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.
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.
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.
What some call “tax basketing” and others call “asset location” is becoming increasingly important, particularly for early retirees and those aspiring to be early retirees.
Tax basketing is not portfolio allocation. Tax basketing is the step after portfolio allocation. First the investor decides the assets he or she wants to invest in and in what proportion.
Once that decision is made, tax basketing starts. The idea is where to hold the desired assets within the available tax categories (Roth, Traditional, Taxable, HSA) that makes the most sense from a tax efficiency perspective and a tax planning perspective.
Early Retirees and Aspiring Early Retirees
To assess tax basketing for many early retirees, I will need to make a few assumptions. First, the aspiring early retiree and the early retiree (our avatars) want to hold three main assets: domestic equity index funds, international equity index funds, and domestic bond index funds. That is simply an assumption: it is not investment advice for you or anyone else.
Second, our avatars have at least 50 percent of their financial wealth in traditional retirement accounts. This assumption makes our avatars like most Americans when it comes to their financial assets, and, in my experience, most considering or in early retirement. Third, our avatars want to have less than 50 percent of their portfolio in domestic bond index funds (again, just an assumption, not investment advice).
Lastly, most of this analysis ignores HSAs unless specifically discussed, since the balances in them tend to be rather modest and most of the Roth analysis below applies equally to HSAs.
Let’s dive deep on where our avatars should hold their desired portfolio, considering that they are either striving for early retirement or in early retirement.
Asset Yield
Tax basketing should consider many things. Chief among them is annual asset yield. Financial assets such as stocks, bonds, mutual funds, and exchange traded funds (ETFs) typically kick off interest and/or dividend income annually (often referred to as “yield”).
The expected amount of that income and the nature of that income strongly inform where to best tax basket each type of asset.
Let’s explore the three assets our avatars want using Vanguard mutual funds as a reasonable proxy for their annual income (yield) profile (not presented as investment advice).
All numbers are as of this writing and subject to change. That said, they strongly inform where we might want to hold each of these types of assets.
Let’s start with VTSAX, our domestic equity index. Notice two things? First, it produces remarkably low yield. Say I owned $1M of VTSAX in a taxable account. How much taxable income does that produce for me? Just around $12,200 annually. Further, most of that is tax-preferred qualified dividend income!
People worry about tax drag when investing in taxable accounts. Tax basketing can solve for most tax drag! Why would you worry about tax drag when it takes $1M of VTSAX to wring out just $12,200 of mostly qualified dividend income on your tax return?
What about VTIAX? In today’s environment, it produces more than twice as much dividend income as VTSAX, and much more of that income will be ordinary income (since only about 61.16% qualifies as QDI).
Lastly, let’s think about VBTLX. Bonds typically produce the most income (bonds tend to pay more out than equities do as dividends) and bonds produce only ordinary income. You can see that from a tax basketing perspective, bonds in taxable accounts tend to be undesirable.
Tax Basketing Insights
Domestic Equity Funds
Domestic equity index funds do great inside a taxable account! They barely produce any income on the owner’s tax return. The small amount of income they produce mostly qualifies for the favored tax rates of 0%, 15%, 18.8%, and 23.8%.
Recall our avatar with $1M in VTSAX. He only gets $12,200 in taxable income from that holding. If that was his only income, he doesn’t have to file a tax return, as the standard deduction is large enough to cancel out that income.
An additional point: most early retirees and potential early retirees will probably have domestic equities in all three of the main baskets: Taxable, Traditional, and Roth. To my mind, that’s not a bad thing. Yes, inside a traditional retirement account, the qualified dividend income becomes tax deferred ordinary income, not a great outcome, but also not a horrible outcome.
The tax tail should not wag the investment dog. But it is logical for most early retirees and aspiring early retirees to only hold domestic equities in taxable accounts and then hold domestic equities in traditional and Roth accounts as needed for their overall asset allocation.
International Equity Funds
International equity funds sit well in retirement accounts, whether they are traditional, Roth, and/or HSAs. They are not awful in taxable accounts, but they are not great. Why do I say that? Compare the 3.22% yield on them to the 1.22% yield on domestic equity index funds. Wouldn’t you rather have the higher yielding asset’s income sheltered by the retirement account’s tax advantages and the lower yielding asset be the one subject to current income taxes?
What About the Foreign Tax Credit?
It is true that holding international equities in a retirement account sacrifices the foreign tax credit. In a world where yields were the same and future gains were the same, the foreign tax credit would be enough to favor holding international equities in a taxable account.
However, we don’t live in that world. Further, the foreign tax credit tends to be quite small. For example, the foreign taxes withheld by Japan when Japanese companies pay Americans a dividend is 10 percent. Not nothing, but considering that there is more than double the yield paid on international equities, not enough to make it highly desirable from a tax standpoint to have income in taxable accounts. Rates vary, but can be as low as zero. Consider that most dividends paid by United Kingdom companies to American shareholders attract no dividend withholding tax and thus create no foreign tax credit on federal income tax returns.
This video breaks down the math on the foreign tax credit.
Domestic Bond Funds
Domestic bonds and bond funds sit very well in traditional retirement accounts. Why waste the tax free growth of Roth accounts on bond funds? Bonds tend to have a lower expected return, making them great for traditional retirement accounts, not Roth accounts. Further, why put the highest yield assets with the worst type of income (none of it QDI) in taxable accounts? The stage is thus set: put all the bonds in traditional retirement accounts and don’t look back.
Two traditional accounts domestic bonds do particularly well in are inherited IRAs and 72(t) IRAs!
