People worry about taxation in retirement. In particular, they worry about the taxation of required minimum distributions (RMDs), especially after the death of a spouse. Widows find themselves in the single tax brackets after decades of enjoying the more favorable married filing jointly tax brackets.
Widows and widowers finding themselves as single taxpayers is often referred to as the Widow’s Tax Trap.
RMDs require taxable withdrawals from traditional retirement accounts such as IRAs and 401(k)s. But just how bad are they when a widow or widower is in the Widow’s Tax Trap?
Let’s unpack just how bad the combination of the Widow’s Tax Trap and RMDs is for an 81 year-old widow with a very tax inefficient structure: almost $3.7 million of her approximately $4.5 million of financial wealth in a traditional IRA.
My experience tells me many financial planners and gurus will tell you this is a terrible outcome. That $3.7 million traditional IRA is infested with taxes!
But is it really?
81 Year-Old Widow in the Widow’s Tax Trap
I put together an analysis of an affluent widow in the Widow’s Tax Trap. Let’s call her Jane. Her traditional IRA causes her to have an RMD of almost $190,000. Wow!
What are the federal income tax rates on that feared RMD?
Isn’t it remarkable that an 81 year-old widow with almost $3.7 million in a traditional IRA has more of her RMD taxed in the 12 percent tax bracket than in the 32 percent tax bracket?
Despite all the fear of taxation of RMDs, that’s the reality when it comes to a very affluent, very inefficient 81 year-old widow.
Yes, Jane pays IRMAA of approximately $6,500 in two years because of her RMDs. And yes, the RMDs trigger approximately $500 of net investment income tax.
But do either of these have any impact on Jane’s lived experience and financial success?
Absolutely not!
The government scores some Garbage Time Touchdowns on Jane by collecting some IRMAA, some net investment income tax, and some income tax in the 32 percent bracket.
A Garbage Time Touchdown is a late in the game touchdown scored by a team that will lose the game regardless of the touchdown. As a New York Jets fan, sadly I’m an expert in Garbage Time Touchdowns.
Jane has some tax inefficiencies that are just Garbage Time Touchdowns.
Think about the lifetime arc of Jane’s taxes in today’s tax planning world:
As a single individual, Jane likely deducted workplace retirement plan contributions at a 22, 24, or 32 percent rate. Win versus the IRS!
As a married couple, Jane and her husband likely deduct into workplace retirement plans at a 22 or 24 percent rate. Win versus the IRS!
In early retirement, they live off taxable accounts and do not do Roth conversions. They may pay nothing in federal income tax! Win versus the IRS!
Once taxable accounts are depleted, traditional retirement account distributions could have benefitted from the Hidden Roth IRA. Win versus the IRS!
Even RMDs are likely subject to the 12 percent and 22 percent brackets while they are both alive. Win versus the IRS!
As a widow, the relatively minor tax inefficiencies creep in. These are Garbage Time Touchdowns.
This arc, which eschewed Roth 401(k) contributions and taxable Roth conversions, screams “Jane wins a blow out victory over the IRS” over the course of her lifetime.
Sure, at the end Jane gave up some Garbage Time Touchdowns to the IRS, but not after decades of defeating the IRS.
What’s more important than winning the spreadsheet is lived experience. Notice that Jane paying 32 percent on about six percent of her RMD has $200K of after-tax cash flow?
In order for the Widow’s Tax Trap to bite hard, the widow generally has to have about $200K or more of after-tax cash flow.
The taxes bite when widows can most afford them!
Watch me break down the tax analysis of our 81 year-old widow on YouTube.
Roth Conversions to Avoid the Widow’s Tax Trap
Should Jane and her husband have done taxable Roth Conversions in retirement to avoid the widow paying 32 percent federal income tax on some of her RMDs?
Here vocabulary becomes very important. Yes, some taxable Roth conversions taxed at 22 percent or 24 percent could have been beneficial. But they were hardly necessary.
Outside of cases where taxable Roth conversions create enough required income to qualify for a Premium Tax Credit, taxable Roth conversions are not necessary.
Yes, there are times where large taxable Roth conversions can be beneficial in that they mitigate harmful effects of the Widow’s Tax Trap. But the analysis above shows that the harmful effects of the Widow’s Tax Trap aren’t all that harmful for the vast, vast, vast majority of Americans. This is true even those with most of their financial wealth in traditional retirement accounts.
This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.
The 400 percent cliff will ruin your early retirement!!!
Neither of these is true. But the messages are out there.
Yes, the Premium Tax Credit for 2026 is very unsettled. Could it create problems for early retirees in 2026? Yes.
But now is the time to embrace solutions, to borrow a phrase from Jon Taffer.
Since 2026 ACA open enrollment begins in less than a week, below I assess the lay of the land for ACA medical insurance and Premium Tax Credits in 2026. I then move onto planning as early retirees consider their ACA medical insurance options for 2026 in late 2025.
Premium Tax Credit
From 2014 through 2020, the Premium Tax Credit reduces ACA medical insurance premiums based on this table. Of note is that this table fully eliminates Premium Tax Credits once one’s income is over 400 percent of the federal poverty level. I refer to the years 2014 through 2020 as the “First Era.”
From 2021 through 2025, the Premium Tax Credit reduces ACA medical insurance premiums based on this more generous table. Of note is that this table ratably reduces, but does not eliminate, Premium Tax Credits once one’s income is over 400 percent of the federal poverty level. I refer to the years 2021 through 2025 as the “Second Era.”
With no change to the laws, in 2026 we start what I refer to as the “Third Era.” The Premium Tax Credit will be determined based on the First Era table. The enhancements to ACA Premium Tax Credits will go away. ACA Premium Tax Credits themselves will not go away.
Fears Over Changes to the Premium Tax Credit
If we look at history, we know that the 400 percent of federal poverty level cliff will not ruin an early retirement.
Why?
We saw from 2014 through 2020 plenty of Americans were successfully early retired. Many of them got Premium Tax Credits.
Yes, the First Era featured the 400 percent of federal poverty level cliff. Yes, that was a financial planning issue for early retirees to deal with. No, it did not ruin their early retirement.
Further, medical insurance premiums are simply one of many financial planning issues early retirees deal with. It’s odd to claim that a change to one expense in 2026 will destroy a retirement plan.
