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The #FightFor15

The #FightFor15 is the movement to raise the minimum wage in the United States, and many other countries in the world. I’ve touched on the topic of minimum wage before, first in a 2013 article “Time to Raise The Minimum Wage” and in 2014, “What Wealth Transfer Looks Like” in which I make the case that taxpayers are directly supporting rich shareholders of companies like Walmart by subsidizing their workers’ income so the company can pay substandard wages. I also addressed the objection that “higher minimum wage will result in fewer jobs.”

Now that we are in the midst of tax reform discussion, I find that the minimum wage discussion is inextricably linked to outrage regarding the huge tax cuts the top 1% are bound to enjoy. I understand that the tax code doesn’t address minimum wage, nor does it address healthcare, but there’s no separating them as congress and the senate are both populated by horse traders, always withholding a vote on one issue to get their way on another. If the tax code is about to get changed so the top .2% can save the $100B tax bill their estates might be subject to, it’s only right to discuss how we can help nearly half the US population who are earning a sub-$15 wage.

There’s a cliche that those who don’t study history are doomed to repeat it. Today, this is appropriate to the GOP propaganda suggesting that cutting corporate taxes will “bring back jobs”, “help middle class workers”, and “raise salaries across the board.” This concept was called Trickle Down Economics, and yes, it was proven to have been a failure. Wikipedia offers a Will Rogers quote that gives a bit of perspective:

“This election was lost four and six years ago, not this year. They [Republicans] didn’t start thinking of the old common fellow till just as they started out on the election tour. The money was all appropriated for the top in the hopes that it would trickle down to the needy. Mr. Hoover was an engineer. He knew that water trickles down. Put it uphill and let it go and it will reach the driest little spot. But he didn’t know that money trickled up. Give it to the people at the bottom and the people at the top will have it before night, anyhow. But it will at least have passed through the poor fellows hands. They saved the big banks, but the little ones went up the flue.”

If a clever quote isn’t satisfying, let’s look at some history –

There are two important things to understand in this graph. In relative numbers, average wages have gone nowhere in 50 years. Less than 18% real growth since 1968. Even worse, the minimum wage has fallen in real terms during this time.

Let me offer you a term you might not have hear before, “Velocity of Money.” When I learned this term in grad school, I thought it was great, I imagined money going through the economy getting spent over and over inside of just one year. That’s actually what this phrase means, it’s the total dollar amount of transactions divided by the money in circulation. This raises a major point. $1000 given to a 1%er (Those making over about $400K per year) is just a rounding error, less than a half day’s wages, and just deposited to their checking account. The minimum wage worker is taking the next dollar, the next hundred dollars, and going to the grocery store to buy food. To the department store to replace their kid’s worn out clothing. In other words, it gets spent so fast that it’s gone before the next pay day comes. If trickle down proved a failure, the bottom up approach would provide spectacular results, if only it could be implemented.

Next, let’s consider the GOP’s recent campaign of 31 Reasons for Tax Reform. I plan to write more on this, but today, I’m thinking about how they suggest that cutting corporate taxes will somehow bring back manufacturing (On the page for Aug 7). It’s not tough to find that Ivanka Trump has her products made overseas and for wages that are sub-$1 per hour. There is no reason to expect that any business with a lower tax burden will use that money to create higher paying jobs, it will simply raise their profits. There are classes of manufacturing, clothing for one, that just aren’t coming back. American Apparel has done an admirable job of declaring their manufacturing to be “Sweatshop Free,” and also filed for bankruptcy a second time.

I’ve continued to see people say that the low wage workers should get an education, college, of course, and get a higher paying job. Now, let me show you why this suggest is remarkably ignorant.