Tax-Exempt Bonds
High income people ask: should I hold tax-exempt bonds since I have such high income? In the early 1980s, it might have made sense to alter investment allocation for tax planning reasons and invest in lower yielding tax-exempt bonds instead of high yielding taxable bonds. Back then tax rates were higher and most affluent Americans had most of their money in taxable accounts and pensions. The era of the IRA and the 401(k) was in its infancy and few had large balances in tax deferred defined contribution accounts such as traditional IRAs and traditional 401(k)s.
The world of the mid-2020s is quite different. Many pensions are gone, and affluent early retirees and aspiring early retirees tend to have much of their financial wealth in traditional IRAs and traditional 401(k)s.
That sets the stage beautifully for holding bonds in traditional retirement accounts. Income generated by bonds is tax deferred inside the traditional retirement account. Further, there’s usually plenty of headroom in the traditional IRAs and 401(k)s to hold all of the investor’s desired bond allocation. So why not hold all of the desired bond allocation inside traditional retirement accounts?
This means that for most people, there’s little reason to adjust a desired asset allocation in order to hold tax-exempt bonds and thereby sacrifice yield. Tax-exempt bonds receive no preference over taxable bonds inside a traditional 401(k) or IRA.
Keeping Ordinary Income Low
Do you see what tax basketing can do for the early retiree? If the only thing he or she owns in taxable accounts are domestic equity index funds (perhaps with a small savings account), he or she will have low taxable income and almost no ordinary income.
Or perhaps it is the Hidden Roth IRA where a retirees uses the standard deduction to live off of traditional retirement accounts. It allows the early retiree to use the standard deduction to fund living expenses from a traditional IRA and pay no federal income tax. Again, who’s complaining about paying no income tax?
Lastly, tax basketing can keep those qualified dividends and long-term capital gains at a 0% long term capital gains rate. For married couples with $96,700 or less of taxable income, the federal income tax rate on all long term capital gains and qualified dividends is 0%. One way to help ensure that outcome is tax basketing. Ordinary income from higher yielding bond funds pushes qualified dividends and long term capital gains up (through income stacking) and can subject some of it to the 15% rate. Why not hide out that ordinary income in traditional retirement accounts and only hold low yielding domestic equities in taxable accounts?
Aspiring Early Retirees
For the still working aspiring early retiree, having taxable investments generate low yield and preferred yield (qualified dividend income) can help save taxes during peak earning years. The high earner would prefer to have less QDI (through dividends paid by domestic equities) rather than more ordinary income (through dividends of ordinary income paid by domestic bond funds) hit their annual income tax return. This keeps taxable income lower, keeps the tax rate better on the portfolio income, and reduces or potentially eliminates exposure to the Net Investment Income tax.
In theory, the early retiree can fund their living expenses in three extreme manners: all from traditional retirement accounts, all from Roth retirement accounts, or all from taxable accounts. Testing these three from a Premium Tax Credit perspective can inform us about which tax basket is the best to spend from first in early retirement.
If Goldilocks funds her early retirement first from traditional IRAs and 401(k)s, she will find it’s too hot from a PTC perspective. All her spending creates taxable income, which reduces her Premium Tax Credit.
If Goldilocks funds her early retirement from Roth IRAs, she will find it’s too cold from a PTC perspective. Her spending creates no taxable income in all likelihood. That’s a huge problem from a PTC perspective. If one’s income is too low, they will not qualify for any PTC, creating a big problem in early retirement.
If Goldilocks funds her early retirement from taxable accounts, she’s likely to find it just right from a PTC perspective. Say she has $60,000 of living expenses. Will that create $60,000 of “modified adjusted gross income”? Absolutely not. It will create $60,000 less her tax basis in the assets she sold in modified adjusted gross income. This gives her an outstanding chance of having a low enough income to qualify for a significant PTC. If her basis was too high and she did not create enough income to qualify for a PTC, she could, prior to year-end, execute some Roth conversions to get her income to the requisite level.
What Goldilocks’ example demonstrates is that it is a good thing to have amounts, perhaps significant amounts, in the taxable basket heading into early retirement. While there is absolutely hope for those with little in the taxable basket, it will require some additional planning in many cases.
You know what can help mitigate RMDs? Tax basketing!
By holding all of one’s domestic bond investments in traditional IRAs and traditional 401(k)s, retirees can keep the future growth inside traditional retirement accounts modest. When compared to equities, bonds have a lower expected return and thus a lower expected future value. This, in turn, reduces future traditional account balances, reducing future required minimum distributions. Recall that RMDs are computed using the account balance from the prior year as the numerator. Keeping that numerator more modest reduces future RMDs.
Sequence of Returns Risk and Tax Basketing
Some worry about sequence of returns (“SoR”) risk: what if I retire and the equity markets happen to have a year like 1987 or 2008 right as I’m retiring? At least in theory this is a risk of retiring at any time and the risk is magnified by an early retirement.
Say Maury, age 50, is about to retire and worried about SoR risk so he wants to have three years of cash going into retirement (again, not an investment recommendation, just a hypothetical). Cash generates interest income, which is bad from a tax efficiency perspective. Can Maury use tax basketing to manage for SoR risk and stay tax efficient? Sure!
Imagine Maury retires with $500K in a domestic equity index fund in a taxable brokerage, $240,000 of cash and/or money markets in a traditional IRA (3 years of expenses), $500K of domestic bonds in a traditional IRA, and about $1M in a combination of domestic and international equities in a traditional IRA.
Maury can live on the cash and only live on his taxable brokerage account. Wait, what? I thought the cash lives in the traditional IRA. It does.
But Maury can simply sell $80,000 of the domestic equity index fund annually and report mostly long term capital gains and (rather modest) qualified dividend income on his tax return. His income might be so low he wants or needs to do Roth conversions! Separately inside the traditional IRA he “spends down” the cash by annually buying $80,000 of any desired combination of domestic equities, international equities, and/or domestic bonds inside his traditional IRA.
