs. In addition, the QBD rules will have no adverse effect on the adoption tax credit. Funds sourced from a QBD for qualified adoption expenses will remain fully eligible for adoption tax credits based on the existing adoption tax credit rules. Lastly, a birth for QBD purposes will include the birth of a baby the parents give up for adoption.

Expand and Rationalize Remedial Measures for Retirement Accounts

22. Adopt a supercharged version of SECURE 2.0 Section 308. Enact section 308 (expanding the IRS Employee Plans Compliance Resolution System) and add a self-correction safe-harbor (available both before an IRS exam and during IRS examination activity) whereby all individual traditional IRAs and Roth IRAs, and SEP IRAs, SIMPLE IRAs, 401(k)s, and qualified plans involving 10 or fewer individuals/employees (including Solo 401(k)s) automatically qualify for self-correction and forgiveness of all penalties so long as (i) the account owner/plan sponsor implements reasonable corrections (such as refunding excess contributions and attributable earnings penalty free, subject to ordinary taxable income inclusion — in the year of the corrective distribution — for earnings and any returned contributions actually deducted on a tax return or previously excluded from taxable income), and (ii) the total amount in the plan or IRA has never exceeded $500,000 as of any year-end. For this purpose, accounts would only be aggregated for a person or plan sponsor at the same financial institution. The new rules would provide that financial institutions can rely on taxpayer representations in issuing Forms 1099-R to report corrective distributions. Financial institutions will continue to compute attributable earnings as they do under current regulations.

This proposal reduces penalties (such as excess contribution penalties) and helps ensure plans and IRAs remain qualified. Self-correction is much better for taxpayers and the IRS, particularly when accounts are relatively modest in size. Currently, the IRS offers the Voluntary Compliance Program for qualified plans. Since VCP covers very large employer plans, it is a very odd fit for Solo 401(k)s and would be an odd fit for traditional IRAs and Roth IRAs. It is much better to encourage the use of self-correction. This encourages compliance, makes correcting mistakes easier, reduces penalties, and makes the IRS’s oversight of modest sized retirement accounts easier and more effective.

23. Repeal and reform section 403 of the SECURE Act as applied to Form 5500-EZ filings. The SECURE Act increased penalties for late filed Form 5500 Series filings by tenfold. While this may make sense for large employer plans, the increase in penalties drastically overshot the mark when it comes to small businesses filing the Form 5500-EZ. Under the new law, a self-employed Solo 401(k) owner could (theoretically) be liable for a $150,000 penalty for failing to file a two page informational tax return (the Form 5500-EZ). Such a penalty is excessive and obscene. While relief procedures are available, it is ridiculous that the penalty could be, at least in theory, so onerous. Replace the current $250 per day penalty with a flat $500 per late Form 5500-EZ penalty (capped at $2,000 per plan sponsor) that can be excused for either reasonable cause or a first time abatement distinct to the Form 5500-EZ return. Cap the IRS period to assess the penalty at four years from the original filing deadline. Further, make the new rules effective to all missed Form 5500-EZ filings regardless of when they occurred. In addition, increase the asset threshold whereby a Form 5500-EZ is required from $250,000 to $500,000 to account for the passage of time and inflation. The Form 5500-EZ would still be required at the closing of the plan under this proposal, regardless of account size.

Repeal Traps for the Unwary

24. Eliminate the once-a-year IRA to IRA 60-day rollover limit. It’s a trap for the unwary and by eliminating it, the rules would be synchronized for all rollovers. The once-a-year limit makes no sense (as the 60-day time limit is sufficient to police money coming out of retirement accounts) and is punitive and unnecessary.

25. Repeal the SIMPLE IRA 25% penalty for early distributions within the first two years of establishing the SIMPLE IRA. Under this rule, the 25% penalty even applies to rollovers to traditional IRAs within the first two years. It’s a trap for the unwary and should be fully repealed.

Miscellaneous

26. Do not pass (or repeal if passed) the rest of SECURE 2.0, the EARN Act, and other related proposals, other than as discussed above. My opinion is that SECURE 2.0/EARN Act introduced changes that were at best marginally beneficial for Americans saving for retirement. Unfortunately, SECURE 2.0 has counterproductive provisions (such as eliminating the tax deduction for 401(k) catch-up contributions) and increases the complexity of the retirement account system.

Revenue Raisers (If Needed)

My hope is that my proposals would reduce federal revenue over the 10 year budget window by only a fairly modest amount, as there are provisions that would cost the government money and proposals that would increase revenue. If this nets out to costing too much money in Congress’s judgment, I recommend the following tax increase: an increase (starting in 2024) of the top capital gain/qualified dividend income rate (currently 20%) by the amount needed to close the gap. Considering that the highest earners have done the best in recent years, and do receive benefits under the overall proposal (see proposals 1, 2, and 4), this tax increase is fair and helps many Americans save for retirement by funding expansion of Roth IRAs and reduction of penalties.

If any other tax increases are deemed necessary, I recommend that Congress consider an increase to the rate of the corporate book minimum tax and/or a tax on investment income of college endowments comprised of $1 billion or more of assets. These two proposals shift the tax burden to those who have benefited the most from the American economy in recent years.

Landscape After Retirement Account Reform

Let’s return to Josh and Sarah. What might their tax-advantaged retirement account contributions look like after my proposed reform. Here’s Josh’s contributions:

401(k) Employee Deferral: $30,000

401(k) Employer Match: $9,000

Roth IRA: $12,000

Total traditional deductible contributions: $39,000, total Roth contributions: $12,000, total contributions: $51,000. Yes, Josh lost his Mega Backdoor Roth IRA. But, now instead of a gimmicky $7,500 Backdoor Roth IRA, he gets to simply make a $12,000 annual contribution to a Roth IRA. Further, Josh did not lose any tax deductions under my proposal. Josh can invest the difference between $81,000 (his old tax-advantaged contribution total) and $51,000 (his new tax-advantaged contribution total), $30,000, in a taxable account.

Sarah has significantly increased the amount of her contributions. She goes from a $7,500 annual contribution to a traditional deductible IRA or Roth IRA to a $12,000 traditional deductible or Roth IRA contribution.

Perfect? No. But instead of a 10.8 to 1 ratio we have moved the needle significantly such that the ratio is now 4.25 to 1. Further, many of the retirement account rules are simpler and fairer. If Josh, Sarah, or other Americans run into problems with their retirement accounts, their remedial paths are likely to be easier to navigate and they are more likely to avoid onerous and unfair penalties.

I believe that our retirement system would be significantly better if Congress passes and the President signs the 26 proposals I outlined above in 2023. If any of you have questions about the above, I would be happy to communicate with you and/or your staff about these proposals.

To my fellow Americans reading this letter, I’d be honored to read your comments in the comments section below. I’m sure there are other ideas that could simplify and improve retirement accounts.

Sincerely,

Sean Mullaney

This post 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.

2022 Year-End Tax Planning

Below are the main tax planning items for the year 2022 as I see them. Of course, this is educational information for the reader, and not tax advice directed toward any particular individual.

The first two tax loss harvesting items are particularly unique to 2022 vis-a-vis recent years.