The Government Shutdown
Currently, many federal government agencies are either closed or working with reduced operations. This is commonly referred to as the “Government Shutdown.”
The Government Shutdown provides a potential leverage point for politicians to extend a version of the enhanced Premium Tax Credits. Democrats generally want to make the Second Era Premium Tax Credit enhancements permanent. Interestingly enough, there are two Republican cohorts that also want to extend some version of enhanced Premium Tax Credits. One is a baker’s dozen of generally Blue State Republicans in the House and one are more populist Republicans led by Representative Marjorie Taylor Greene.
There are no guarantees. It is absolutely possible that some version of enhanced Premium Tax Credits will apply in 2026. However, from a planning perspective, early retirees should consider the very real possibility that we go back to the First Era Premium Tax Credit rules in 2026.
2026 Premium Tax Credit Solutions
One year’s medical insurance premiums are not likely to ruin anyone’s early retirement and finances.
That being said, early retirees should approach the situation by embracing solutions.
To my mind, for those looking to improve their tax and ACA medical insurance premium picture in 2026, as of late October 2025 there are two primary paths. The first path is “Bronze Plan and Lower Income” and the second path is “Catastrophic Plan and Lower Premiums.”
Bronze Plan and Lower Income
I have previously said that in the new planning environment, Bronze is Gold.
For many early retirees, Bronze ACA plans will be very desirable in 2026. Why? First, the premiums are lower than Platinum, Gold, and Silver plans, reducing pressure on the Premium Tax Credit issue.
Third, this sets up a tax free pot of money from which to pay medical expenses in 2026. From a Premium Tax Credit perspective, it’s better to reach into a tax free pot than to fund medical expenses by selling a capital gain asset or taking a taxable distribution from a traditional IRA.
A component of Bronze is Gold planning is keeping taxable income low. One helpful tactic in this regard is to hold all taxable bonds in traditional retirement accounts. This keeps interest income off one’s tax return, reducing Premium Tax Credit damage that taxable bond interest can do.
Cody Garrett and I anticipated that keeping income low for Premium Tax Credit purposes would be a big issue in 2026 when we wrote Tax Planning To and Through Early Retirement. That’s why, on pages 176 and 177 of the paperback version, we include 8 tactics early retirees might be able to use to lower their income in 2026 and increase their Premium Tax Credit.
Catastrophic Plan and Lower Premiums
A little-noticed change in September 2025 can be very helpful to those thinking about enrolling in ACA medical insurance in November 2025 for 2026.
The government now allows those with incomes above 400 percent of the federal poverty level to enroll in an ACA Catastrophic medical insurance plan. Previously, catastrophic plans were mostly open only to those under age 30 or could otherwise demonstrate a hardship. Now the rules allow having income over 400 percent of federal poverty level to qualify as having a hardship, and thus enroll in Catastrophic coverage.
I believe that Catastrophic coverage is an option well worth considering for many early retirees. Catastrophic policies generally have no coinsurance to start, but they do have in-network annual out-of-pocket maximums. To my mind, that latter feature is, by far, the most important benefit of a medical insurance policy–avoidance of financial ruin in the event of significant medical expenses.
Those on a Catastrophic plan do not qualify for a Premium Tax Credit. That can be a feature rather than a bug if you’re likely to be near the 400 percent of federal poverty level cliff anyways. Being on a Catastrophic plan makes Roth conversions much more desirable. With no Premium Tax Credit to manage for, the early part of an early retirement becomes a much more desirable time to do Roth conversions.
In today’s planning environment, I’m generally conservative when it comes to Roth conversions when one is on an ACA medical insurance plan. Why do Roth conversions when you are subject to what are essentially two federal income taxes; the federal income tax itself and the possible reduction or elimination of the Premium Tax Credit?
Catastrophic plan enrollment can open the door to more potentially beneficial Roth conversions.
Think twice when you hear fearful messages about 2026 Premium Tax Credits. For early retirees, now is the time to plan and embrace solutions. It’s also time to keep one’s ear to the ground. It’s possible that eventually some version of the Second Era’s Premium Tax Credit enhancements will ultimately be enacted.
FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com
This post is for entertainment and educational purposes only. It does not constitute accounting, financial, legal, investment, medical, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, legal, investment, medical, and tax matters. Please also refer to the Disclaimer & Warning section found here.
It’s that time of year again. The air is cool and the New York Jets season is over. That can only mean one thing when it comes to personal finance: time to start thinking about year-end tax planning.
I’ll provide some commentary about year-end tax planning to consider, with headings corresponding to the timeframe required to execute.
As always, none of this is advice for your particular situation but rather it is educational information.
Urgent
By urgent, I mean those items that (i) need to happen before year-end and (ii) may not happen if taxpayers delay and try to accomplish them late in the year.
Yes, there can be some taxable Roth conversions that are highly advantageous. But they tend to be much more limited in scope and scale than most commentators acknowledge. In our book, Cody and I detail the sorts of taxable Roth conversions that tend to be beneficial.
Back to timing. For a Roth conversion to count as being for 2025, it must be done before January 1, 2026. That means New Year’s Eve is the deadline. However, taxable Roth conversions should be done well before New Year’s Eve because
It requires analysis (hopefully done with up-to-date thinking) to determine if a taxable Roth conversion is advantageous,
If advantageous, the proper amount to convert must be estimated, and
The financial institution needs time to execute the Roth conversion so it counts as having occurred in 2025.
For those age 65 or older by year-end, the Roth conversion calculus should consider the new senior deduction.
The donor advised fund is a great way to contribute to charity and accelerate a tax deduction. My favorite way to use the donor advised fund is to contribute appreciated stock directly to the donor advised fund. This gets the donor three tax benefits: 1) a potential upfront itemized tax deduction, 2) removing the unrealized capital gain from future income tax, and 3) removing the income produced by the assets inside the donor advised fund from the donor’s tax return.
In order to get the first benefit in 2025, the appreciated stock must be received by the donor advised fund prior to January 1, 2026. This deadline is no different than the normal charitable contribution deadline.
Due to much year end interest in donor advised fund contributions and processing time, different financial institutions will have different deadlines on when transfers must be initiated in order to count for 2025. Donor advised fund planning should be attended to sooner rather than later.
