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Death of the Stretch IRA?

Over the years, I’ve focused on the bits of the tax code that a middle class tax filer might benefit from. The Roth Conversion (still a good tool) and the Recharacterization, which the tax code killed, among them. Another bit of the tax code allowed a beneficiary of a taxable IRA or 401(k) to take distributions over his/her own lifetime, ‘stretching’ the withdrawals over decades to both allow for growth over time and reduce each year’s tax burden. Consider, if I have one married child, and leave her $1M, with no other income, no deductions, a $50K withdrawal taxed on $26K (due to the current standard deduction) produces a tax bill of $2739. Not too bad. Of course, if they have other income, they’ll see a higher bill, but this is just an example of the benefit of the stretch feature. Now, H.R. 5282, ironically titled “Retirement Enhancement and Savings Act of 2018” proposes to limit the withdrawal option for one’s inherited retirement accounts. A five year required withdrawal. The million would need to be withdrawn $200K/yr, resulting in a taxable $176K resulting in a $30,819 tax due. Over $150K (over the 5 years) or 15%+ vs an effective rate of about 5.5%.

Those who support this approach claim that once I (and my wife) are gone, we don’t ‘need’ the money and it’s up for grabs by the government. Yet the same folk pushed to get the estate tax exemption to $11M+ per person. Under the guise of ‘saving the family farms’, as if this were truly their motive. Adding to the irony are multiple New York Times articles, first reporting that Fred Trump, aided by his children, moved large sums of wealth into their names over their lifetimes to avoid proper taxes and the 55% tax rate on gifts over those decades. Second is that the president’s son-in-law also manages to escape any tax via his real estate holdings. In Jared’s case, the write off’s may be legal, albeit an example of how the tax code is structured to favor the rich and not the middle class who worked for decades to save up that $million vs accumulating hundreds of millions via tax loopholes.

Keep in mind, the bill hasn’t passed yet, but if it does, start doing the math. If you have multiple children, the tax hit is reduced. You can reduce it further if you have grandchildren, as the rules for their forced withdrawals are more lenient. If this new law is passed, you can also used Roth conversions over the next decades to move a small amount each year and pay the tax at your rate in retirement. Adding say, $25-$40K each year to your taxable income might have a far lower tax than to add 20% of the retirement account balance each year to your kid’s income.

If this bill is passed, or when I read that it failed to pass, I’ll be back with an update.

EDIT: The billed passed, and an easy estate planning tool for the middle class just went away. We are not likely to get it back.

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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’.”

 

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A fellow blogger wrote about the debt snowball. For those of you who do not know what the debt snowball is, it’s a method of paying one’s debt off (a good thing) ordered from lowest balance to highest. I wrote about this over 7 years ago when I was Thinking about Dave Ramsey. In that article, I was trying to keep an open mind. I’ll even suggest that for the lost few hundred dollars, if the good feelings you get from knocking off the first card help keep you going, a few hundred, or even a thousand dollars might be a small price to pay for long term success. In my opinion, the fastest way to eliminate all one’s debt is simple – make all minimum payment due, and send any extra money to the highest interest debt. Others insist on the snowball good feelings.

But. As a numbers guy, I ask, “Where do you draw the line?” And toward that end I wrote to Derek, the blogger I mentioned –

“I don’t dispute that killing off a card completely can provide an emotional reward, a boost to one’s feeling of accomplishment, etc. But, I often say “knowledge is power” and one should know the cost of that decision. A few hundred dollars over 4 years? No big deal. Thousands of dollars? Look carefully at the numbers before choosing the method.

Consider “snowballers” suggest you pay your 8 student loans, all zero interest, $10,000 each, before paying that $20,000 18% card. Of course, that’s an exaggeration, but one that easily illustrates why it’s important to look at the numbers.”

What I expected was an acknowledgement that there are some extreme, contrived, cases when you just pay off that 18% debt first. Nope. His response?

“I used to be like you “a hard-nosed financial professional that only believed in the numbers and percentages. Today, I understand much more about the emotional side of money. If you make no progress over the course of a year, there’s about a 100% chance of giving up. If, however, you pay off a $2,000 loan and get rid of that payment completely, you’ll be charged up and ready to tackle another!

I’d still suggest that people pay off their $10,000 zero interest loan before their $20,000 18% interest loan because there’s a greater percent chance of them getting rid of the smaller debt and continuing their debt payoff journey! Pay a couple thousand extra dollars in interest but paying off the debt is better than trying to save the interest and failing at the debt payoff entirely, don’t you think??”

snowball17

What? I aimed to find the most ridiculous spread from high rate to low, trying to show how there’s some point where it’s silly to pay off your low-to-no interest debt first. And, with a daughter about to enter college, I figured that an example of 8 low rate separate loans was actually possible. Here’s what this would look like. Do you see what makes this so ridiculous? You graduated college, and the loans happen to be individual loans. The lender could just as easily have made this into one loan with a monthly $664 due. In which case, the snowballers would have no issue paying the “low balance” $20,000 card first. But because these loans are each $10,000, they rise to be the priority, pay them off, get rid of 1, 2, 3, etc as fast as you can, before sending an extra dime to the $20,000 high rate loan.