This is a forecast from the Bureau of Labor Statistics. It offers a look at the jobs they expect to grow in number by the most over the next decade, beginning in 2014. What do you see? I’ll tell you the two things that spoke the loudest to me. First, manufacturing didn’t make the list, these are all service jobs. More important, I added the numbers. Of the 4.13M jobs projected, 55% were sub $15, in this case, $26,590 or lower. There is something disingenuous (and innumerate) about the rich person suggesting that it’s possible for everyone to have an above average education and approach an above average wage.  When I go to a restaurant, I’m not thinking my waitperson should go get a better job, I’m hoping that she is making tips and an overall wage that gives her a good life. It gets even more personal when I visit my mother in law, in an assisted living facility. An average $11/hr for personal care aides who are taking care of our loved ones. The same people saying “go get an education” would be disappointed to find they can’t get any care for their own parents when the time comes. I’ll say it to anyone, I love my mother in law. Unfortunately, we are at a point where she needs the care that can only come from 24/7 heath aides taking care of her. They are not lazy by any means, and deserve to be well paid. You can read the full list above, and hopefully walk away with one message – we need people to do these jobs, and all they ask for is that as wealth in the US grew enormously this past half century, their wages should have kept up. The disparity in the graph I offered above is the creation of a shift in the distribution of income, where the newly created wealth went to the top, at the expense of the middle class.

A few years ago, I read an article, The Pitchforks Are Coming… For Us Plutocrats. Written by a multibillionaire who recognizes that the divide between rich and poor is growing, rapidly. You can read the full article, but I’ll share the most frightening part – “But the problem isn’t that we have inequality. Some inequality is intrinsic to any high-functioning capitalist economy. The problem is that inequality is at historically high levels and getting worse every day. Our country is rapidly becoming less a capitalist society and more a feudal society. Unless our policies change dramatically, the middle class will disappear, and we will be back to late 18th-century France. Before the revolution.” He goes on to say, “In fact, there is no example in human history where wealth accumulated like this and the pitchforks didn’t eventually come out. You show me a highly unequal society, and I will show you a police state. Or an uprising. There are no counterexamples. None. It’s not if, it’s when.”

The most unfortunate thing is that the solution is not difficult, in fact, it’s very simple. A living minimum wage has a remarkable domino effect. When people are not going to bed hungry every night, or making decisions between one necessity and another, local crime goes down. The need for medical care due to malnutrition also goes down. When parents are making enough money to make ends meet on only 80 hours a week combined,  they are available to their children, and the next generation performs better. We are at a critical juncture in our history, there’s a choice to be made here that will be regarded by historians as either “the moment we decided as a society to eliminate poverty in the US” vs “the new tax code that spoke volumes about being ‘doomed to repeat it’.”


Tax Reform 2017 – The AMT

If you haven’t noticed, one thing that has reared its head again is tax reform. The ‘plan’ hasn’t been made public yet, only a one pager, a summary of the goals. The lack of details hasn’t kept our government from starting the marketing ball rolling on this one. Marketing is the word I’m using here, and I’ve chosen this word carefully. Products can be sold 2 ways. The ‘just the facts’ approach is one. It’s a bit boring, I’ll admit, but it’s how I prefer to discuss most financial topics.

The other way is the ‘marketing’ way, giving bits and pieces of information that appeal more to one’s emotions than to their logic. The slide I show here? It’s what the House Ways and Means Committee published last week. It’s not just marketing, it’s a lie. And it’s not a reason to repeal AMT.

First, let’s take a step back. What is the AMT? Do you know? Do you care? 37% of people thought AMT meant a cash machine, confusing this with the acronym ATM. (I made that last line up. But now that I read it twice, I believe it) AMT is the alternative minimum tax. Some time ago, congress realized that there were people who managed to come up with so many deductions that they paid little, and in some cases, no tax at all. The AMT forces tax payers, in effect, to phase out their deductions when at a certain level compared to their income. I’ll offer one example. A couple with $212K gross income. With itemized deductions of $57K, and their 4 exemptions, they have a taxable $139K, and a tax bill of $26K. Keep in mind, they are in the 25% bracket. This means if I go back to the tax return (I’m using 2016 tax software to run these numbers) and drop the income $1000, the tax bill drops $250. But, even though there’s still room in the 25% bracket, the next $1000 of income will show a rise of $325. $75 of which is due to the AMT effect. The taxpayer sees a phantom 32.5% tax rate even though they are the 25% bracket. 