Adjust Withholding
This varies, but it is a good idea to look at how much tax you owed last year. If you are on pace to get 100% (110% if 2024 AGI is $150K or greater) or slightly more of that amount paid into Uncle Sam by the end of the year (take a look at your most recent pay stub), there’s likely no need for action. But what if you are likely to have much more or much less than 100%/110%? It may be that you want to reduce or increase your workplace withholdings for the rest of 2025. If you do, don’t forget to reassess your workplace withholdings for 2026 early in the year.
One great way to make up for underwithholding, particularly for retirees, is through an IRA withdrawal mostly directed to the IRS and/or a state taxing agency. Just note that for those under age 59 ½, this tactic may require special planning.
These items can wait till close to year-end, though you don’t want to find yourself doing them on New Year’s Eve.
Tax Gain Harvesting
For those finding themselves in the federal 0% long-term capital gains tax bracket and with an asset in a taxable account with a built-in gain, tax gain harvesting prior to December 31, 2025 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 federal 0% long-term capital gains tax bracket.
I’m also quite fond of tax gain harvesting that reallocates one’s portfolio in a tax efficient manner.
Tax Loss Harvesting
The deadline for tax loss harvesting for 2025 is December 31, 2025. Just remember to navigate the wash sale rule.
RMDs from Your Own Retirement Account
The deadline to take any required minimum distributions from one’s own retirement account is December 31, 2025. 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.
Can Wait Till Next Year
Traditional IRA and Roth IRA Contribution Deadline
The deadline for funding either or both a traditional IRA and a Roth IRA for 2025 is April 15, 2026.
Backdoor Roth IRA Deadline
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 2025 tax year is April 15, 2026. Those doing the Backdoor Roth IRA for 2025 and doing the Roth conversion step in 2026 may want to consider the unique tax filing when that happens (what I refer to as a “Split-Year Backdoor Roth IRA”).
HSA Funding Deadline
The deadline to fund an HSA for 2025 is April 15, 2026. 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 2025 is April 16, 2026.
New for 2026! All Bronze and Catastrophic ACA plans will qualify as HDHPs!This opens the door for many self-employed and early retired individuals covered by these plans to make deductible HSA contributions. These deductible contributions can increase Premium Tax Credits and lower income taxes.
As I write this in mid-October 2025, the Premium Tax Credit is in flux. I do think many early retirees and self-employed individuals will benefit from considering a Bronze or Catastrophic plan. As I’ve said before, Bronze is Gold!
For those who already have a HDHP, now is a good time to review payroll withholding into the HSA. Many HSA owners will want to max this out through payroll deductions so as to qualify to reduce both income taxes and payroll taxes.
Self-Employment Tax Planning
Year-end is a great time for solopreneurs, particularly newer solopreneurs, to assess their business structure and retirement plans. Perhaps 2025 is the year to open a Solo 401(k). Often this type of analysis benefits from professional consultations.
FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com
This post is for entertainment and educational purposes only. It does not constitute accounting, financial, legal, investment, medical, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, legal, investment, medical, and tax matters. Please also refer to the Disclaimer & Warning section found here.
We will be on several more podcasts in the coming weeks and months discussing the book and its concepts.
One I’m particularly excited about is this Friday’s BiggerPockets Money podcast episode where we discuss tax planning for the five phases of retirement drawdown. You can find that episode on September 26th on the BiggerPockets Money YouTube channel and on podcast players.
I have also put two special YouTube videos on my YouTube channel discussing concepts from the book.
Today I posted a video discussing just how much tax a retired married couple might pay on a $40,700 Roth conversion using an example from the book. You might be very pleasantly surprised by the result.
A Favor Request
I speak for both Cody and myself when I say we are grateful for all of the support we have received for this project.
If you have purchased the book and read it, we humbly for one more favor. Please write an honest and objective review of the book on Amazon. The number and quality of reviews is vital to the book remaining one that Amazon recommends to its customers.
We want to get word out about Tax Planning To and Through Early Retirement. You can help us do that with an Amazon review!
Thank you for considering our request.
FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com
This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.
The tax planning world has changed. Have I and my fellow advisors caught up?
Below I discuss three changes in the past three years. These recent changes make a big impact on retiree taxation. Most commentators and gurus have largely ignored these changes.
The world has changed. It’s time for financial planners and tax advisors to adjust their advice accordingly.
No RMDs Until Age 75
In September 2022 required minimum distributions (“RMDs”) began at age 72. RMDs make traditional retirement account balances in retirement accounts less desirable, since they require taxable distributions.
In December 2022, SECURE 2.0 became law. For those born in 1960 and later, it delayed the onset of RMDs until age 75. SECURE 2.0 moved the needle when it comes to the desirability of traditional retirement accounts since it cancelled the three most likely to occur RMDs.
How long do we expect people to live beyond age 75? Take a look at the most recent Social Security Trustees Report actuarial table. For the vast majority of Americans, RMDs will now impact a very small proportionate share of their lifetime.
It’s time for advisors to question prioritizing a planning concern, RMDs, that now impacts a very small slice of most Americans’ lives.
Permanently Extended Lower Tax Brackets and Higher Standard Deduction
In 2022, advisors were on alert.
Better do those Roth conversions before lower tax rates sunset in 2026 was the common refrain. To be fair, in 2022 the Internal Revenue Code stated that the lower tax rates and the higher standard deduction expired on New Year’s Day 2026.
Since 2022, both the world and the Internal Revenue Code have changed.
The sunset never happened! In July 2025, the One Big Beautiful Bill permanently extended the previously “temporary” lower tax brackets and the higher standard deduction. In fact, the new bill slightly increased the higher standard deduction ($750 for singles, $1,500 for those married filing jointly).
Let’s think about what that means for taxes in retirement. RMDs that would have been taxed at 15%, 25%, and/or 28% will now be taxed at 12%, 22%, and 24%. That makes a big difference in planning, as the taxation of RMDs becomes less harmful.
It gets better! Less of most Americans’ RMDs will be taxed in a taxpayer’s highest bracket, thanks to the higher standard deduction. The higher standard deduction drags taxable income down in retirement, decreasing the amount of an RMD subject to the taxpayer’s highest marginal tax bracket.