Tax Loss Harvesting

2022 has given us plenty of lemons. For some Americans, it’s time to make some lemonade through tax loss harvesting. The deadline to do this and obtain a benefit on one’s 2022 tax return is December 31, 2022.

Tax Loss Harvesting and Bonds

There is a tax loss harvesting opportunity in 2022 that has not existed in recent years to the scope and scale it exists today: tax loss harvesting with bonds and bond funds. In a recent post I went into that opportunity in detail and how it might create both a great tax loss harvesting opportunity and a great tax basketing opportunity.

Tax Loss Harvesting Crypto

Many cryptocurrencies have declined in value. This can create a tax loss harvesting opportunity, regardless of whether the taxpayer wants to remain invested in crypto. To harvest the loss if one wants to get out of crypto, it’s easy: just sell the asset. For those wanting to stay in crypto, it’s not that much harder: sell the crypto (by December 31, 2022 if wanting the loss on their 2022 tax return) and they rebuy the crypto shortly thereafter. Crypto is not a “security” for wash sale purposes, and thus, repurchases of crypto are not subject to the wash sale rule, regardless of when they occur.

Solo 401(k) Establishment

Quick Update 12/23/2022: My initial reading of SECURE 2.0 is that it does not change any 2022 Solo 401(k) deadlines. The one deadline it appears to change is effective starting for plan years beginning in 2023.

For Schedule C solopreneurs looking to make a 2022 employee contribution to a Solo 401(k), the Solo 401(k) must be established by December 31, 2022. This is NOT the sort of thing you want to try to do on December 30th. Almost certainly those trying to establish a Solo 401(k) will want to act well before the end of December, as it takes time to get the Solo 401(k) established prior to year-end.

The deadline to establish a Solo 401(k) for an employer contribution is the tax return filing deadline. For individuals, this is April 18, 2023, but can be extended to October 15, 2023. For S corporations, this is March 15, 2023, but can be extended to September 15, 2023.

Solo 401(k) Funding for Schedule C Solopreneurs

Employee elective deferral contributions (traditional and/or Roth) must meet one of two standards. Either (i) they must be made by December 31st or (ii) they are elected by December 31st and made by the tax return filing deadline, including any filed extensions.

Employer contributions must be made by the tax return filing deadline, including any filed extensions.

Roth Conversions

Taxpayers with lower income (relative to the rest of their lives) may want to consider taxable conversions of traditional retirement accounts to Roth accounts. The deadline to get the Roth conversion on one’s 2022 tax return is December 31st, though it is not wise to wait until the last minute.

For the self-employed, there may be a unique opportunity to use Roth conversions to optimize the qualified business income deduction.

Tax Gain Harvesting

For those finding themselves in the 12% or lower federal marginal income tax bracket and with an asset in a taxable account with a built-in gain, tax gain harvesting prior to December 31, 2022 may be a good tax tactic to increase basis without incurring additional federal income tax. Remember, though, the gain itself increases one’s taxable income, making it harder to stay within the 12% or lower marginal income tax bracket.

HSA Funding Deadline

The deadline to fund an HSA for 2022 is April 18, 2023. Those who have not maximized their HSA through payroll deductions during the year may want to look into establishing payroll withholding for their HSA so as to take advantage of the payroll tax break available when HSAs are funded through payroll.

The deadline for those age 55 and older to fund a Baby HSA for 2022 is April 18, 2023.

Roth IRA Contribution Deadline

The deadline for funding a Roth IRA for 2022 is April 18, 2023.

Backdoor Roth IRA

There’s no law saying “the deadline for the Backdoor Roth IRA is DATE X.” However, the deadline to make a nondeductible traditional IRA contribution for the 2022 tax year is April 18, 2023. Those doing the Backdoor Roth IRA for 2022 and doing the Roth conversion step in 2023 may want to consider the unique tax filing when that happens (what I refer to as a “Split-Year Backdoor Roth IRA”).

Anyone who has already completed a Backdoor Roth IRA for 2022 should consider New Year’s Eve. December 31st is the deadline to be “clean” for 2022. Anyone who has done the Roth conversion step of a Backdoor Roth IRA during 2022 will want to consider (to the extent possible and desirable) “cleaning up” all traditional IRAs, SEP IRAs, and SIMPLE IRAs as of December 31, 2022.

Charitable Contributions

The deadline to make charitable contributions that can potentially be deducted on one’s 2022 tax return is December 31, 2022. Planning in this regard could include contributions to donor advised funds. If one is considering establishing a donor advised fund to get a deduction in 2022, I recommend moving well before December 31st, since it takes time for financial institutions to process donations and establish donor advised funds.

RMDs from Your Own Retirement Account

The deadline to take any required minimum distributions from one’s own retirement account is December 31, 2022. Remember, the rules can get a bit confusing. Generally, IRAs can be aggregated for RMD purposes, but 401(k)s cannot.

RMDs from Inherited Accounts

The deadline to take any RMDs from inherited retirement accounts is December 31st. For some beneficiaries of retirement accounts inherited during 2020 and 2021, the IRS has waived 2022 RMDs. That said, all beneficiaries of inherited retirement accounts may want to consider affirmatively taking distributions (in addition to RMDs, if any) before the end of 2022 to put the income into a lower tax year, if 2022 happens to be a lower taxable income year vis-a-vis future tax years.

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.

The MAGI Limitation on Roth IRA Contributions

During a recent Econome Encore presentation, a questioner asked a question that caused me to do a double take: Do Roth conversions create MAGI (modified adjusted gross income) for purposes of determining whether someone exceeds the MAGI thresholds to make an annual contribution to a Roth IRA?

I did a double take for several reasons. First, the presentation was early on a Sunday morning 😉 . Second, in practice, the issue rarely comes up, for reasons we will discuss later. Third, why wouldn’t income created by a Roth conversion count as MAGI for this purpose? It is taxable income, after all. Fourth, I was pretty sure the rule states that no, Roth conversions do not create MAGI for this purpose.

I quickly stated that I thought the rule does not consider Roth conversions to be included in MAGI, but I looked it up to be sure. My initial take was correct. Roth conversions are not included in MAGI for purposes of determining whether one can make an annual contribution to a Roth IRA. See IRC Section 408A(c)(3)(B)(i).

The Creation of the Roth IRA in 1997

It’s a bit of an odd rule, though. Why carve out Roth conversion income from the Roth IRA MAGI test? It’s especially odd considering that actual taxable withdrawals from a traditional IRA or 401(k) create MAGI for this purpose. Why carve out income from Roth conversions of traditional IRAs and 401(k)s?

It has to do with how Roth IRAs were created. In 1997, Congress created the Roth IRA to be effective starting in 1998. Roths were new. There was likely a concern along the lines of “a vehicle with tax-free growth could be abused.” Thus, there were two features of the Roth IRA subject to a MAGI limitation. Both the ability to make a direct annual contribution to a Roth IRA and the ability to convert amounts from a traditional retirement account to a Roth IRA were subject to a MAGI limitation. See page 40 of the 1997 Taxpayer Relief Act text.