Maury just used tax basketing to live off almost a quarter million of cash for three years without reporting a penny of interest income to the IRS!
Announcement
You have just read a sneak preview of part of the new book! Cody Garrett, CFP(R) and I are working on, tentatively titled Tax Planning To and Through Early Retirement. In 2025 the retirement tax planning landscape is changing, and Cody and I want to be on the cutting edge as retirement tax planning changes.
This post will, in modified form, constitute part of the book’s tax basketing (a/k/a asset location) chapter.
When will the book come out? Well, that’s a question better asked of elected officials in Washington DC than of your authors. 😉
What topics would you like us to cover in the book? Let us know in the comments below!
Stay tuned to me on X and LinkedIn and Cody on LinkedIn for updates on when the book will be available!
Conclusion
Tax basketing can be a great driver of success to and through early retirement. From a purely tax basketing perspective, domestic equity index funds tend to sit well in taxable accounts, international equity index funds tend to sit well in retirement accounts, and domestic bond index funds tend to sit well in traditional retirement accounts. Premium Tax Credit considerations tend to favor having some money in taxable accounts in early retirement. Good tax basketing can keep taxable income low and facilitate excellent early retirement 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.
The 2025 fires in Los Angeles have been devastating. My heart goes out to all those affected, and you are in my prayers.
Los Angeles County now has a deadline delay for their 2024 tax returns, 2024 and 2025 tax payments, and IRA contributions.
Los Angeles County Tax Deadline Delay
The IRS announced that because of the January 2025 fires in Los Angeles, Angelenos have an extended deadline, October 15, 2025, to perform most 2024 tax acts that otherwise would have been due early in 2025. The Franchise Tax Board has followed suit and also issued their own delay announcement with respect to California state income tax returns and payments.
2024 Traditional and Roth IRA Contributions
The deadline for Los Angeles County residents to make 2024 contributions to traditional and/or Roth IRAs has been extended to October 15, 2025. As a practical matter, I wouldn’t encourage reliance on this particular deadline delay. Financial institutions may find it difficult to allow “late but timely” 2024 IRA contributions on their platform when it is available only to residents of a single county.
If you are an Angeleno reading this after April 15, 2025 and want to make an IRA contribution for 2024, I recommend initiating the process by calling the financial institution rather than using the financial institution’s website.
2024 Backdoor Roth IRAs
Los Angeles County residents now have until October 15, 2025 to execute the first step of a 2024 Backdoor Roth IRA, the nondeductible contribution to a traditional IRA for 2024. This would be a Split-Year Backdoor Roth IRA.
2024 Tax Returns and Payments and 2025 Q1 Through Q3 Estimated Tax Payments
Los Angeles County residents now have until October 15, 2025 to (i) file their 2024 federal and California income tax returns, (ii) pay the amount due with their 2024 federal and California income tax returns, (iii) make fourth quarter 2024 estimated tax payments, and (iv) make 2025 first through third quarter estimated tax payments.
Who Benefits?
Residents of Los Angeles County qualify for the extended deadline. Note (1) there’s no need to have suffered any loss or damage due to the fires and (2) the extensions apply to the entirety of Los Angeles County. It is not just limited to residents of the City of Los Angeles.
Taxpayers with records in Los Angeles County can also benefit.
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.
There are only three types of annual contributions to individual retirement accounts (“IRAs”). They are:
Traditional, nondeductible contributions
Traditional, deductible contributions
Roth contributions
This post discusses when a taxpayer can make one or more of these types of annual contributions.
Let’s dispense with what we are not talking about. This post has nothing to do with annual contributions to employer retirement plans (401(k)s and the like) and self-employed retirement plans. We’re only talking about IRAs. The Individual in “IRA” is the key – anyone can set up their own IRA. IRAs are not pegged to any particular job or self-employment.
The above list is the exhaustive list of the possible types of annual contributions you can make to an IRA. But there is plenty of confusion about when you are eligible to make each of the three types of annual contributions.
Two notes on this. First the limit is shared between traditional IRAs and Roth IRAs. In theory, someone under age 50 could contribute $4,000 to a traditional IRA and $3,000 to a Roth IRA. In practice, contributions are rarely divided between the traditional and the Roth, but it does occasionally happen.
Second, the limits have an additional limit: the contribution cannot exceed earned income. This means that those fully retired cannot contribute to an IRA unless they have a spouse who has earned income. A fully retired person (or a homemaker) can use their spouse’s earned income as their earned income and contribute to what is often referred to as a Spousal IRA.
Why Contribute to an IRA?
Why you would consider contributing to an IRA? The main reason is to build up tax-deferred wealth (traditional IRAs) and/or tax-free wealth (Roth IRAs) for your future, however you define it: financial independence, retirement, etc. A second potential benefit is the ability to deduct some annual contributions to traditional IRAs. A third benefit is some degree of creditor protection. States offer varying levels of creditor protection to traditional IRAs and Roth IRAs, while the federal government provides significant bankruptcy protection for traditional IRAs and Roth IRAs.
Traditional Nondeductible IRA Annual Contributions
There’s are only one requirement to contribute to a traditional, nondeductible IRA for a taxable year:
You and/or your spouse have earned income during that taxable year.
That’s it! As long as you satisfy that requirement, you can contribute to a traditional nondeductible IRA, no further questions asked.
Example: Teve Torbes is the publisher of a successful magazine. He is paid a salary of $1,000,000 in 2025 and is covered by the magazine’s 401(k) plan. Teve can make up to a $7,000 nondeductible contribution to a traditional IRA, and Teve’s wife can also make up to a $7,000 nondeductible contribution to a traditional IRA.