Senior Deduction
New for 2025 is the senior deduction. It is up to $6,000 per person for those 65 or older by year end. Yes, it is subject to modified adjusted gross income (“MAGI”) phaseouts between $75,000 and $175,000 for singles and $150,000 to $250,000 for those married filing jointly. But those income phase outs still allow many rather affluent retirees to claim some or all of the senior deduction.
Many affluent retired couples will not show $150,000 of MAGI, especially prior to claiming Social Security. Even those with $200,000 of MAGI, a very limited cohort of affluent retired couples, get $6,000 of the potential $12,000 deduction. While the senior deduction may be more limited for affluent single retirees, many will be able to control income so as to qualify for some of the senior deduction.
The senior deduction helps with several retirement tax planning tactics and objectives. For some, the senior deduction opens the door wider for significant tax free taxable Roth conversions prior to collecting Social Security. For others, it will open the door to very significant Hidden Roth IRA distributions prior to collecting Social Security. The senior deduction also reduces the tax hit on RMDs, since it lowers the amount of the RMD subject to the taxpayer’s highest marginal tax rate.
2025 Increased Deduction: Consider a married couple both turning 65 in 2025. On New Year’s Day, their 2025 standard deduction was $33,200. Pretty good. With the increased standard deduction and the new senior deduction, assuming their MAGI is $150,000 or less, their total combined 2025 “standard” deduction is now $46,700. Yes, the tax planning world has changed!
Senior Deduction Uncertainty
Some worry: doesn’t the senior deduction vanish in 2029?
Aren’t we back to the “temporary” tax cuts that lowered the tax brackets and increased the standard deduction?
“Temporary” was simply the weigh station to “permanent” in that case. I strongly suspect something similar will happen with the senior deduction.
Let’s play out the politics. If Congress does nothing, in 2029, the senior deduction, the new deduction for tipped income, and the new deduction for overtime income all vanish overnight. Is it politically wise for Congress to allow seniors, waiters, waitresses, and many blue collar workers to face tax hikes?
Congress tends to act in its own best interests. While there are no guarantees, the politics are well aligned for the senior deduction to be extended into 2029 and beyond.
Tax Planning Impact
Fewer RMDs. Lower tax rates and a higher standard deduction. The senior deduction.
Three big changes in three years change tax planning.
We’ve heard commentators push for Roth 401(k) contributions during the working years and aggressive Roth conversions during the early part of retirement. Both tactics optimize for taxes in the later part of retirement. But we’ve just seen three changes in three years that significantly lower taxes later in retirement.
If the goal is to pay tax when you pay less tax, it’s time to adjust our thinking.
This is particularly true when it comes to Roth 401(k) contributions. These contributions, for most taxpayers, tend to cost a tax deduction at the taxpayer’s highest lifetime marginal tax rate. In a changed world where retiree taxation has been significantly reduced, that’s not likely to be good planning for most Americans.
My view is that the new tax planning environment reduces the desirability of significant Roth conversions prior to collecting Social Security. As Mike Piper stated, one of the main benefits of Roth conversions is to reduce tax drag caused by RMDs. The new tax laws significantly reduce that tax drag. Thus, accelerating income tax through Roth conversions becomes much less desirable.
Tax Planning Resource For a Changed World
Cody Garrett, CFP(R), and I created a resource for the new tax planning landscape.
Tax Planning To and Through Early Retirement is a book that tackles the new realities of tax planning, including deep dives into accumulation planning, drawdown tactics, taxable Roth conversions, RMDs, the Widow’s Tax Trap, and the senior deduction.
We also have an entire chapter titled Planning for Uncertainty. In that chapter we tackle the “What about future tax hikes?” question using history, logic, and reason.
Conclusion
In football and in tax planning, the game changes. The recommendations advisors made four years ago may have been the right recommendations then. But big changes in the retirement tax landscape require advisors to reevaluate their strategies and tactics when it comes to tax planning.
FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com
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.
On July 4th, President Trump signed into law the reconciliation bill, commonly referred to as the One Big Beautiful Bill.
The Bill will drive a significant amount of my content creation this summer.
On my YouTube channel, I will devote my Saturday videos to discussions of how the One Big Beautiful Bill impacts financial planning and retirement planning. Already I did a video stating that the One Big Beautiful Bill ought to have us questioning our thinking about the future, and a video about how One Big Beautiful Bill changes the tax planning landscape for charitable giving.
Separately, I am working with Cody Garrett, CFP(R), to put the finishing touches on our forthcoming book, Tax Planning To and Through Early Retirement, which we anticipate publishing later this year. The book will devote significant space to how the new law changes retirement planning.
To find out when we are publishing the book, please sign up for an email alert here.
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.
If there is a single article of faith in the personal finance world, it’s you’ve gotta worry! IRMAA! RMDs! Widow’s Tax Trap!
You’re rich? Great, start worrying! There’s plenty to worry about.
Hopefully most long time readers and YouTube viewers know I’m kidding since I’m a glass half-full type. Today I tackle one worry that sometimes dwarfs the previously mentioned three. Sequence of returns risk. People wonder if they should hold years of cash at retirement because of sequence of returns risk.
What is Sequence of Returns Risk?
Broadly defined, sequence of returns risk is that during the early part of a lengthy retirement, one or more bad years will hit the stock market. The early retiree is no longer accumulating, drawing down, and losing equity value. If the market takes years to recover, this could significantly hamper the early retiree’s chance of financial success in retirement.
Karsten Jeske, known as Big Ern online, discusses sequence of returns risk here.
Below I discuss five reasons I don’t worry about sequence of returns risk much as applied to well diversified retirees.
Diversification
We tend to think our portfolio exists in a vacuum. It doesn’t.
As Rick Ferri has observed, a well diversified equity portfolio rapidly declining will be accompanied by several offsetting things in the world. Policy makers and central banks are likely to take action, perhaps significant action. As the economy is down, layoffs are up and fellow retirees are feeling the pinch.
What’s happening to prices in that environment? Fewer businesses are paying for work travel and fewer retirees are staying at hotels. Fewer workers are getting bonuses and bidding up the price of grass-fed ribeyes at the supermarket. In environments where the entire economy is hurting, prices for goods and services are likely to be stable or themselves falling.