The MAGI limitations begged the question: how to define MAGI for this purpose? The bill drafters started with a common technique: they found another relevant definition of MAGI already existing in the Internal Revenue Code. Why reinvent the wheel? They started with the MAGI definition used to determine the ability to make a deductible traditional IRA contribution.

By itself, however, this definition would create a circular definition problem with respect to Roth conversions, as the IRA deduction MAGI definition used starts with AGI and then kicks out certain items. Roth conversions are included in AGI, so to avoid a circular calculation, the bill drafters had to kick Roth conversion income out of the Roth MAGI definition.

If Roth conversion income was included in the MAGI definition, then the taxpayer would have to test Roth conversions against themselves to determine if Roth conversions were allowed! For example, if AGI was $90K prior to a $40K Roth conversion, the $40K Roth conversion would disqualify itself, as the MAGI limitation on the ability to convert was $100K of MAGI.

Further, the bill drafters decided to create one MAGI definition for the two different limitations. They could have created two different MAGI definitions, but this would have made a new Code section even more lengthy and complicated. Remember, none of this existed as of 1997 when the bill was written. So, the final bill only had one MAGI definition for both limits. That one definition kicked out Roth conversion income, which it had to do to avoid the circular definition problem with respect to Roth conversions.

Changes to Roth IRAs

In 2006, Congress repealed the MAGI limitation on the ability to do Roth conversions, effective 2010. See pages 21 and 22 of this PDF of the Tax Increase Protection and Reconciliation Act of 2005. This is what opened the door to the Backdoor Roth IRA starting in 2010.

Interestingly enough, had there never been a MAGI limitation on the ability to do a Roth conversion, the kick out of Roth conversion income from the MAGI limitation on the ability to make an annual contribution to a Roth IRA might not exist. First, there would have been no circular definition problem to solve. Second, it would have been neater to simply reference the deductible traditional IRA contribution MAGI definition and leave it at that.

But, that’s not how the history of the Roth IRA transpired. We will never know if there would not have been a kick out of Roth conversion income in defining MAGI for annual Roth contribution purposes had today’s rules been the original Roth IRA rules.

Roth Conversions and Annual Roth IRA Contributions

For *many* taxpayers, particularly those in the FI community, the time to do Roth conversions is not while one is working. When one is working, he or she is likely to (a) qualify for annual Roth contributions and (b) to be in their highest lifetime marginal tax brackets. Usually, the best time to do a Roth conversion is during early retirement rather than during one’s highest earning years.

As a practical matter, at the time many Americans qualify to make a Roth contribution, they are not likely to be in an optimal Roth conversion posture. Of course, your circumstances could vary. For example, consider someone taking a 12 month sabbatical from the workforce (starting March 1st) who has 2 months of earned income during the year. Perhaps he or she should (a) make a Roth IRA contribution based on their 2 months of earnings and also (b) do Roth conversions based on having a relatively low income for the year.

Click here for the IRS website detailing the 2023 MAGI limitations on the ability to contribute to a Roth IRA.

While We’re On the Subject of the Annual MAGI Limit on Roth IRA Contributions . . .

My belief is that one of the next changes Congress should make to Roth IRAs is to remove the MAGI limit on contributions.

Let’s think about this. A 50+ year old billionaire can contribute up to $30,000 to a workplace traditional or Roth 401(k) regardless of their income level. If this is possible, why is there a MAGI limitation on the ability to contribute $6,500 or $7,500 (age 50 or older, 2023 numbers) to a Roth IRA? It makes absolutely no sense, especially considering that some people, though not all people, can get around the MAGI limitation through the Backdoor Roth IRA.

Further, our neighbors to the north have no income limitation on the ability to contribute to a Tax-Free Savings Account, Canada’s equivalent of the Roth IRA. It’s time for Congress to repeal the MAGI limitation on the ability to make an annual Roth IRA contribution.

Watch me discuss the real answer to the Backdoor Roth IRA gimmick, which is the repeal of the MAGI limitation on the ability to make an annual Roth IRA contribution.

Conclusion

There’s a bit of an odd rule when it comes to determining MAGI for purposes of determining whether a taxpayer can make a contribution to a Roth IRA. It stems from the creation of the Roth IRA in 1997 and the fact that back then, there was also a MAGI limitation on the ability to convert amounts to a Roth IRA. Today, the kick out of Roth conversion income is a taxpayer favorable rule that is rarely significant in practice. More broadly speaking, I hope Congress repeals the MAGI limitation on the ability to make an annual Roth IRA contribution.

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

Follow me on Twitter: @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.

Sean on New Podcast Episodes

This week I’m on episodes of The Stacking Benjamins Show and the Earn & Invest podcast talking about taxes, retirement savings, and my new book, Solo 401(k): The Solopreneur’s Retirement Account.

I’ve also recently recorded, and will record, several other podcast episodes with some great podcast hosts, so please be on the lookout for those.

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

Follow me on Twitter at @SeanMoneyandTax

This post and the podcast episodes referenced in it, are for entertainment and educational purposes only. They do not constitute accounting, financial, legal, investment, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.

The Special Tax Loss Harvesting Opportunity for 2022

There is a tax loss harvesting opportunity in 2022 that has not existed in recent years to the scope and scale it exists today: tax loss harvesting with bonds and bond funds. In most recent years, many bonds and bond funds have not had significant built-in-losses. 2022 is different: now there are plenty of bonds and bond funds in taxable accounts with significant built-in-losses.

Tax Basketing for Bonds and Bond Funds

Bonds tend to be tax inefficient, for two reasons. First, they generate ordinary income, which is taxed at the taxpayer’s highest marginal tax rate. Second, they tend to have higher yields than equity investments. Thus, a dollar of a bond fund often produces more taxable income than a dollar of an equity fund, if they are both owned inside a taxable account.

As a result, holding bonds and bond funds in traditional retirement accounts is often logical from a tax basketing (or tax location) perspective. If they produce ordinary income anyways, why not hold them in a traditional retirement account (IRA, 401(k), etc.) where the owner can defer the timing of the ordinary income taxable event (through later Roth conversions and/or distributions)?

Tax Basketing for Stocks and Equity Funds

Bonds also don’t suffer from the “transmutation” problem equities have. Stocks and equity funds, in most cases, pay “qualified dividend income” which qualifies for the lower long term capital gains tax rates (including the 0% long term capital gains tax rate). Holding them in a traditional retirement account transmutes that preferred income into ordinary income, subject to the taxpayer’s marginal ordinary tax rate.

Now, as a practical matter, most Americans have most of their non-real estate financial wealth in traditional retirement accounts. Having some equities in traditional retirement accounts should not in any way cause despair. But, on the margins, it can be beneficial to review the overall portfolio to see if there can be some tax efficiency gains made by some tax rebasketing of assets.

Rebasketing and Tax Loss Harvesting

The deadline for tax loss harvesting for 2022 is December 31, 2022.

To my mind, some of the best 2022 tax loss harvesting will be selling bonds and bond funds at a loss in taxable accounts. Why is that? Because this sort of tax loss harvesting enjoys the main benefits of tax loss harvesting and it can achieve a great tax basketing result.