There is no tax deduction for contributing to a traditional nondeductible IRA. The amount of your nondeductible contribution creates “basis” in the traditional IRA. When you withdraw money from the traditional IRA in retirement, a ratable portion of the withdrawal is treated as a return of basis and thus not taxable (the “Pro-Rata Rule”).
Example: Ted makes a $6,000 nondeductible traditional IRA contribution for each of 10 years ($60,000 total). When he retires, the traditional IRA is worth $100,000, and he takes a $5,000 distribution from the traditional IRA. Ted is over 59 ½ when he makes the withdrawal. Of the $5,000 withdrawal, Ted will include $2,000 in his taxable income, because 60 percent ($3,000 — $60,000 basis divided by $100,000 fair market value times the $5,000 withdrawn) will be treated as a withdrawal of basis and thus tax free.
Traditional nondeductible IRA contributions generally give taxpayers a rather limited tax benefit. However, since 2010 traditional nondeductible IRA contributions have become an important tax planning tool because of the availability of the Backdoor Roth IRA.
Making a nondeductible IRA contribution requires the filing of a Form 8606 with your federal income tax return.
Traditional Deductible IRA Annual Contributions
In order to make a deductible contribution to a traditional IRA, three sets of qualification rules apply.
ONE: No Workplace Retirement Plan
Here are the qualification rules if neither you nor your spouse is covered by an employer retirement plan (401(k)s and the like and self-employment retirement plans):
You and/or your spouse have earned income during that taxable year.
That’s it! As long as you satisfy that requirement and you and your spouse are not covered by an employer retirement plan, you can make a deductible contribution to a traditional IRA, no further questions asked.
Example: Teve Torbes is the publisher of a successful magazine. He and his wife are 45 years old. He is paid a salary of $1,000,000 in 2025. Neither he nor his wife is covered by an employer retirement plan. Teve can make up to a $7,000 deductible contribution to a traditional IRA, and Teve’s wife can also make up to a $7,000 deductible contribution to a traditional IRA.
TWO: You Are Covered by a Workplace Retirement Plan
Here are the deductible traditional IRA qualification rules if you are covered by an employer retirement plan:
You and/or your spouse have earned income during that taxable year.
Your modified adjusted gross income (“MAGI”) for 2025 is less than $89,000 (if single), $146,000 (if married filing joint, “MFJ”), or $10,000 (if married filing separate, “MFS”).
Note that in between $79,000 and $89,000 (single), $126,000 and $146,000 (MFJ) and $0 and $10,000 (MFS), your ability to make a deductible contribution to a traditional IRA phases out ratably. Here is an illustrative example.
Example: Mike is 30 years old, single, and is covered by a 401(k) plan at work. Mike has a MAGI of $84,000 in 2025, most of which is W-2 income. Based on a MAGI in the middle of the phaseout range, Mike is limited to a maximum $3,500 deductible contribution to a traditional IRA.
Assuming he makes a $3,500 deductible IRA contribution, Mike has $3,500 worth of IRA contributions left. He can either, or a combination of both (up to $3,500) (a) make a contribution to a nondeductible traditional IRA, since he meets the qualification requirement to contribute to a nondeductible traditional IRA or (b) make a contribution to a Roth IRA, since he meets the qualification requirements (discussed below) to contribute to a Roth IRA.
THREE: Only Your Spouse is Covered by a Workplace Retirement Plan
Here are the deductible traditional IRA qualification rules if you are not covered by an employer retirement plan but your spouse is covered by an employer retirement plan:
You and/or your spouse have earned income during that taxable year.
Your MAGI for 2025 is less than $246,000 (MFJ) or $10,000 (MFS).
Note that in between $236,000 and $246,000 (MFJ) and $0 and $10,000 (MFS), your ability to make a deductible contribution to a traditional IRA phases out ratably.
Roth IRA Annual Contributions
Here are the Roth IRA annual contribution qualification rules.
You and/or your spouse have earned income during that taxable year.
Your MAGI for 2025 is less than $165,000 (single), $246,000 (MFJ), or $10,000 (MFS).
Note that in between $150,000 and $165,000 (single), $236,000 and $246,000 (MFJ), and $0 and $10,000 (MFS), your ability to make a Roth IRA contribution phases out ratably.
Notice that whether you and/or your spouse are covered by an employer retirement plan (including a self-employment retirement plan) is irrelevant. You and your spouse can be covered by an employer retirement plan and you can still contribute to a Roth IRA (so long as you meet the other qualification requirements).
Here is an example illustrating your options in the Roth IRA MAGI phaseout range.
Example: Mike is 30 years old, single, and covered by a workplace retirement plan. Mike has a MAGI of $159,000 for 2025, most of which is W-2 income. Based on a MAGI 60 percent through the phaseout range, Mike is limited to a maximum $2,800 contribution to a Roth IRA.
Assuming he makes a $2,800 annual Roth IRA contribution, Mike has $4,200 worth of IRA contributions left. He can make up to $4,200 in annual contributions to a nondeductible traditional IRA, since he meets the qualification requirement to contribute to a nondeductible traditional IRA.
Deadlines
The deadline to make an IRA contribution for a particular year is April 15th of the year following the taxable year (thus, the deadline to make a 2025 IRA contribution is April 15, 2026). The deadline to make earned income for a taxable year is December 31st of that year.
Rollover Contributions
There’s a separate category of contributions to IRAs: rollover contributions. These can be from other accounts of the same type (traditional IRA to traditional IRA, Roth IRA to Roth IRA) or from a workplace retirement plan (for example, traditional 401(k) to traditional IRA, Roth 401(k) to Roth IRA).
Rollover contributions do not require having earned income and have no income limits and should be generally tax-free. For a myriad of reasons, it is usually best to effectuate rollovers as direct trustee-to-trustee transfers.