Will it be good for the early retiree to have their well diversified equity portfolio tank in early retirement? No. But Rick Ferri’s observation that related factors reduce the adverse impact of significantly falling equity prices is very instructive as to the importance, or lack thereof, of sequence of returns risk.
Where sequence of returns risk worries me greatly is a situation where an early retiree has a very undiversified portfolio. Imagine Sean retires today and 80 percent of his equity portfolio is in Apple stock. Apple stock can drop for a host of reasons while the rest of the economy is booming. The price of steak, travel, accommodations, etc. could care less about the stock price of Apple.
For the undiversified early retiree, sequence of returns risk is one of many very significant risks in early retirement and one worthy of spurring on major changes to a portfolio.
Social Security
Many early retirees will receive significant Social Security benefits. Those benefits are not too far out in the future for the early retiree. Social Security benefits are not subject to sequence of returns risk. Further, Social Security benefits reduce the retiree’s reliance on their equities and bonds.
You Won’t March Off the Cliff
People worry about financial failure caused by things like sequence of returns risk. Here’s the thing: you will not blindly march off the cliff when it comes to your spending, as Michael Kitces observed on the BiggerPockets Money podcast.
Both subconsciously and consciously, retirees will adjust their spending in down markets. A 14 day vacation becomes a 10 day vacation. You eat out one less meal a week. A new Camry becomes a new Corolla or becomes a used Corolla.
Spending adjustments during down markets can mitigate sequence of returns risk with little impact on lived experience quality.
Market Bounce Backs
When discussing the sequence of returns risk issue, we need to consider two issues. First, how much of the portfolio does an early retiree need at any one moment in time? Yes, this year’s withdrawal at reduced equity prices hurts the early retiree. But the rest of the portfolio declining this year is not at detrimental this year. Further, the rest of the portfolio might bounce back spectacularly, as I’ll discuss below.
Second, what is the investment horizon for an early retiree? For the 55 year old retiree, it could easily be 35 years.
Let’s picture Amelia. Amelia is retiring today (congratulations!) and is currently 60 years old. According to the most recent Social Security Trustees’ Report actuarial data, Amelia is expected to die, on average, a bit before her 84th birthday. Obviously most Americans do not do financial planning to account for living only to their average life expectancy. Amelia easily has a 30 year or more investment time horizon today.
If Amelia is invested in a well diversified portfolio (including both an equity allocation and a bond allocation), she has plenty of time to ride out a very significant dip in the stock market. Imagine the S&P 500 is down 38.49 percent during the first year of her retirement. That’s what happened to the S&P 500 in 2008. According to the Social Security Trustees’ Report actuarial data, she has about 22.65 years over which to make up for that loss.
How many 22.65 year periods over the past 100 years has the American stock market not made up that sort of loss?
Let’s consider a retired couple that has already battled through sequence of returns risk. On December 31, 2007, Mark and Mary retired at age 50 with a well diversified equity and bond portfolio. The S&P 500 was at 1,468.36. A year later it was at 903.25. Since then, Mark and Mary have been through March 2020, the year 2022 when the S&P 500 was down 18.1%, and the March/April 2025 stock market decline.
How are Mark and Mary doing today? Well, the S&P 500 is at 6,000.36 (June 6, 2025 close) and now Mark and Mary upgrade their airfare to first class.
Is the market always guaranteed to bounce back? Surely not. But you might want to refer to the 110 year Dow Jones Industrial Average graph that JL Collins shares several times in the new version of The Simple Path to Wealth, including on page 52.
Cash is Not a Free Lunch
Let’s discuss the most commonly applied technique to mitigate sequence of returns risk: holding significant amounts of cash and spending it down first in retirement.
This tactic has drawbacks. Cash is subject to inflation risk. It’s a store of value, and storing value is increasingly difficult, in my opinion. Further, by investing in cash the retiree foregoes the chance to invest in equities or bonds, potentially reducing future expected return (sometimes referred to as “cash drag“). Lastly, in a taxable account significant cash balances generate inefficient ordinary income in the form of interest payments.
Conclusion
When it comes to retiree portfolio construction, I view sequence of returns risk as being similar to the prospect that the New York Jets will finish in last place in the AFC East.
Are both risks real? Yes
Are both unpleasant? Yes
Do both present significant risks of financial failure in retirement for well diversified retirees: No!
Yes, I exaggerate by equating sequence of returns risk with the performance of the New York Jets. But for the five reasons I stated above, I do not believe that sequence of returns risk should be a significant factor in portfolio construction for most well diversified retirees.
Further Reading
If you’ve gotten this far, I suspect you might be thinking to yourself, “Sean, you’ve convinced me on sequence of returns risk. But I’m still losing sleep over RMDs, IRMAA, and the Widow’s Tax Trap!”
Don’t worry. Cody Garrett and I have you covered in Tax Planning To and Through Early Retirement, our forthcoming book likely to be published later this year. Sign up to find out when the book will be published here.
FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com
This post is for entertainment and educational purposes only. It does not constitute accounting, financial, investment, legal, or tax advice. Please consult with your advisor(s) regarding your personal accounting, financial, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.
The House of Representatives passed their version of the The One Big Beautiful Bill Act. Now it is onto the Senate.
Below I discuss several ways the bill would help retirees if it enacted as is and provide thoughts on where we go from here.
Permanent extension of the 2017 TCJA greater standard deduction. Arguably the most important provision for retirees in the tax bill. It’s found in Section 110002 of the bill.
Regardless of age and income, the greater standard deduction helps retirees. From a planning perspective, it can be very helpful. The greater standard deduction opens the door for substantial Hidden Roth IRAs prior to collecting Social Security.
Permanent extension of the 2017 TCJA lower tax brackets, including the 12 percent tax bracket. Helps retirees of all ages and all but the lowest income levels. The lower tax brackets make traditional retirement accounts that much more attractive in retirement. Section 110001 of the bill text contains the permanent extension.
New senior bonus deduction ($4K per person). From 2025 through 2028, OBBB contains a provision increasing the standard deduction or itemized deductions by $4,000 per senior (those age 65). See Section 110103.