Let’s talk for a moment about the lies. I have never done my taxes by hand. I could, I suppose, but I’ve always bought tax software. In fact, I just threw out my copy of the MacInTax (later taken over by TurboTax) from 1985. It was on a floppy disc, and my wife said it was strange to keep it. My mementos should be about people not 32 year old tax software. But I digress. I’d also guess that few people are doing it by hand. The DIY means using one of the tax softwares each year. There is no ‘double time,’ the software just does it. Those who go to a storefront or individual preparer are also shielded from the efforts, I assure you, they are using software as well. As far as “double tax” is concerned, the incremental tax looks like a higher marginal rate, nothing is doubled. and the overall tax has the smallest of impacts. Except, of course, for even higher level earners who had far more in the way of deductions.

I’ll admit, the AMT calculation is a bit convoluted regarding how different deductions are eliminated as income rises. In general, it will take over $100K in gross income, and a lot of itemized deductions to put you into AMT land. The exemption amount is $84K for a married couple. Whether that number is fair is up for debate. When our politicians want to make some change to the tax code, they should just be honest, they object to the tax and its impact on their constituents, for whatever reason. The way they are marketing their cause is just a smokescreen.


Tax Reform 2017 – The Estate Tax

Tax reform is on the table again, and it’s time to start looking at the individual parts of the code up for discussion. Today, I’d like to look at the estate tax. Those who want to repeal it entirely are fond of calling the ‘Death Tax’, as that will stir up some repulsion in their constituents, and support for them.

First, let’s look at a bit of the history of the estate tax. In 2001, shortly after my daughter was born, the exemption was $675K. At that time, my wife and I were going to do the ‘responsible’ thing and get life insurance, term policies. $1M each, which was pretty cheap at the time as we were still young. But this meant that if we died, we would leave our child $2M of which $700K would be subject to tax. On top of that, our 401(k) and IRAs would add to this number, and every bit of it taxed. Even at that earlier stage of investing, I knew enough to start planning. $2000 and one trust later, we did not own the insurance, it was owned by the trust, and bought with money gifted to our daughter. The estate tax was always up for discussion and it quickly was raised in the late 2000’s. In 2017, it’s $5.49M per person. And there’s a little additional benefit, the preservation of the exemption for the second to die spouse. This means that if I die tomorrow, in effect, my wife can leave our daughter the $10.98M with no tax due. Just a form to send in when I meet my maker. No need for any lawyer or trust. And no, we’re nowhere close to worrying about hitting that number. Further, we can gift her $28K/year from now until we pass. That’s close to another million dollars. And $28K/yr to her spouse if and when she gets married, or even to her ‘special friend’ if she stays single, and we’re generous. When you bring on the grandkids, the numbers multiply up fast. A couple with 2 children and 4 grandkids has 8 people to gift to (including the spouses) which adds to $224K/yr under the current limits. If one has the money and sufficient offspring, it’s not tough to gift away another $6M or so depending on the situation.

When you look at the distribution of wealth, the data show that only the top .2%, 1 in 500, estates owe any tax at all, and for those who just go over, the tax is minimal. It gets to be quite a bit when billionaires pass away. Say someone worth $10B passes. The $10.98M exemption is tiny compared to this number, and the estate can owe close to $4B.

When politicians push for this cut, until now, it wasn’t because they were rich, that tax wasn’t likely to affect them either. They had some very large donor whose money they wanted to keep flowing. The politicians are great marketers, talking about the ‘small farms and family businesses’ hurt by the estate tax. Let’s talk about farms for just a moment.

Exact numbers aren’t easy to come by, but we have a good hint. Only 3% of family farms have sales over $1M. This results in a value of $5M or so, given that $1M isn’t profit, but gross sales. This type of business is typically valued at 7X profits. It’s not hard to assume that to get past $11M in value we are at fewer than 1% of farms. Now, if the whole point is that the kids want to keep the farm and stay with the business, it would be easy to use the strategies I suggested above. Giving not money, but a percentage each year. Yes, it takes a tax attorney, and yes, the tax code is convoluted, but we are back to the “family farm” rarely being lost to estate taxes. The repealers post, tweet, and write about it as if each and everyone in the country should be outraged over this tax, while 41% of us are not even making $15 per hour. They would like to give their wealth patrons this windfall, but will look to cut SNAP funding by $125B, cut Pell Grants and other pro-college funding, and perhaps worst of all, repeal the ACA.