As a practical matter, it is often the case that IRAs serve at the retirement home for workplace retirement plans such as 401(k)s.
Further Reading
Deductible traditional IRA or Roth IRA? If you qualify for both, it can be difficult to determine which is better. I’ve written here about some of the factors to consider in determining whether a deductible traditional contribution or a Roth contribution is better for you.
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, 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.
Incredibly, Donald Trump has signed up to make that choice, starting January 20th.
How can that be? It relates to SECURE 2.0. SECURE 2.0 made dozens of additions to the already complicated retirement account rules. Many like its delaying retirement account required minimum distributions (“RMDs”) for many Americans from age 72 to age 73 (and eventually to age 75).
But there is a big time issue few have commented on.
It has to do with the Omnibus Bill’s purported passage in December 2022. If the Omnibus, which contained SECURE 2.0, was not passed in a Constitutionally qualified manner, any Administration enforcing it would be acting counter to the Constitution and contrary to the rule of law.
The Constitutional Problem with SECURE 2.0
A federal judge, in a very well written and reasoned opinion, determined that the 2022 Omnibus Bill, was passed by the House of Representatives at a time the House did not have a required quorum to enact legislation. In Texas v. Garland (accessible here and here), Judge James W. Hendrix ruled for the State of Texas that the House of Representatives impermissibly used proxies to establish a quorum. The House did not have a majority of members physically present, and thus did not have a sufficient quorum to enact legislation at the time of Omnibus’s purported passage.
The quorum rule isn’t contained in the back of a House of Representatives parliamentary procedure manual. Rather, it is contained in the Quorum Clause of the United States Constitution, making it the highest level of legal authority.
This ruling has broad implications for SECURE 2.0. If the Omnibus was not enacted in a Constitutionally qualified manner, SECURE 2.0 is not the law of the land. Any Administration enforcing it would be enforcing a law that is simply not the law of the land.
I encourage the reader to read the Texas v. Garland opinion. I find it convincing, but you get to be the judge and jury in your own mind.
Assuming the new Administration agrees with Judge Hendrix’s reasoning, they should announce they will not enforce SECURE 2.0 in order to avoid acting contrary to the law.
Proposed Action
I recommend that shortly after President Trump’s inauguration the IRS and Treasury issue a Notice announcing the following:
In order to uphold the Constitution and the rule of law, the IRS and Treasury will not enforce SECURE 2.0.
Considering the equities involved, the uniqueness of taxpayers having acted under an announced law that was not, in fact, the law, and the limited enforcement resources available, the IRS will not challenge any acts made, plan/account qualification, and tax return positions taken based on SECURE 2.0 prior to the issuance of the Notice. Plans and financial institutions will be allowed a reasonable amount of time to adequately account for the Notice.
In order to eliminate harm from detrimental reliance on SECURE 2.0, appropriate equitable remedies will be applied to prior acts taken under SECURE 2.0 with relevance going forward. For example, any Roth SEP IRAs and Roth SIMPLE IRAs properly created and funded under SECURE 2.0 will be deemed to be Roth IRAs with respect to which valid contributions were previously made.
The IRS and Treasury will exercise their authority under Sections 402(c)(3)(B) and 408(d)(3)(I) and waive the 60-day requirement with respect to rollovers for any SECURE 2.0 qualified distributions followed by three year repayments so long as the distribution occurred prior to the issuance of the Notice and repayment is made back to the retirement account no later than December 31, 2025.
The IRS will not require RMDs and not enforce the failure to withdraw penalty for those who turned age 72 in 2023 and for those who turned age 72 in 2024.
The IRS will require RMDs and enforce the failure to withdraw penalty for those who turn age 72 starting in 2025.
Update February 3, 2025 — the previous version of this post said “73” instead of “72” in the previous two bullets — my apologies for the error.
Relevant 2025 limits will be applied not factoring in provisions from SECURE 2.0. Thus, guidance such as Notice 2024-80 is modified accordingly. For example, the 2025 qualified charitable distribution limit is $100,000 and for those age 60-63 the catch-up contribution limit is $7,500.
I recommend the new Administration issue that notice shortly after Inauguration Day to uphold the Constitution regardless of whether the new Congress chooses to take additional action with respect to SECURE 2.0.
The question then becomes what to do in Congress, if anything, with respect to SECURE 2.0. Since it is likely Congress will enact significant tax legislation, there will be one or more opportunities to address the issue.
I propose that as part of the 2025 tax changes Congress passes, Congress include a provision repealing SECURE 2.0 for the avoidance of doubt. That will end any possible litigation around SECURE 2.0, since the IRS will have waived any challenges resulting from acts occurring prior to the Trump Administration, and Congress will have repealed it (in case it is the law, counter to my opinion) going forward.
SECURE 2.0 had more to do with 401(k) plan administrators and lawyers securing full employment than securing retirement for working Americans. SECURE 2.0 being pushed to the side would be no tragedy. Perhaps Congress should salvage a few good provisions, but most of it should be left on the scrap heap while Congress focuses on more important tax reforms and extending Tax Cuts and Jobs Act individual tax cuts.
I am more ambivalent about the delays in RMDs. Congress could simply enact SECURE 2.0’s RMD delays as part of its 2025 tax reforms. That said, I believe that tax cuts such as eliminating the taxes on tips and overtime are much better tax policy and should be prioritized.
Further, the tax benefit of eliminating the tax on Social Security potentially dwarfs the tax benefit of a one or three year delay in RMDs. There’s a very valid argument that eliminating taxes on Social Security and having RMDs start at age 72 is appropriate and will leave many seniors in a vastly improved tax position when compared to where they stood prior to 2025.