The new $4,000 per senior deduction phases out 4 cents on the dollar, by my initial reading, from $75,000 to $175,000 of modified adjusted gross income for singles and $150,000 to $250,000 of MAGI for those married filing joint.
This provision replaces No Tax on Social Security. Is it No Tax on Social Security? Absolutely not. Is it helpful for those 65 and older regardless of whether they are collecting Social Security? Absolutely.
This provision is likely to encourage seniors to delay collecting Social Security until age 70. Picture a 65 year old affluent retired couple. They likely don’t need Social Security now anyway. Why not keep delaying and use that new $8,000 tax deduction to shelter other income, such as a Roth conversion or a Hidden Roth IRA?
Note that this provision, and several other new provisions in the tax bill, last just four years. I’ve previously said there’s nothing more permanent than a temporary tax cut, which should be kept in mind when considering these provisions.
New addition to the standard deduction ($1,000 singles / $1,500 head of household / $2,000 married filing joint). This provision is also in Section 110002 of the bill text. It too is for four years. Hat tip to Ben Henry-Moreland and apologies — the original version said $1,500 for MFJ and did not reference HoH. Sorry for the error.
Higher SALT cap. The $10,000 maximum state and local tax deduction is increased to $40,000. I’m still very much assessing this, but my initial impression is that this may not help many retirees, who will pay little state income tax with proper planning and because many states, such as California, do not tax Social Security.
I think the big retiree beneficiaries here will be single and widowed homeowners in high property tax states such as New Jersey, who are now much more likely to itemize. This is a backdoor reduction of their Widow’s Tax Trap, a concern which tends to be overblown.
All Bronze Plans are automatically HDHPs. See section 110206. This could be a gamechanger for those retired prior to age 65. The idea would be to sign up for a Bronze plan, pay lower premiums, deduct HSA contributions, and then qualify for a higher Premium Tax Credit with the lower modified adjusted gross income.
This new rule would be effective January 1, 2026 and is permanent.
199A Qualified Business Income deduction made permanent and increased from 20 percent to 23 percent. See section 110005 of the bill. This helps early retirees by very slightly reducing their income tax on dividends from REIT funds, which do make up a small component of popular domestic equity index funds such as VTSAX.
Where We Go From Here
OBBB now heads to the U.S. Senate.
If I were making bets, and (a) I am not and (b) I am not providing you or anyone else with gambling advice, my first dollar, given even odds, would be on the remaining OBBB process being rather convoluted. My second dollar would be on a tax bill similar to OBBB being enacted during the summer of 2025.
Several things are possible. The SALT deduction will be an area of contention in the U.S. Senate. My hope is the amount of the $4,000 senior bonus deduction is increased, but I would not bet on that.
I think July is the month this does or does not get done, i.e., signed into law by President Trump. It could be sooner if the Senate decides, after much debate, to simply pass the House version of the bill, a theoretically possible, if not likely, outcome.
OBBB, Accumulators, and More
I have plenty of thoughts about how OBBB would impact accumulators. I will discuss the eventual tax bill’s impact on both accumulators and retirees in Tax Planning To and Through Early Retirement, the book Cody Garrett and I are currently writing and hoping to publish this year. You can sign up for updates on the book here.
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.
So who is right? The FI Tax Guy or Scott Trench and Mindy Jensen of the BiggerPockets Money podcast?
This isn’t just a discussion in my mind or a late night debate at the Waffle House. It’s become a debate in the financial independence space. Just last week, the Middle Class Trap was the topic of the ChooseFI podcast.
We will return to that episode of ChooseFI later. For now, I want to start by defining the Middle Class Trap and providing the two reasons I don’t believe the Middle Class Trap is a trap. Then I will move onto several numerical examples, including four Mindy Jensen provided on ChooseFI.
The Middle Class Trap Defined
Scott Trench and Mindy Jensen walk through their definition of the Middle Class Trap from in this YouTube video. I encourage you to watch it.
Boiled down, the argument is that primary residence wealth is trapped and traditional retirement accounts are trapped until age 59 ½. Thus, many in the middle class have trapped wealth and cannot retire prior to age 59 ½ despite good numbers on paper.
There are two problems with their argument. First, primary residence wealth isn’t the owner’s wealth as we ordinarily conceive and define it. Second, traditional retirement accounts are not trapped prior to age 59 ½.
The Primary Residence Question
Too often we think of primary residences as investments. They are not, as Douglas Boneparth observes. They are a form of consumption.
People say “I have a million dollars in home equity so I am a millionaire.”
No, you are not.
I can prove it.
Peter has a $500 checking account, a car, clothes, and a $1 million home with no mortgage. He sells the home for $1 million. He immediately must get a hotel room to sleep in tonight.
John has a $500 checking account, a car, clothes, rents an apartment, and has $1 million in VTSAX in a taxable account. He sells $10,000 of VTSAX for cash. He now has a pile of cash and need not make any adjustments to have a bed for the night.
Is Peter’s home equity really his wealth when accessing causes significant life adjustments? John’s VTSAX is his wealth. His accessing it requires no life adjustments.
So what then is market driven appreciation in home equity? It’s growth in asset value that primarily benefits three classes of people:
The next generation
Owners willing to change geographies or willing to significantly downsize
Owners needing long-term care at the end of life
Market driven increases in home equity are not a trap. Rather, they are wealth that, in many cases, someone else gets to enjoy.
Imagine I’m writing a blog post and the doorbell rings. I answer and the delivery man says, “Mr. Mullaney, congratulations! You won a contest. The prize is $1,000 of Blippi toys!”
Those Blippi toys are my wealth that my toddler Goddaughter gets to enjoy.
It’s no different with market driven increases in home equity. It’s wealth that shows up on your doorstep that most likely will be enjoyed by the next generation.
In no way do those Blippi toys trap me. Same with market driven increases in home equity.
The 10% Early Withdrawal Penalty is No Bar to Early Retirement
I’ve written about the myriad ways to fund retirement prior to 59 ½ without incurring the 10 percent early withdrawal penalty. I’ve spoken about it on two episodes of the ChooseFI podcast (475 and 491).
But until now, I have never explicitly said the following:
Those 50 and older with sufficient assets are in no way barred from early retirement due to the 10 percent early withdrawal penalty even if all of their financial asset wealth is in traditional retirement accounts.