If you are in favor of repeal, would you mind dropping me a note and explaining why you support it? Given how few will benefit from repeal, I’m very curious. I’ve never heard a real legitimate reason.

Off to College – The Tax Mistake to Avoid

It was one thing to start writing about Social Security and Retirement when I was still over a decade away, and quite another to write as a retiree with Social Security just a few years away. College is in that same category and my topic today.

I started saving for my daughter’s college the month she was born. We started to save all we could, as I had a forecast, from a spreadsheet I pulled up from then – the cost then was $20,000, as listed on one of the college planning sites, and with a 5% annual increase, this year would cost $48,000, and the 4 year bill, $208K. The cost I tracked was for private, out of state, schools. Better to plan for the high end than to assume a closer state school and come up short.

In the back of my mind, I knew that I was planning to retire early, but looking nearly 20 years out, I made the assumption that we’d both be working until college graduation. This assumption meant we shouldn’t plan to get any aid. In hindsight, we hit a bit of a Catch-22. By saving for college, we pushed ourselves into a situation where we wouldn’t qualify for aid. To be clear, had we planning for the “retirement before college” we might have paid off the mortgage and lined up an equity line for some of our spending over the 4 years. This is the irony to how aid is given. You can own a home with a $200K mortgage, and have $200K in the bank. In this case, that $200K is fair game, you’re paying tuition. But, no mortgage, no savings, you’re likely to get some aid. I’m not advocating this approach, but I am certain there are many who manage to game the system this way.

I do want to look at two things that can snag you, no matter how good your intentions. Both are related to the American Opportunity Credit (AOC). This is a credit of $2500 against college expenses. Not a tax deduction, a credit. It’s calculated as 100% of the first $2000, and then 25% of the next $2000 of college cost. The first potential snag is related to the 529 College Savings Account. This account allows you to save money post tax, and then use the money for college with no tax on the gains. A bit similar to the Roth IRA as far as tax treatment goes. But, here’s the rub. If you take the money for all college expenses from the 529 account, you have no expenses left to claim the AOC. What if you have the exact amount saved? You are still better off using $4000 cash to pay for school. You get back $2500, and can easily afford the tax if you withdraw from the 529 after school is over. In my case, I came very close to using money from a tax-favored Coverdell Education Savings Account (which is pretty similar to the 529) for the full first semester tuition, until I realized this. It would be awful to hit this issue and lose $2500 due to this.

The other AOC issue has to do with MAGA MAGI, Modified Adjusted Gross Income. The ability to take this credit is phased out over the MAGI between $80K-$90K if filing single or $160K-$180K if joint. If you are nowhere near this range, either low or high, you may not have any decision to make. On the other hand, say you were going to be at exactly $90K and filing single. Consider, you are in the 25% bracket, but with the loss of the AOC, the last $10K really cost you $5K. If you can plan ahead and bump your 401(k) or IRA deduction by $10K, your tax bill will be $5K less. Even a stock loss of up to $3K will help you along. For joint filers, the range is $20K wide, so the impact is a bit less dramatic. The $2500 difference over $20K of income feels like a phantom 12.5% vs the 25% for a single filer.

For further reading IRS Publication 970 is a great read to end your exciting summer.

Any questions or comments? Feel free to leave them below.