Conclusion
I would pick the Constitution over delayed RMDs any day of the week. The Constitution is far more important than any retirement account tax rule. While it is not good to say dozens of rules that Americans have planned around are invalid, it is far worse to disregard the Constitution.
My hope is that the new Administration’s tax policy staff, including the new Assistant Secretary for Tax Policy, work to uphold the Constitution.
The new Administration, consistent with Judge Hendrix’s ruling, should acknowledge the Constitutional problem with SECURE 2.0 and addresses it head on. Doing so will demonstrate President Trump’s commitment to honor the Constitution and the rule of law.
This post is for 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.
Note that a version of this proposal has been posted to the crowd sourced policy website PoliciesforPeople.com. The views reflected in this post are only those of the author, Sean Mullaney, and are not the views of anyone else.
It’s that time of year again. The air is cool and the Election is in the rear-view mirror. 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.
Donor Advised Fund Contributions
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 2024, the appreciated stock must be received by the donor advised fund prior to January 1, 2025. This deadline is no different than the normal charitable contribution deadline.
However, 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 2024. Donor advised fund planning should be attended to sooner rather than later.
Taxable Roth Conversions
For a Roth conversion to count as being for 2024, it must be done before January 1, 2025. 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 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 2024.
Before the Election, many commentators said “you’ve gotta get your Roth conversions done before tax rates go up in 2026!” If this were X (the artist formerly known as Twitter), the assertion would likely be accompanied by a hair-on-fire GIF. 😉
I have disagreed with the assertion. As I have stated before, there’s nothing more permanent than a temporary tax cut! Now with a second Trump presidency and a Republican Congress, it is likely that the higher standard deduction and rate cuts of the Tax Cuts and Jobs Act will be extended.
Regardless of the particulars of 2025 tax changes, I recommend that you make your own personal taxable Roth conversion decisions based on your own personal situation and analysis of the landscape and not a fear of future tax hikes.
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 2023 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 2024. If you do, don’t forget to reassess your workplace withholdings for 2024 early in the year.
One great way to make up for underwithholding 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 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, 2024 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.
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 2024 is December 31, 2024. 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, 2024. 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, 2021, 2022, and 2023, the IRS has waived 2024 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 2024 to put the income into a lower tax year, if 2024 happens to be a lower taxable income year vis-a-vis future tax years.
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 2024 is April 15, 2025.
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 2024 tax year is April 15, 2025. Those doing the Backdoor Roth IRA for 2024 and doing the Roth conversion step in 2025 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 2024 is April 15, 2025. 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 2024 is April 15, 2025.
2025 Tax Planning at the End of 2024
HDHP and HSA Open Enrollment
It’s open enrollment season. Now is a great time to assess whether a high deductible health plan (a HDHP) is a good medical insurance plan for you. One of the benefits of the HDHP is the health savings account (an HSA).
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 2024 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, 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.
It happened. The frontrunner for the Presidency said “Sure, . . . why not?” when asked if he would eliminate the income tax on the Joe Rogan podcast. Whoa!!!
Okay, let’s calm down. Let’s not plan on never filing a tax return again just yet.
Tax planning is all about probabilities. Over the 2024 presidential campaign, probabilities have shifted. Below I’ll discuss the changing landscape, what it means for how Americans should approach their own planning (at year-end in 2024 and beyond), and a few thoughts on the future of American taxation.
Trump Tax Promises and Trend
Trump has been quite explicit with three individual income tax cut promises during the campaign:
No tax on tips
No tax on Social Security
No tax on overtime
Trump and his campaign have frequently mentioned these. It’s more than fair for the electorate to hold Trump to these promises.
I saw then what has become even clearer thanks to Donald Trump’s answer Joe Rogan’s question: the Trump Era would, to at least some degree, shift America away from income taxes and towards tariffs.
I do not view Trump’s answer to Rogan as a promise. It was one line during a 3 hour interview. It should be taken seriously, not literally. Trump briefly stated it in response to Rogan’s question. Importantly, Trump then went into detail not on eliminating income taxes but rather on his fondness of tariffs.
The above caveats aside, trend here is obvious. Much like with polling, trends matter much more than the top line. I have previously stated that tariffs might become very popular with politicians after Trump’s retirement. Voters don’t file tariff tax returns! That alone indicates future politicians might be more than happy to adopt pro-tariff positions, which could mean less in the way of income taxes.
What this Means for Americans
Does a Joe Rogan episode radically change financial planning for most Americans? No. But considering the odds, I think it, combined with Trump’s other promises, gives us two insights to consider.
2024 Year-End Roth Conversions
First, there is little reason to rush year-end 2024 Roth conversions, particularly before Election Day. The conventional wisdom had been “better do those Roth conversions before taxes go up in 2026!” That conventional wisdom is now out the window.
I generally recommend Roth conversions when they make sense for the individual based on the individual’s circumstances. I don’t recommend Roth conversions based on “conventional wisdom” about tax changes in 2026.
If future income taxes are trending down, why not take the deduction while it is valuable? That’s where we are going into the 2024 Election.
Does this mean we should never go Roth? No! But now we must start to question paying tax to get into Roth.
Please don’t read this to say “oh wow, FI Tax Guy is against Roth.” Far from it! But I must question paying federal income tax in 2024 to get into Roth.
There are times we pay tax to get into a Roth. Contributing to a Roth 401(k) instead of to a traditional 401(k) is paying tax to get into Roth, because we have foregone the tax deduction that we could have received for a traditional 401(k) contribution. Taxable Roth conversions are another time we pay tax to get into a Roth.
There are times we don’t pay tax to get into a Roth. For most people, an annual Roth IRA contribution involves no additional tax, since most Americans do not qualify to deduct contributions to traditional IRAs. Backdoor Roth IRA contributions are the same – there’s no forgone tax deduction. “Taxable” Roth conversions against the standard deduction are another example where there’s no additional federal income tax incurred to get money into a Roth.