While 72(t) payment plans are not the ideal retirement plan, they are more than adequate enough to use to retire in the year one turns age 50 or later. Those 50 or older, with a simple spreadsheet and some diligence, are in no way barred from early retirement due to the 10 percent early withdrawal penalty.
What about those under age 50?
Few under age 50 will be able to retire on traditional retirement accounts alone because of sufficiency concerns. Tax concerns are not the problem when thinking about retiring prior to age 50 – it’s all about sufficiency!
Fortunately, the profile tends to resolve itself. To have enough financial wealth to retire in one’s 40s, the prospective early retiree most likely contributed to some combination of Roth accounts or taxable accounts prior to retirement. While not insignificant, traditional retirement account contribution limits are such that for many, it will be difficult to rely on them exclusively to build up sufficient assets for retirement prior to January 1st of the year of one’s 50th birthday. The 40-something early retiree can start their early retirement distributions from Roth accounts, taxable accounts, or a combination of both, obviously without penalty.
Summed up, when assessing the Middle Class Trap, for those under 50, their profile itself usually resolves the issue. For those 50 and older, the 72(t) payment plan rules are so advantageous (due to a major change in 2022) that a spreadsheet requiring one amortization calculation, some coordination with a financial institution, and a bit of ongoing additional diligence resolves the issue.
For both age cohorts, there is no tax trap.
Does this mean the 10 percent early withdrawal penalty has been, in effect, repealed? Hardly! If someone like me, in their late 40s, wants to take $20,000 from a traditional 401(k) to fly round-trip in a suite, I will pay a hefty 10 percent early withdrawal penalty. The penalty is still effective to discourage impulsive onetime withdrawals before retirement. But the penalty is not effective to prevent early retirements with a systematic, sustainable withdrawal plan. That’s the obvious intention behind the series of substantially equal periodic payments exception.
Examples from Mindy Jensen on ChooseFI Episode 543
During the ChooseFI episode, Mindy offered some numerical examples to argue for her case. That is a very legitimate tactic, and I personally love examples. Unfortunately, using numerical examples ran up against a limitation of the audio podcast format, since it can be difficult for participants and listeners to fully process multiple numbers while listening to an episode.
Mindy started sharing numerical examples around 25:00 in the podcast. I went back to the YouTube video and put Mindy’s numbers in the below table. I then added a row totaling financial assets and two rows laying out theoretically possible annual withdrawal rates.
Let’s use a range of withdrawal rates just for illustrative purposes. On the low end, we’ll use Morningstar at 3.7 percent, which can be fairly considered to be conservative. On the high end, let’s roll the dice a bit and use 6 percent.
Notice that the problem in the examples is not that the person has everything locked up in traditional accounts. The problem is sufficiency! Aside from Person C, it does not matter if all of the financial wealth is in Roth accounts, taxable accounts, or split between the two of them.
Persons A, B, and D are not in the Middle Class Trap. Rather, they are in a situation where they need to work longer unless their annual spending is incredibly modest, even by financial independence standards.
I believe that Person C could consider living on cash and later starting a 72(t) payment plan, but we really can’t tell without knowing much more information, including their age and their annual spending level in retirement.
Middle Class Trap 72(t) Payment Plan Examples
In one podcast episode, Mindy and Scott put the parameters of the Middle Class Trap at $1M to $1.5M of trapped wealth (see 3:19 of this video). How bad is the federal income tax result if we assume practically all of that wealth is in traditional deferred retirement accounts?
Using the old Four Percent Rule of Thumb for our 72(t) annual payment at both ends of the spectrum, and assuming a $40,000 taxable savings account and 5 percent interest on it and on the annual 72(t) payment taken at the beginning of the year and spent evenly during the year, here’s the 2025 federal income tax result by my estimation.
72(t) Payment Funding for Expenses Other Than Federal Income Tax
$36,878
$54,416
$38,700
$56,457
Effective Federal Income Tax Rate
7.26%
8.79%
3.02%
5.58%
AGI as a Percent of 2025 Federal Poverty Level
274.76%
405.75%
203.31%
300.24%
I believe this table strongly supports my contention that the tax laws want you to retire early. Look how light the taxation is on 72(t) payments!
You may ask “I thought federal tax rates started at 10 percent – how do these people pay effective rates less than that?” The answer is the standard deduction, which loves early retirees. Because of the standard deduction, all four taxpayers enjoy what I refer to as the Hidden Roth IRA. They take some amounts from their traditional IRAs and pay 0 percent federal income tax on them.
I will note two things. First, I am not arguing anyone should simply plan on getting to an early retirement age and have every last penny in traditional retirement accounts. I am arguing that it is hardly a trap if someone gets to age 50, has every penny in traditional retirement accounts, and wants to retire using a reasonable withdrawal rate.
Second, managing for Premium Tax Credit can be a concern. At the high end of Mindy and Scott’s Middle Class Trap range, a single taxpayer would be shut out of a Premium Tax Credit (having gone a bit over the 400 percent of FPL cliff) if they were on an ACA medical insurance plan in 2026, unless later tax law changes in 2025 amend Section 36B. This person could turn on Premium Tax Credits by electing a slightly lower initial 72(t) annual payment.
Sufficiency Is The Real Problem
We should spend more time on the real problem: retirement sufficiency. According to UBS, median adult wealth in the United States in 2023 was just $112,157. Even considering that older Americans are likely to have greater wealth than younger adults, the median wealth statistic means many Americans of all ages are significantly behind in retirement savings. The best way to catch up is by making traditional retirement account contributions.
Update May 1, 2025
Thank you to Mindy Jensen who wrote a thoughtful response to this blog post. You can read it over at BiggerPockets.
Stay Tuned
This won’t be the last time you hear from me on this topic. Cody Garrett and I are currently writing Tax Planning To and Through Early Retirement, a book we hope to publish later this year. We will address all sorts of issues when it comes to accessing wealth and tax planning for those retiring prior to turning 59 ½.
What questions do you have about retiring prior to 59 ½? Let us know in the comments below and we might just answer your questions in Tax Planning To and Through Early Retirement!
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.
Did you receive a Form 1099-DIV which lists an amount in Box 5 “Section 199A dividends”? If so, you might be asking, what the heck are Section 199A dividends?