Bonds create ordinary income and are generally higher yielding than equities, which often produce tax favored qualified dividend income. Thus, from a tax basketing or tax location perspective, it can often make sense to hold bonds and bond funds in a traditional retirement account and hold equities in a taxable account. Today, many investors can do some tax loss harvesting and strategically reconfigure their portfolios to make them much more tax efficient. Here is an example of how this could play out.

Jorge is 30 years old. He currently owns a diversified equity fund (Fund A) inside his workplace traditional 401(k) plan worth $80,000. It has a 2% annual dividend yield, most of which is qualified dividend income (though of course it is tax deferred inside the 401(k) and will later be subject to ordinary income tax when withdrawn or Roth converted). Separately, he owns a diversified bond fund (Fund B) inside his taxable brokerage account. It is worth $20,000, and Jorge has a $24,000 tax basis in the fund. The bond fund has a 3% annual interest yield ($600), all of which is ordinary income. Jorge wants to have an 80% / 20% equity to bond allocation.

Here’s Jorge’s portfolio today:

Asset	Amount	Annual Taxable Income
401(k) Fund A (Equity)	$80,000	None
Taxable Fund B (Bond)	$20,000	$600
Total	$100,000	$600

Jorge, could, in theory, execute two transactions to both tax loss harvest and become more tax efficient from a tax basketing perspective. First, Jorge could exchange his $20K of Fund B for $20K of an equity fund inside his brokerage account with a dividend yield similar to Fund A. Second, inside his 401(k), he could exchange $20K worth of his Fund A holding for a bond fund with an income yield similar to Fund B. If Jorge’s new fund inside the 401(k) is not substantially identical to Fund B, he can claim most, if not all, of the $4,000 loss, though the prior month’s Fund B dividend might slightly reduce the loss under the wash sale rule.

Here’s Jorge’s portfolio after these two transactions:

Asset	Amount	Annual Taxable Income
401(k) Fund A (Equity)	$60,000	None
401(k) Bond Fund	$20,000	None
Taxable Equity Fund	$20,000	$400
Total	$100,000	$400

Jorge may obtain two tax benefits from these transactions. First, assuming he successfully navigates the wash sale rule, he may be able to deduct up to $3,000 against ordinary income by triggering the capital loss on the Fund B sale.

Second, regardless of whether he successfully navigated the wash sale rule, he has just made his portfolio more tax efficient. It used to be that he reported $600 of ordinary income (from Fund B) on his tax return. Now that sort of interest income is hidden inside the 401(k). If he now receives approximately $400 a year in qualified dividend income from the new equity fund inside the taxable brokerage account, he has (i) reduced his annual taxable income by $200 (and growing through compounding) and (ii) now has mostly qualified dividend income from the taxable account instead of ordinary income, lowering his federal tax rate on his portfolio income. He has done all that without disturbing his overall asset allocation.

Getting the tax basketing of his investments better without changing his investment allocation is likely to be worth it even if loses the tax loss due to the wash sale rule. He would want to review the options available to him inside his 401(k) to see if there is an acceptable (to him) bond fund that is not “substantially identical” to Fund B so as to avoid the wash sale rule being triggered by the investment in a bond fund inside the 401(k).

Conclusion

Declines in the stock and bond market are some of the lemons of 2022. But, there’s a chance to make some lemonade. When it comes to bonds held in taxable accounts, there may be an opportunity to obtain two benefits: tax loss harvesting and better tax basketing.

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

Sean Presentation at CampFI

These are the slides for my presentation at CampFI in Julian, CA on October 8, 2022.

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

Follow me on Twitter at @SeanMoneyandTax

Three Ways the Solo 401(k) Supports Financial Independence

Financial independence encourages thinking about one’s financial future in a different way. You were told to “build a career and retire at age 65.” Financial independence says you should write your own financial script. The system, your parents, and a large employer should not be the authors of your financial future.

Guess what goes perfectly well with a financial independence mentality? The Solo 401(k)! The Solo 401(k) helps you control today’s tax burden and helps you plan for your retirement your way.

Here are three ways the Solo 401(k) can support the financial independence journey.

Choice and Low Fees

One advantage of working for yourself is you gain control over your workplace retirement account. Solopreneurs themselves determine where their Solo 401(k) is established and the investment options available to them. They determine contribution levels and whether or not to contribute to a Roth account.

Solopreneurs are no longer at the mercy of a large employer’s 401(k) plan, which may not have the investments they want, a Roth option, and/or low fees.

Further, many Solo 401(k) providers offer low or no fees to establish a Solo 401(k) with their institution. For example, today neither Schwab nor Fidelity charges Solo 401(k) fees, other than the fees of the underlying investments (such as mutual fund expenses). Vanguard charges $20 per mutual fund inside a Solo 401(k) (other than the underlying fund fees), though the $20 fee can be waived if the solopreneur has enough qualifying assets invested with Vanguard.

Tax Rate Arbitrage

The Solo 401(k) supports very significant tax deductions. For those at their peak earning years, contributions to Solo 401(k)s can benefit from high marginal tax rates. Further, in certain circumstances, traditional deductible Solo 401(k) contributions can help solopreneurs qualify for the qualified business income deduction, increasing the marginal tax rate benefit of traditional, deductible Solo 401(k) contributions.

During early retirement, retired solopreneurs can convert traditional retirement accounts to Roth accounts. Those Roth conversions can be sheltered by the standard deduction, and then taxed at the 10 percent and 12 percent marginal federal income tax rate. This arbitrage opportunity (deduct contributions at high marginal rates, later convert the contributions and earnings to Roth accounts at lower tax rates) can supercharge the journey to financial independence.

Reducing MAGI for PTC Qualification

Many solopreneurs have their medical insurance through an Affordable Care Act plan. These plans often have hefty annual premiums. However, there is a Premium Tax Credit (“PTC”) that can significantly reduce the cost of those premiums.

PTCs decline as modified adjusted gross income (“MAGI”) increases. Very generally speaking, from a planning perspective, as MAGI increases, PTCs decline by approximately 10 to 15 percent. Solopreneurs can reduce MAGI by contributing to a traditional deductible Solo 401(k). That decrease in MAGI can significantly increase the PTC, defraying their ACA medical insurance premiums.

Conclusion

The Solo 401(k) can help solopreneurs achieve financial independence. Chapter 13 of my new book, Solo 401(k): The Solopreneur’s Retirement Account, goes into further detail about marrying the Solo 401(k) with one’s own FI journey. The book is available from Amazon, Barnes & Noble, and other outlets.

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, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.

The Advantages of Living On Taxable Assets First in Early Retirement

The FIRE community loves the accumulation phase. Build up assets towards the goal of financial independence.

Questions increasingly creep in when it comes to the distribution phase. Members of the FIRE community wonder: what do I live on when I get to retirement? This is particularly true when one reaches early retirement prior to age 59 ½.

Below I discuss the options and the reasons I believe that for many, the best assets to live off of first in early retirement are taxable assets. This analysis assumes the early retiree has access to some material amount of assets in each of the three tax baskets discussed below.

Early Retirement Drawdown Options

For most Americans reaching retirement prior to age 59 ½, there are three main tax baskets of assets that can be lived off prior to age 59 ½.