Let’s look at what happens when we prioritize that awful 18% debt. I happen to choose a total $1,200 available to pay debt, just $236 more than the minimums required. If we pay the low balances first, the interest jumps by over $20,000. A $10K loan is too small to kill in less than a year with only the $236 extra, so the snowball takes 32 months to eliminate one debt, while my plan gets rid of the credit card 18% debt in 56 months. Would you really be happier paying interest-only for 89 months on that 18% debt but feeling great that you have fewer loans, fewer checks to write?

The truth is that most people are not in such an extreme situation. And the real cost may be far less that this contrived example. As I offered on Derek’s site, knowledge is power. Why would you not wish to know the cost of one method vs another? And if you knew the cost, how high (or low) would it need to be to sway your approach to paying off your debt? What could you do with the $20,000 you’d have saved over these 10 years? How much snowball Kool-Aid does one have to drink to state they will stick to a method no matter the cost?

By the way, I do believe in more than numbers and percentages. I also believe one shouldn’t fall for bad advice offered by a celebrity, Dave Ramsey, who takes a “my way or the highway” approach to his advice. Know your options, and decide for yourself.

On a final note, as I was writing this, John, another blogger who writes at Military Fire, also visited Derek’s article, and agreed with me, stating,

“If the snowball method costs you a couple thousand annually, and you make less than $50K a year, you would have to work 13 months a year to recoup that unnecessary interest. The snowball requires nuance. Lets help people work smarter, not harder.”

Derek, on the other hand, wasn’t budging,

“I’m a nerd just like you and understand the percentages perfectly. After helping hundreds of people though, there’s no denying that those who pay off a debt early are far more likely to stick with their debt snowball. To help the most people possible, I’m sticking with this method for life.”

Check out John’s excellent article Debt Snowball: Not a Chance in Hell, because John doesn’t like throwing away money on interest any more than I do. If you comment at either site, let them know that Joe sent you.

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Rich Country / Poor People

The country has grown richer, a lot richer. Our total net worth, as reported by the Federal Reserve, and the WSJ graphic, has passed $92.8T. That’s Trillion, as in a “one” with 12 zeros. A trillion is also a million million, so $92.8T is $92.8 million times a million.

How many households are we talking? If we divide this huge treasure over the population, what are we worth, on average? Good question.

 

 

 

 

 

 

We are up to 119.03 million households in the US. When we divide, the result is $779,635.

As a country, this makes us pretty well off. The average family can own a paid-off house worth $235K, and still have $545K which, for retirees, can provide over $20K per year income. Combine this with another $20K in social security, for a couple, and the numbers still look good.

Not so fast. The totals reported, the treasure of nearly $93 trillion dollars, fails to discuss one crucial factor, the distribution of this wealth.

CNN offered a look at how this wealth is distributed.

That leaves just 1% of the total pie for the entire bottom half of the population. Note that while that article was written in 2016, just before the election, it used data from 2013. The point remains, half are sharing just 1% of this wealth. I don’t have a solution, today I am just making an observation. The totals and the averages that are reported are meaningless without digging deeper. A $500K average doesn’t help when your family and others have virtually nothing, but one family has $5M. Keep all this in mind when you see any articles that offer this type of news presented as if we are all somehow better off.

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Roth Recharacterization R.I.P.

Roth Recharacterization, we hardly knew ye. You were the bit of the tax code that let us undo any or all of our Roth conversion, up until the time we filed our taxes. Why was this so valuable? For many of us, taxes are a bit of an unknown. We might not know our exact taxable income until we finish filing our return. From that, it follows that if, during the year, there was a conversion from a traditional IRA to a Roth, the impact to the final tax bill might not be known.

The rules for a recharacterization were very friendly. If, at tax time, you realized the conversion put you into the next bracket, e.g. of a $10,000 conversion, $8000 would be taxed at 15% but the last $2000, 25%, you could send in the paperwork and undo that last $2000. Or, if you moved a stock worth $20,000 and at tax time, the stock is trading at $15,000, just send the stock back to the traditional IRA. On the flip side, if your stocks rose in price, you’d be better off keeping them in the Roth, with tax due on the valuation on the date of conversion.

The Roth conversion hasn’t been removed from the tax code. You should just be careful on the amount and the timing. If your income is stable, and you can forecast your taxable income early on, by all means, take advantage of the opportunity to ‘top off’ your current bracket. If you’re not so sure, you might wish to wait until tax time. I don’t mean April. I mean late November/early December. This is when the tax software comes out and you will have a better idea what your final situation looks like.

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