To my mind, these “tax free” ways are the best way to get money into Roth accounts, and in this environment should be favored.
My Proposal
Many questions and challenges remain regardless of the outcome of the Election. It remains to be seen how much revenue can be raised by tariffs. The 47th President must prioritize significant cuts to federal spending, particularly foreign military spending. Oh, and the federal government has over $35 trillion of accumulated debt.
We are a long way away from axing the individual income tax. But, perhaps a relatively modest measure could get many Americans there. I propose doubling the standard deduction. The IRS just announced the 2025 standard deduction will be $15,000 for singles and $30,000 for married filing joint couples. Why not double it to $30K for singles and $60K for marrieds?
My proposal achieves some great outcomes. Combined with no taxes on Social Security, a doubled standard deduction would eliminate income taxes for most retired Americans. Trump could say he eliminated millions of tax returns with this one change.
Doubling the standard deduction would be a significant tax cut for millions of working Americans. Further, it would greatly reduce the number of Americans claiming itemized deductions, making the tax code easier to administer for the Internal Revenue Service.
Lastly, a government with $35 trillion plus of debt probably shouldn’t stop taxing the Elon Musks of the world. My proposal keeps taxing him and is no tax cut for him at all (assuming he makes more than $30,000 annually in charitable contributions).
Assuming Congress passes significantly increased tariffs in 2025, I recommend a five year doubling of the standard deduction. That would give the government five years to test out the new system to see if increased tariffs and decreased income taxes, hopefully in concert with significant spending cuts, is successful.
Conclusion
I will cry no tears if the income tax goes away. However, I don’t think we can plan for its demise.
While the income tax is likely here to stay, the trend is becoming obvious. Tariffs are likely on the way up and income taxes are likely on the way down. That informs retirement and tax planning. There’s little reason to rush Roth conversions, and traditional retirement account contributions are more attractive.
Of course, stay tuned. The Election is not over. There are no guarantees as I write this on October 26, 2024. I promise I’ll have plenty of commentary about year-end planning and more after the Election.
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, 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 100%/110% safe harbor protects the late-in year lottery winner (among others). As long as he or she has withholding or estimated tax payments that meet 100% or 110% (as applicable) safe harbor, he or she can have millions or billions of dollars in income, meet the safe harbor requirements, avoid the underpayment penalty and pay most of the 2024 tax by April 15, 2025.
Estimated tax payments are great, but they require early in the year action not possible in the fourth quarter. To meet the safe harbor, generally one quarter of the total amount due under the safe harbor must be paid by April 15th, June 15th, September 15th, and the following January 15th. That’s great, but for those who didn’t make the first three payments going into the fourth quarter, estimated tax payments may not be all that helpful at this point.
Most states with an income tax have rules that mirror the federal income tax withholding rules, but some states have differences.
The Retiree’s Secret Weapon for Estimated Tax Payments
Retirees have a secret weapon for making income tax payments, particularly late in the year. IRAs!
People miss paying taxes during the year. It happens for a variety of reasons. If I were a retiree and I found myself underpaid for either (or both) federal and state income taxes purposes in the fourth quarter, the first place I would look to make an estimated tax payment would be a traditional IRA.
Why?
Because income tax withheld from a traditional IRA is deemed paid equally to the IRS throughout the year regardless of when the withholding occurs.
IRA owners can initiate a distribution from their traditional IRA and direct that most of it be directed to the IRS and/or the state taxing authority. That withholding is treated as if it is paid equally throughout the year regardless of whether it occurs on January 5th or December 21st.
That’s pretty good! A late in the year IRA distribution withheld to the IRS can meet either (or both) the 90% safe harbor and/or the 100%/110% safe harbor.
The downside is that it creates taxable income. In many cases, it turns out retirees are rather lightly taxed. As long as the retiree had a relatively low income tax burden either last year or this year, the taxable withdrawal won’t be a large number, because the applicable required safe harbor withholding will be modest. Thus, the tax hit on the mostly withheld distribution should be rather modest.
Another advantage of using a traditional IRA to pay income taxes is RMD mitigation. While I believe the concerns around RMDs are wildly overstated, RMD mitigation is a perfectly valid financial planning objective and a good outcome.
Using an IRA to Pay Income Taxes Under Age 59 ½
You may now be thinking “Sean, that’s a great idea for those over age 59 ½. But what if I’m under age 59 ½? Won’t I be subject to the 10% early withdrawal penalty on the amount I fork over to the IRS?”
That’s an excellent thought! Fortunately, the answer to your questions is “maybe.”
The IRS maintains a list of exceptions to the 10% early withdrawal penalty. Many will not be applicable to most retirees. But there are some options–let’s explore two of them: Inherited IRAs and 72(t) payment plans.
Inherited IRAs
Beneficiaries of inherited IRAs never pay the 10% early withdrawal penalty with respect to distributions from their “inherited IRAs.” Thus, the inherited IRA is a great place to look to pay taxes from late in the year.
The only downside is the distribution to the IRS or the state taxing authority is itself taxable to the beneficiary. However, the money in the inherited IRA has to come out eventually (usually under the 10 year rule at a minimum), so why not whittle the traditional IRA down by using it to pay income taxes and avoid an underpayment penalty?
72(t) Payment Plan to Pay Income Taxes
Could someone start a 72(t) payment plan to pay required income taxes? Absolutely, in my opinion. It might even be a good idea!
72(t) Payment to Pay Income Taxes Example
Homer and Marge both turned age 56 in the year 2024. They retired early in 2023 and thus had some W-2 income and some investment income in 2023. They had approximately $120K of adjusted gross income in 2023 and thus paid approximately $8,800 of federal income taxes in 2023 (see Form 1040 line 24 less most tax credits — see the comment below) and $2,000 of California income taxes in 2023.