Taxable Assets: This can include cash in bank accounts, brokerage accounts (stocks, bonds, mutual funds, and ETFs), and for some, income from rental properties. For purposes of this blog post, I will assume the early retiree does not own any rental real estate.

Roth Basis/HSAs: Early retirees can live off of what I colloquially refer to as “Roth Basis.” Generally, Roth Basis is the sum of previous annual contributions to Roth accounts and Roth conversions that are at least five years old. Further, early retirees can harvest amounts in HSAs tax and penalty free to the extent that they have allowable previously unreimbursed qualified medical expenses (what I refer to as PUQME). HSAs can also be used for qualified medical expenses incurred in early retirement.

Traditional Retirement Assets: Assets such as traditional 401(k)s and traditional IRAs. Generally “inaccessible” prior to turning age 59 ½ due to being subject to both ordinary income tax and the 10% early withdrawal penalty. However, there are exceptions to the early withdrawal penalty. They include:

Rule of 55: Separation from service from an employer after turning age 55 (exception available for withdrawals from that workplace retirement plan only).
72(t) Payments: Establishing a series of substantially equal periodic payments.
Governmental 457(b) Plans

Drawbacks of Using Roth Basis/HSAs

Some might argue for using tax-free withdrawals of Roth Basis and HSAs to fund early retirement. This allows the early retiree to pay no taxes on funds used for living expenses.

To my mind, the main drawback of doing so is opportunity cost. Removing assets from Roths and HSAs cuts off the opportunity for future tax free growth.

As a general planning objective, many will want to let their Roths and HSAs grow as long as possible to maximize tax-free growth.

Using Roths and HSAs can also have a significant drawback from a creditor protection perspective, as I will discuss below.

Drawbacks of Using Traditional Retirement Assets

The below analysis assumes that the early retiree qualifies for an exception from the 10% early withdrawal penalty.

The biggest drawback to using traditional retirement accounts to live off of in early retirement is all living expenses become subject to federal and state income taxes. It puts the most important consideration (funding living expenses) in opposition to the secondary (but still important) consideration: tax planning.

Living off traditional retirement accounts in early retirement reduces tax planning flexibility. It reduces the ability to do tax-optimized Roth conversions in early retirement. In addition, living off traditional retirement accounts during early retirement can reduce Premium Tax Credits for those on Affordable Care Act (“ACA”) medical insurance plans.

Premium Tax Credit Planning: Many early retirees will use an Affordable Care Act medical insurance plan. The premiums are subsidized through a tax code mechanism: the Premium Tax Credit (the “PTC”). PTCs are reduced as the taxpayer’s modified adjusted gross income (“MAGI”) increases. Very roughly speaking, for planning purposes, an additional dollar of MAGI often reduces the PTC by 10 to 15 cents, meaning early retirees using traditional retirement accounts to fund living expenses may be subject to a surtax of 10 to 15 percent on retirement account withdrawals due to PTC reduction. Resources for the PTC include this article and this spreadsheet.

There’s an argument that it is good to live off traditional retirement accounts early because withdrawals used to fund living expenses reduce future required minimum distributions (“RMDs”). But one must consider that there are two types of withdrawals an early retiree can make from a traditional retirement account: an actual withdrawal or a Roth conversion. Both reduce future RMDs, but a Roth conversion is the most tax efficient withdrawal for the early retiree. Why? Because it sets up future tax-free growth! Actual withdrawals used for living expenses do not enhance future tax-free growth.

Another drawback of using traditional retirement accounts to fund early retirement includes being constrained by the parameters of the applicable penalty exception. For example, needing to keep money inside a former employer’s retirement plan in order to qualify for the Rule of 55, or needing to withdraw precise amounts annually if using a 72(t) payment plan. Further, using traditional retirement accounts in early retirement has creditor protection drawbacks, discussed below.

Advantages of Using Taxable Assets

Living off drawdowns of taxable assets can be a great way to fund the first expenses of early retirement. Here are some of the advantages.

Zero Percent Long Term Capital Gains Rate

Early retirees worry: I need $60,000 of income to live my life. Won’t that create $60,000 of taxable income?

If drawing from a taxable account, almost certainly it will not. Consider Judy, an early retiree needing $60,000 to pay her living expenses. If she sells $60,000 worth of the XYZ Mutual Fund (all of which she has owned for over a year), in which she has $40,000 of basis, her resulting taxable income is only $20,000. Not $60,000!

But it gets even better for Judy. The capital gain can qualify for the 0% federal long term capital gains tax rate. Outstanding! By using taxable assets, Judy may pay $0 federal income tax, and likely only a very small state income tax, on the money she uses to fund her living expenses. Pretty good.

Even if Judy’s income puts her above the 0% federal capital gains tax bracket, (i) some of her capital gains will likely qualify for the 0% rate, and (ii) the next bracket is only a 15% tax rate.

Basis Recovery While Basis is Valuable

During 2022, we learned an important financial lesson: inflation is a thing. Retirement draw down planning should consider inflation.

One way to fight inflation is to use tax basis before its value is inflated away. Tax basis is never adjusted for inflation. Thus, failing to harvest tax basis exposes the early retiree to the risk that future capital gains in taxable accounts will be subject to taxation on inflation gains. Early retirees should consider harvesting basis (like Judy in the above example) when the tax basis is its most valuable.

Using taxable assets as the first assets to fund early retirement takes maximum advantage of tax basis, unless the U.S. dollar begins to deflate (a possible but not very likely long term outcome, in my opinion).

Opens the Door for Roth Conversions

Now we get to the fun part. Roth conversions! Using taxable assets first for living expenses in early retirement facilitates conversions of amounts in traditional retirement accounts to Roth accounts. The idea is to have artificially low taxable income such that the taxpayer can do Roth conversions taxed at 0% federal (offset by the standard deduction) and then in the 10% or 12% tax bracket. Occasionally, it will be logical for the taxpayer to incur an even greater tax rate on such Roth conversions.

These Roth conversions move assets to Roth accounts where they enjoy tax free growth. In addition, early retirement Roth conversions reduce future RMDs.

There is a taxpayer-friendly rule that assists early retirement Roth conversion planning: long-term capital gains income is stacked on top of ordinary income in the tax computation. Thus, Roth conversions can benefit from being sheltered by the standard deduction (or itemized deductions if the taxpayer itemizes). This makes Roth conversion planning in early retirement that much better, as some Roth conversions can benefit from a 0% federal income tax rate.

Further, this tells us it is generally better from a tax basketing perspective not to have bonds and other assets that generate ordinary income, since that income eats up part of the standard deduction, diminishing the opportunity to 0% taxed Roth conversions. One way to avoid having such ordinary income is to sell bonds, bond mutual funds, and other assets that generate ordinary income and use the proceeds to fund early retirement living expenses.

Another advantage of early retirement Roth conversions is the reduction of the risk that future tax increases will drive up taxes on future traditional retirement account withdrawals.