The Broken 401(k) Solution

Over 5 years ago, I wrote Fixing the 401(k) loan. It was in response to the number 1 reason to avoid the loan, the fact that it’s a risk. One day, you are working, paying all your bills, funding your 401(k), and doing it all right. The loan was to clean up the 18% credit card that was a result of medical bills, and you had no choice. Better to pay yourself, than to pay 18% for years. The risk of course is that if you lose your job, the loan is called in. If you don’t pay it back, it’s deemed a withdrawal, and you have taxes as well as a 10% penalty due. Ouch. This is why the 401(k) loan is frowned upon. Even if you just change jobs, you may not easily get the new 401(k) set up and move enough from the old account in time to borrow from the new account to pay the old. Just thinking about this give me heartburn.

Recently, I’ve been giving great thought to this. Not because I had a loan, but because my wife and I are retired. We’ve done very well using the advice that I offered readers in The 15% solution, a recommendation to strive to keep one’s tax bracket from creeping higher than 15% by strategically taking advantage of pre-tax retirement accounts while working. Now, retired, it’s a matter of throttling withdrawals to straddle the 15/25% line. Our budget has been fine these five years, but I’ll admit, we’d probably go over if we hit a very large expense, such as the new roof I’m anticipating. With other factors such as a rental property, the 15% bracket and 25% bracket aren’t precise. 15% results in about 20% of the last $10K as tax, and the 25%, closer to 29% of the next $10K. To keep it simple, let’s call it a 10% hit for going over.

As I pondered this, the light bulb moment came. I have Schedule C income, and therefore I was able to open a Solo 401(k). With just part time income, it’s not a large balance. However, I can transfer funds from my old job’s 401(k) or my IRA to this account. And the Solo 401(k) permits a loan, same rules as my old employer’s 401(k). I can borrow up to $50K or 50% of the account balance, whichever is lower. The interest is negotiable, typically, prime or a bit higher. My wife can follow the same strategy, offering us a combined $100K of accessible funds.

For the retiree, I can think of another important benefit. As I wrote about in the article The Phantom Couple’s Tax Rate Zone, a couple taking Social Security benefits can think they are in the 15% bracket, but the next $1000 of IRA withdrawal causes more SS money to be taxed. So, instead, they pay $275 on the next thousand (or $2750 on the next $10K). Obviously, they can’t do this each and every year. This strategy is for a one-time, or once every few years, event. It’s a cheap way of shifting taxable income out by a year or averaging it over the next couple years.

When I discussed how to beat the standard deduction, I shared a strategy that I used by year end. I’ll walk you through it now. As retirees, we pay our own health insurance premium. Normally, it’s not deductible as it’s just about 10% of our annual income. I wondered what the impact would be if I just paid ahead, paying the 2017 premiums in December 2016. I checked to be sure that prepaid premiums were deductible, and saw they are. I already had the 2016 tax software, and saw that it worked just fine, I’d see a combined 20% refund on the extra premium. Which immediately let me bump our withdrawal to again top off the 15% bracket making the benefit a full 30%, including our state tax. I offer this anecdote as part of this post for one reason. If I didn’t want to take a larger withdrawal and didn’t have the funds to pre pay the insurance, the 401(k) loan would have been my backup. Say my premium was $10K. The average of all 12 payments is mid-year, making my 20% benefit not a 20% annualized return, but more like 40%. The full $10K, along with just $500 or so in interest goes back into the 401(k), and you are still $2500 better off.

One last example of the beauty of the Solo 401(k). You have an IRA, which is valued at $100K, but includes $50K of non-deducted deposits. This could be for any reason, but likely because you started a job some time ago that offers a 401(k). Now, if you were to convert this whole IRA to a Roth, you’d be subject to tax on $50K, the portion that was deducted from income. If only there were a way to convert just the non-deducted $50K, so it could grow for decades, tax free. There is. You arrange a transfer of the $50K into your Solo 401(k). This leaves the remaining $50K with a $50K basis, and the Roth conversion is tax free. 8%/yr for 30+ years and this money should double 4 times to over $400K, only now, it’s tax free.

There’s a lot here to absorb. As you can see, the Solo 401(k) adds to the flexibility of your retirement investing, whether or not you take advantage of the loan provision. If you have any questions about any strategy I mentioned here, please drop a comment. Have you been caught with a 401(k) loan while changing jobs or getting let go from your job? Share your story with my readers.



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