You probably never came across the term “Section 199A dividends” in high school algebra. That’s okay. Below I discuss what a Section 199A dividend is and how to report it on your tax return.
Who Pays Section 199A Dividends?
Real estate investment trusts (“REITs”) pay Section 199A dividends. REITs are a special type of business entity. A REIT owns almost entirely real estate. Many office buildings, hotels, hospitals, malls, and apartment buildings are owned by REITs. Investors can own the stock of a single REIT, or they can own mutual funds or ETFs that are partly or entirely composed of REIT stock. For example, there are some REITs in the Vanguard Total Stock Market Index Fund (VTSAX).
REITs are advantageous from a tax perspective. In exchange for paying 90 plus percent of its income out to investors as dividends, the REIT itself does not pay federal corporate income taxes. This results in REITs often paying higher dividends than companies in other industries. The dividends paid by the REIT are Section 199A dividends.
What is the Tax Benefit of a Section 199A Dividend?
Here is an example of how the tax deduction works for Section 199A dividends.
Catherine owns shares of ABC REIT Mutual Fund. The mutual fund pays her $1,000.00 of dividends, all of which are Section 199A dividends reported to her in both Box 1a and Box 5 of Form 1099-DIV. She gets a $200 qualified business income deduction on her federal tax return (20 percent of $1,000.00) because of the $1,000.00 of Section 199A dividend.
There are several things to keep in mind when considering Section 199A dividends:
First, Section 199A dividends are a slice of the pie of dividends. The full pie of dividends, “total ordinary dividends,” is reported in Box 1a of Form 1099-DIV. Since Box 1a reports all of the dividends, Box 5 must be equal to or less than Box 1a.
Second, there is no income limit (taxable income, MAGI, or otherwise) on the ability to claim the Section 199A qualified business income deduction for Section 199A dividends. The QBI deduction for self-employment income is generally subject to taxable income limitations on the ability to claim the deduction. Not so with the Section 199A dividends.
Third, taxpayers get the Section 199A QBI deduction regardless of whether they claim the standard deduction or itemized deductions.
Fourth, there is no requirement to be engaged in a qualified trade or business to claim the QBI deduction for Section 199A dividends.
Sixth, Section 199A dividends are not qualified dividends (which are reported in Box 1b of Form 1099-DIV). They are taxed as ordinary income subject to the taxpayer’s ordinary income tax rates. They do not qualify for the preferred federal income tax rates for qualified dividends.
Seventh is a 2025 revision to this article: Some taxpayers cannot get the QBI deduction because their long-term capital gains exceed their ordinary income. This is usually a good outcome. See “An Exception: Too Little Ordinary Income to Claim a Section 199A Deduction” below.
Where Do I Report a Section 199A Dividend on My Tax Return?
Section 199A dividends create tax return reporting in three prominent places on a federal income tax return.
First, Form 1099-DIV Box 1a total ordinary dividends are reported on Form 1040 Line 3b. As Section 199A dividends are a component of Box 1a total ordinary dividends, they are thus reported on the Form 1040 on Line 3b. Section 199A dividends are not reported on Line 3a of Form 1040 because Section 199A dividends are not qualified dividends.
Second, Section 199A dividends are reported on either Line 6 of Form 8995 or Line 28 of Form 8995-A. In most cases, taxpayers will file the simpler Form 8995 to report qualified business income and Section 199A dividends. By reporting Section 199A dividends on one of those lines most tax return preparation software should flow the dividends through the rest of the form as appropriate (but it never hurts to double check).
Third, the QBI deduction, computed on either Form 8995 or Form 8995-A, is claimed on Line 13 of Form 1040.
Tax return software varies. Hopefully, by entering the Form 1099-DIV in full in the software’s Form 1099-DIV input form, all of the above will be generated. Ultimately, it is up to the taxpayer to review the return to ensure that the information has been properly input and properly reported on the tax return.
An Exception: Too Little Ordinary Income to Claim a Section 199A Deduction
In this 2025 article revision, I want to consider cases where a taxpayer might not be able to claim a QBI deduction for Section 199A dividends.
At first glance, you might think that this is a bad thing. But it’s usually indicative that someone has structured their tax basketing very effectively.
There is a limit on the Section 199A deduction. If your ordinary income is low vis-a-vis your long-term capital gain income, you lose the Section 199A for dividends and all other qualified business income. See Section 199A(a)(2) for the rule providing this result.
This sounds bad but it usually is good! Here’s an example:
Justin, an early retiree 56 years old in 2025. He has $90,000 of annual living expenses, which he funds by selling $90,000 of ABC Domestic Equity index fund in his taxable account. Those sales generate $50,000 of long-term capital gains. Further, he reports $13,000 of qualified dividend income, $1,000 of nonqualified dividends, and $1,000 of Section 199A dividends from his ABC Domestic Equity Index Fund. He also reports $2,000 of interest income.
Justin’s net taxable income is $52,000 ($67,000 of adjusted gross income less a $15,000 standard deduction), which is less than his long-term capital gain income of $63,000 ($50,000 long-term capital gains plus $13,000 qualified dividend income).
When long-term capital gain income exceeds net taxable income, the taxpayer cannot claim the QBI deduction, even for Section 199A dividends. This happens in situations where ordinary income is less than capital gain income. Justin is thus precluded from taking a QBI deduction, even for his Section 199A dividends.
Never fear, however. Justin’s total federal income tax for 2025 is just $746 on his AGI of $67,000. I put together a spreadsheet illustrating how his income is taxed, which I think you will find illuminating.
Does Justin need a $200 QBI deduction when his federal income tax effective rate is just 1.11%?
As I discussed in my Tax Basketing article, early retirees benefit from having as little ordinary income as possible. Any small QBI deduction on Section 199A dividends that sacrifices is well worth it, as Justin’s example illustrates.
Conclusion
Section 199A dividends create a taxpayer favorable federal income tax deduction. They are reported in Box 5 of Form 1099-DIV and should be reported on a taxpayer’s federal income tax return.
FI Tax Guy can be your financial planner! Find out more by visiting mullaneyfinancial.com
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, investment, legal, and tax matters. Please also refer to the Disclaimer & Warning section found here.