Roth Conversions, ACA PTC Eligibility, and Medicaid

Lastly, there can be an ancillary benefit to Roth conversions. Taxpayers lose all ACA subsidies (thus, PTCs) if their MAGI is below certain thresholds. For example, a family of four in California with MAGI less than $41,400 (2023 number) would meet the income threshold for Medi-Cal (Medicaid in California) and thus would get no ACA PTC.

Roth conversions can keep early retirees’ MAGI sufficiently high such that they do not meet the income threshold for Medicaid. By keeping MAGI above the Medicare threshold, early retirees can qualify for significant PTCs.

Creditor Protection

Financial assets can receive protection from creditors to varying degrees. Taxable brokerage accounts tend to have little, if any, creditor protection. 401(k) and other ERISA government workplace retirement accounts benefit from ERISA’s anti-alienation provisions. Generally speaking, only the IRS and an ex-spouse can get assets out of a 401(k). Traditional IRAs and Roth IRAs enjoy significant protection in bankruptcy. Traditional IRAs have varying degrees of non bankruptcy creditor protection, but in many states are fully protected. Roth IRAs are non bankruptcy protected in most states, but more states protect traditional IRAs than Roth IRAs.

HSAs do not enjoy federal bankruptcy protection, but do enjoy creditor protection in some states (to varying degrees).

By spending down taxable assets in early retirement, the early retiree optimizes for creditor protection in two ways. First, diminishing taxable assets by using them for living expenses reduces creditor vulnerable assets. Second, when an early retiree lives off taxable assets, they leave their more protected assets (traditional and Roth retirement accounts) to grow. Diminishing vulnerable assets while growing protected assets improves the early retiree’s balance sheet from a creditor protection perspective.

Lastly, early retirees should always consider personal umbrella liability insurance and other relevant property and casualty insurance for creditor protection.

Premium Tax Credit Planning

Living off taxable assets in early retirement limits taxable income. This has a good side effect. It increases the potential PTC available for early retirees using an ACA medical insurance plan.

Reducing Future Uncontrollable Taxable Income

Roths and HSAs are great because their taxable income is entirely controllable, and generally speaking should be $0. Even traditional retirement accounts have very controllable taxable income. There are no RMDs until age 72, and even then the amount of taxable income is quite modest for the first few years.

Taxable assets, on the other hand, expose the early retiree to uncontrollable taxable income, in the form of interest, dividends, and capital gain distributions. You never know when a mutual fund or other investment will spit out a taxable dividend or capital gain distribution. Such income reduces the runway for tax planning and can reduce PTCs.

Further, in recent years, we have become accustomed to living in a low-yield world. In the past decade plus a taxable portfolio has kicked off (in many cases) income yields of 3%, 2%, or less. Thus, the tax hit from taxable assets has not been too bad for many. That said, low yields are not guaranteed in the future. It could be that yields will rise, and thus taxable assets will generate increasing amounts of taxable income.

By living off taxable assets first, early retirees reduce and ultimately eliminate taxable interest, dividends, and capital gain distributions generated by holding assets in taxable accounts. This reduces the tax cost of the overall portfolio, and makes planning MAGI, taxable income, and tax paid annually an easier and potentially more beneficial exercise.

I discuss the early retirement Roth Conversion Ladder strategy in this video.

Conclusion

In many cases, I believe that the tax optimal path for the early retiree is to live off taxable assets first in early retirement prior to accessing Roth Basis, HSAs, and traditional retirement accounts. Of course, this is not individualized advice for you or any other particular individual. Those considering early retirement are well advised to consider their future drawdown strategy as they are building their assets. Those already retired should consider their own particular circumstances and ways to optimize their drawdown strategy.

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

Follow me on Twitter at @SeanMoneyandTax

TikTok Tax Advice

There’s tax advice available on TikTok. Is it worth following? Does it miss the big picture?

Retirement Saving Through Various Forms of Life Insurance

TikTok tax advice often boils down to something like the following: don’t save in traditional retirement accounts where you will get crushed by taxes in retirement. Rather, save for retirement through permanent life insurance products (such as indexed universal life insurance policies) to get tax free growth and tax free withdrawals during retirement.

Watch me discuss two problems with TikTok tax advice on YouTube.

This advice is not just offered on TikTok, though, anecdotally, it appears TikTok is at least something of a hub for promoting indexed universal life (“IUL”) and other forms of permanent life insurance.

One recent example of this sort of advice posits a retired couple making $160,000 a year in IRA/401(k) distributions and $40K in Social Security/pension income and worries that the couple will have a terrible tax problem.

But is that really the case? Let’s play it out with a detailed example.

Sally and Joe both turn age 75 in 2022. They are California residents. During their working years, they were prodigious savers in their workplace 401(k) plans, and their employers offered generous matching contributions. As a result, in 2022 they have required minimum distributions (“RMDs”) of $160,000. They also will have $40,000 of Social Security income, $4,000 of qualified dividend income, and $1,000 of interest income. Further, being tax savvy, they contribute $500 a month to their church through qualified charitable distributions (“QCDs”) from their traditional IRAs. They claim the standard deduction as their home is paid off and thus have no mortgage interest deductions.

Alright, let’s see what Sally and Joe’s 2022 tax picture (all numbers are estimates) looks like:

First, their rough 2022 federal income tax return:

Federal Income Tax Return
RMDs	$ 160,000
Social Security	$ 40,000
15% Social Security Exclusion	$ (6,000)
Interest	$ 1,000
Qualified Dividends	$ 4,000
QCD RMD Exclusion	$ (6,000)
Adjusted Gross Income (“AGI”)	$ 193,000
Standard Deduction	$ (25,900)
Additional SD Age 65+	$ (2,800)
Federal Taxable Income	$ 164,300

Let’s turn to what their $164,300 federal taxable income means in terms of federal and California income taxes paid and their 2022 cash flow:

2022 Income Taxes and Cash Flow (Estimated)
Federal Income Tax	$ 27,100
Effective Tax Rate on AGI	14.04%
Marginal Federal Income Tax Rate	22%
California Taxable Income (Approximate):	$ 149,000
California Income Tax (Approx.)	$ 7,862
Effective CA Income Tax Rate on Fed AGI	4.07%
Marginal CA Income Tax Rate	9.30%
Total Fed & CA Effective Income Tax Rate	18.11%
Cash Flow After Fed & CA Income Tax & QCDs	$ 164,038

By my math, after paying both income taxes and charitable contributions, this retired couple has $164,000 in cash flow for living expenses. Considering that, like many retirees, they live in a paid-off home, do we really believe there is a significant risk they will not be able to pay their bills? This couple ought to be able to enjoy a very pleasant, comfortable lifestyle, including recreational activities and travel.

Are Sally and Joe really getting crushed by income taxes? As residents of a high tax state, they do pay about $35K in combined federal and state income taxes. Sure, if $35K was on the table in front of you, you’d grab it pretty quick. But considering the $200K plus in cash flow they generated during the year, paying $35K in income taxes to the IRS and California is hardly financially debilitating.

Most retired couples, even financially successful couples, will not have federal adjusted gross income of $193,000. If Sally and Joe are not crushed by income taxes (paying just an 18.11% estimated effective rate even living in a high-tax state), it is likely most retirees will be able to withstand the tax hits at retirement from having significant savings in traditional deferred retirement accounts.