In 2024 they have ordinary income below the standard deduction and taxable income below the top of the 12% federal income tax bracket. Thus, they owe no federal income tax and a very small amount of California income tax for 2024. They’ve made no estimated tax payments.
In August 2024 they decided to sell their Bay Area home worth $2M to move to a more rural part of California. The sale closed in October 2024 and they had a $500,000 basis in the home. Qualifying for the $500K exclusion, this triggers a $1M taxable long term capital gain to Homer and Marge in 2024. D’oh!
Very, very roughly, the capital gain creates approximately $175K of federal income tax, $30K of federal net investment income tax, and $100K of California income tax. Note also that the proceeds from the home sale are likely to cause some taxable income in December 2024, but let’s just use the above three tax numbers for illustrative purposes only.
One of their other assets is a $2M traditional IRA. They have no inherited retirement accounts but they do have some taxable brokerage accounts. To my mind, there are four main ways Homer and Marge can avoid an underpayment penalty.
Option 1: Q4 Estimated Tax Payments
Homer and Marge could make substantial fourth quarter estimated tax payments out of their taxable brokerage accounts by January 15, 2025. They would owe 90% their entire 2024 tax liability at that time and would need to use annualization on the Form 2210 to avoid an underpayment penalty.
Compared to the other three methods described below, this costs them 3 months of interest on about $275K. In today’s interest rate environment, that is about $2,700 of interest in an online FDIC insured savings account.
Option 2: IRA Regular Distribution
Homer and Marge could, no later than December 31st, trigger a distribution from one of their traditional IRAs, say for $11,100. They could direct the institution to send $8,880 (80%) to the IRS, $2,109 (19%) to the California Franchise Tax Board, and $111 (1%) to themselves (the intuition will likely require they take at least 1% of the distribution). This creates $11,100 more taxable income (taxed at a low federal rate due to income stacking).
The advantage is this qualifies for the safe harbor, meaning Homer and Marge don’t have to pay most of their 2024 income tax until April 15, 2024. The downside to this is it triggers a 10% early withdrawal penalty ($1,110) payable to the IRS and a 2.5% early withdrawal penalty ($278) payable to California.
Option 3: IRA Regular Distribution and Rollover
This option is the IRA Regular Distribution option plus refunding the $11,100 traditional IRA distribution to the traditional IRA from their taxable accounts within 60 days. This has all the same advantages as the IRA Regular Distribution option plus it reduces 2024 taxable income by $11,100 and avoids the early withdrawal penalties.
Gold, right? My view: I tend to disfavor this tactic. Why? Americans are limited to one 60 day rollover from an IRA to an IRA every 12 months. My personal opinion is that pre-age 59 ½ retirees are usually better served to keep that option on the table. You never know when a significant sum will pop out of a traditional IRA. It will be good to have the option to put that money back into the traditional IRA. If Homer and Marge do the $11,100 IRA Regular Distribution and Rollover, they are locked out from the ability to do a 60 day IRA to IRA rollover for the next 12 months.
Option 4: 72(t) Payment Plan
This option is simply the IRA Regular Distribution option as part of a 72(t) payment plan. The advantage of adding the 72(t) payment plan is avoiding the 10% early withdrawal penalty (federal) and the 2.5% early withdrawal penalty (California).
Here’s how it works. Before making the $11,100 IRA withdrawal, Homer and Marge do a 72(t) distribution calculation and have their financial institution set up a $172,116.10 72(t) IRA. Here is the 72(t) fixed amortization calculation:
Item
Amount
Source
Interest Rate
5.00%
Notice 2022-6
Single Life Expectancy Years at Age 56
30.6
IRS Single Life Table
Account Balance
$172,116.10
Annual Payment
$11,100.00
Homer and Marge then take the distribution from the 72(t) IRA prior to the end of 2024, directing 80% to the IRS and 19% to the Franchise Tax Board.
You say, but wait a minute, now they have $11,100 they have to take annually for each of the following four years. I say, well, okay, they have $2M in tax deferred accounts, why not take some of that without a penalty (perhaps as a form of the “Hidden Roth IRA”) and whittle down future RMDs a bit?
That said, Homer and Marge can drastically reduce the annual 72(t) payment if they want with a one-time change to the RMD method. Assuming the 72(t) balance on December 31, 2024 is $164,000, here’s what the 2025 taxable RMD from the 72(t) could look like:
Item
Amount
Source
Account Balance
$164,000
Single Life Expectancy Years at Age 57
41.6
Notice 2022-6 Uniform Life Table
2025 Payment
$3,942.31
One would hardly expect that $4,000 of taxable income would derail Homer and Marge’s tax planning in retirement. Further, they can direct most of that $4,000 to the IRS and Franchise Tax Board to help take care of 2025 tax liabilities, if any.
Conclusion
For those under age 59 ½, a 72(t) payment plan might be the answer to an underpayment of estimated taxes problem. It is a bit of an “out of the box” solution, but it has several advantages. It allows some taxpayers to delay paying significant amounts of tax until April 15th of the following year by qualifying the taxpayer for the 100% of prior year tax safe harbor. Second, it avoids the 10% early withdrawal penalty. Third, it avoids the once-every-twelve-months 60 day rollover rule. Lastly, a 72(t) payment plan is rather flexible and the required taxable distribution in future years can be significantly reduced by a one-time switch to the RMD method.
The above said, the first IRA I would look to if I was under age 59 ½ and looking to pay estimated taxes is an inherited IRA. Those are never subject to the early withdrawal penalty and can always be accessed in a flexible manner.
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.