The Trade-Off Unstated on TikTok

TikTok tax advice often presents the boogeyman of taxes in retirement. It says “don’t invest in your 401(k) because it will get crushed in retirement.” Even if that were true, it usually neglects an important consideration: the upfront benefit of investing in a 401(k).

During their working careers, it is likely that Joe and Sally were subject to marginal income tax rates of 24% or more federal and 9.3% California. Had they used permanent life insurance to save instead of using their 401(k)s, they would have lost 33 cents (or more) on every dollar in immediate tax savings, as there is no tax deduction for amounts contributed to life insurance policies.

The existence of the tax deduction for amounts contributed to a traditional 401(k) does not automatically mean that using permanent life insurance products for retirement is a bad idea. However, in weighing the tax benefits of the traditional 401(k) approach compared to the permanent life insurance approach, one must consider the immediate, and potentially substantial, tax benefits of traditional 401(k) contributions.

One consideration in weighing the pros and cons of each: traditional 401(k) contributions generally get a tax benefit at the taxpayer’s marginal tax rate, while withdrawals from traditional 401(k)s and IRAs are more generally taxed at a taxpayer’s lower effective rate. On the way out, withdrawals are taxed through the relatively progressive tax brackets existing today, getting the benefits of the 10%, 12%, and 22% federal income tax brackets.

Uncertainty

But, Sean, what about future tax rate increases! The federal government is running a huge deficit and it’s not getting any better.

This is a valid point. But let’s consider a few things. First, in my example, Sally and Joe were subject to a 33.3% marginal tax rate during their working years, and barely over an 18% effective tax rate during their retirement. For the math to work out to make permanent life insurance more attractive (tax-wise) than traditional 401(k)s for them, tax rates would need to be increased substantially, by over 80%. Thus, even if tax rates on retirees such as Joe and Sally were to increase 85% from current levels, the tax math might only marginally favor using permanent life insurance instead of a traditional 401(k).

Second, if there are going to be income tax rate increases, they are more likely to be to the upper tax brackets. There are fewer taxpayers (read: voters) subject to the higher tax brackets, so those are the ones the politicians are more likely to increase. Increasing the 10%, the 12%, and/or the 22% tax brackets will impact more voters and lead to more election risk for the politicians.

Third, recent history suggests that the politicians are not likely to target retirees. It’s true that Social Security went from being tax free to being largely subject to taxation, up to 85% taxable. Interestingly enough, the second Social Security tax increase, which subjected Social Security to possibly being 85% taxable, passed through a Democratic Congress in 1993. The following year the Democrats suffered historic losses in the House and Senate elections. Many factors came into play, but it is interesting that since 1994 tax policy has generally benefited retirees (no more tax increases on Social Security, increasingly progressive tax brackets, and the increased standard deduction).

Perhaps the politicians in both parties have learned a lesson when it comes to retiree taxation.

Is there zero risk that retirees could be subject to higher taxes in the future? Absolutely not. But, is that risk great enough to eschew traditional 401(k) contributions in favor of permanent life insurance? Not in my opinion.

Further, there are simpler, less costly planning techniques other than permanent life insurance that those using 401(k)s for retirement planning can avail themselves of, including Roth accounts and health savings accounts.

Roth Accounts

Savers worried about future tax rate hikes have a simple, easy to implement tool to hedge against future tax rate increases: the Roth IRA. The Roth IRA solves the same tax problem that permanent life insurance solves for. In today’s environment, Roth IRAs are available at a vast array of financial institutions with very low fees.

As I have previously discussed, many savers will benefit from the combination of a maxed out traditional 401(k) and a maxed out annual Roth IRA.

Many will point out the possibility of much greater contributions to an indexed universal life insurance policy than to a Roth IRA. While true, many of those concerned with getting large amounts into tax-free accounts while working can turn to the Roth 401(k), which has significantly greater annual contribution limits than the Roth IRA.

Roth Conversions

Many in the FIRE community have access to Roth conversions during what are likely to lower taxable income years. The tax idea behind retiring early is to load up on traditional 401(k) contributions during working years, and then convert amounts inside traditional retirement accounts to Roth accounts during early retirement years prior to collecting Social Security.

In early retirement years, many in the FIRE movement appear, at least initially, to be poor on their tax return. No longer working, and not yet collecting Social Security, one’s tax return only includes interest income, dividend income, and some capital gains income. If that income is relatively low (which it is likely to be for many early retirees), it likely leaves room for Roth conversions at the 10% or 12% tax brackets during early retirement.

This is tax rate arbitrage. First, deduct 401(k) contributions in the 24% or greater federal income tax brackets during one’s working years. Then, during early retirement, convert amounts in the traditional retirement accounts at a 10%, 12%, or perhaps 22% marginal federal income tax rate.

Two observations: A) using permanent life insurance instead of traditional 401(k) contributions followed by early retirement Roth conversions denies members of the FIRE community a significant tax rate arbitrage opportunity. While there is no taxable income inclusion when withdrawing from a permanent life insurance policy, there is also no tax deduction for contributions to IULs, whole life insurance, and other permanent life insurance policies.

B) By doing Roth conversions during early retirement, FIRE members reduce the uncertainty risk described above. FIRE members face a shorter time frame during which significant savings are in traditional retirement accounts, as the goal is (generally speaking) to get the money (mostly) converted to Roths prior to age 70.

The Roth conversion tool reduces the risk that future tax increases will crush savers who mostly use traditional 401(k)s during their working years. While this is true for all savers, it is most especially true for members of the FIRE community.

A note on tax optimization: Imagine Joe and Sally were retired at age 55, today’s tax laws existed, and they had many years with artificially low taxable income. Say they did not do Roth conversions during this time. Is that a mistake? From a tax optimization perspective, absolutely. They would have likely been able to do Roth conversions at a 10% or 12% federal income tax rate, which is lower than both their retirement 22% marginal federal income tax rate and 18.11% combined effective income tax rate. While they are not tax optimized, they are something more important in my example: financially successful. Yes, tax optimization is important, but it is not the be-all and end-all. My guess is that financially successful individuals do not regret the failure to tax optimize on their deathbeds, though I look forward to reading Jordan “Doc G” Grumet’s new book to be sure.

Conclusion

I’m not here to tell you exactly how to save for retirement. But I am concerned that TikTok tax advice has two deficiencies. First, it overstates the problem of taxation in retirement. Is there a potential problem? Yes. Is it as severe as some make it out to be? Not under today’s laws. Further, there are tactics such as annual Roth IRA contributions and Roth conversions during early retirement that can address the problem. Second, TikTok tax advice understates the current benefit of deductible traditional 401(k) contributions during one’s working years.

Four Ways to Fight Inflation

Decisions you make today can subject you to more inflation tomorrow! Read below about ways to increase or decrease your exposure to inflation tomorrow.

Watch me discuss fighting back against inflation.

Tax Planning

As a practical matter, most Americans have the majority of their retirement savings in traditional, pre-tax vehicles such as the 401(k). Having money in a traditional 401(k) is not a bad thing. However, the traditional 401(k) involves trade offs: an upfront tax deduction is the primary benefit in exchange for future taxation when there is a withdrawal or Roth conversion.

Having money inside traditional retirement accounts subjects future inflation to taxation. Some of the future growth in a traditional retirement account is likely to be attributable to inflation, and thus there will be a tax on inflation. Further, there are no inflation adjustments when it comes to the taxation of traditional IRA and traditional 401(k) withdrawals.

An antidote to this problem is the tax free growth offered by Roth accounts and health savings accounts. Getting money into Roths and HSAs excuses future growth from taxation, including growth attributable to inflation.

Roth 401(k) versus Roth IRA

Of course, inflation is only one consideration. Many will do some traditional retirement account contributions and some Roth retirement account contributions. The question then arises: which Roth account to use?

My view is that for many a Roth IRA contribution (whether a direct annual contribution or a Backdoor Roth IRA) is better than a Roth 401(k) contribution. Many do not qualify to deduct a traditional IRA contribution but can deduct a traditional 401(k) contribution. Considering that reality, why not combine a deductible traditional 401(k) contribution and a Roth IRA contribution?

Long Term Fixed Rate Debt

Often we discuss how inflation hurts Americans, and we should be concerned about the bad effects of inflation. However, there is a way to become a beneficiary of inflation: using long-term, low interest fixed rate debt to your advantage.

That’s right: hold onto that low rate 30 year mortgage like it’s a life raft! Okay, that’s a bit hyperbolic, but the overall point holds. Inflationary environments are great for debtors, particularly those debtors who have locked in a low interest rate for a long term.

Here is an example: Sarah and Mike have a 30 year, $400,000 mortgage on their primary residence at a 2.9% fixed interest rate. By paying the required monthly payment, and no more, they benefit from any future inflation. By paying off the mortgage later rather than sooner, they are using devalued future money to pay the mortgage rather than more valuable current day dollars.

Sarah and Mike benefit from inflation! Are there reasons to pay off a mortgage early? Sure. But in an inflationary environment, paying off the mortgage early gives the bank more valuable dollars to satisfy the debt.

To my mind, a fixed rate, long term mortgage is a great hedge against inflation.

That said, there are few perfect financial planning tactics. Most involve risk trade offs. One risk Sarah and Mike assume by not paying down the mortgage early is the risk of deflation. To obtain this inflation hedge, they expose themselves to the risk of deflation. If the U.S. dollar starts to deflate (i.e., it appreciates in value), Sarah and Mike will find themselves paying more valuable dollars to the bank in the future.

Travel Rewards

Travel rewards can help fight inflation. One way is using sign-up bonuses and other accrued points to pay for hotel room nights or flights. Using points gets out of cash paying and thus inflation of the dollar hurts a bit less.

However, keep in mind that travel reward points are subject to their own inflation! The hotel chain or airline can devalue the redemption value of points at any time. Thus, if everything else is equal, those with significant travel rewards point balances might want to spend those points sooner rather than later for travel.

A second consideration are the features of credit cards. Some travel branded credit cards come with certificates for free nights or a companion pass for a companion to receive free or discounted flights. If flighting inflation is a key goal, favoring cards that offer free-night certificates or companion passes can be a way to fight inflation.

Spending that Leads to More or Less Future Spending

We’re used to assessing the price tag. $28,000 for that brand new car: “that’s a great deal!” or “that’s a terrible deal!” But the price tag is only one part of the financial picture.

If you buy a black cup of coffee at Starbucks, it might cost you $2.65. Fortunately, that’s it. The cup of coffee isn’t likely to cause you to incur later costs.

What about a $45,000 SUV? That purchase will cause later costs, many significant. For example, the cost to insure a $45,000 SUV might be significantly more than insuring a $22,000 sedan. What about gas? By purchasing a larger, less fuel-efficient car, you lock in more future spending, and thus more exposure to future inflation.

Think about buying a large home with a pool in the backyard. That square footage attracts property tax, heating and cooling costs, and inflation in both costs. The pool in the backyard requires constant upkeep, subjecting the homeowner to another source of inflation.

To my mind, food is a big one in the fight against inflation. What you eat today could very well translate into medical costs tomorrow, exposing you to significant inflation. Spending on foods with vegetable oils and sugars today is likely to increase your future exposure to medical expense inflation.

The lesson is this: you can use today’s spending to reduce your exposure to future inflation.

Conclusion

Is there a perfect answer to inflation? No. But with some intentional planning and spending today, Americans can reduce their exposure to the harmful effects of future inflation.

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

Follow me on Twitter: @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.

An Open Letter to the Members of the 118th Congress

Problems with the Current Retirement Savings System

Limits Are Unequal and Unfair

Other Retirement Account Problems

Goals for Retirement Account Reform

Retirement Tax Reform Proposals

Expanded Universal Roth IRAs and Closing Backdoors

Eliminate Traditional Retirement Account Basis

Simplify and Rationalize Retirement Account Rules

Combat Mega Retirement Accounts and Limit Benefits for the Very Rich

Penalty Reform

Eliminate Loopholes Benefitting Very Few

Reform, Expand, and Simplify Qualified Birth Distributions

Expand and Rationalize Remedial Measures for Retirement Accounts

Repeal Traps for the Unwary

Miscellaneous

Revenue Raisers (If Needed)

Landscape After Retirement Account Reform

Tax Loss Harvesting

Tax Loss Harvesting and Bonds

Tax Loss Harvesting Crypto

Solo 401(k) Establishment

Solo 401(k) Funding for Schedule C Solopreneurs

Roth Conversions

Tax Gain Harvesting

HSA Funding Deadline

Roth IRA Contribution Deadline

Backdoor Roth IRA

Charitable Contributions

RMDs from Your Own Retirement Account

RMDs from Inherited Accounts

The Creation of the Roth IRA in 1997

Changes to Roth IRAs

Roth Conversions and Annual Roth IRA Contributions

While We’re On the Subject of the Annual MAGI Limit on Roth IRA Contributions . . .

Conclusion

Tax Basketing for Bonds and Bond Funds

Tax Basketing for Stocks and Equity Funds

Rebasketing and Tax Loss Harvesting

Conclusion

Choice and Low Fees

Tax Rate Arbitrage

Reducing MAGI for PTC Qualification

Conclusion

Early Retirement Drawdown Options

Drawbacks of Using Roth Basis/HSAs

Drawbacks of Using Traditional Retirement Assets

Advantages of Using Taxable Assets

Zero Percent Long Term Capital Gains Rate

Basis Recovery While Basis is Valuable

Opens the Door for Roth Conversions

Roth Conversions, ACA PTC Eligibility, and Medicaid

Creditor Protection

Premium Tax Credit Planning

Reducing Future Uncontrollable Taxable Income

Conclusion

Retirement Saving Through Various Forms of Life Insurance

The Trade-Off Unstated on TikTok

Uncertainty

Roth Accounts

Roth Conversions

Conclusion

Further Reading

Tax Planning

Roth 401(k) versus Roth IRA

Long Term Fixed Rate Debt

Travel Rewards

Spending that Leads to More or Less Future Spending

Conclusion