July 29, 2021

Bogleheads® Chapter Series – Sean Mullaney Discusses Tax Strategies

Sean Mullaney, a financial planner with Mullaney Financial & Tax, Inc., discusses tax strategies for the pre-retirement and early retirement life stages.

Hosted by the Pre-Retirement life stage chapter. Recorded on July 29, 2021.

The slide presentation can be accessed here.

Chat from the recorded meeting can be accessed here.

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Bogleheads® Chapter Series – Sean Mullaney Discusses Tax Strategies


Jim: Welcome to the Bogleheads Chapter Series.This episode w.as hosted by the Pre and Early Retirement Life Stage Chapter and recorded July 29, 2021. It features Sean Mullaney. a CPA, financial planner, and president of Mullaney Financial and Tax Incorporated. He also blogs at fitaxguy.com.  Bogleheads are investors who follow John Bogle's investing philosophy for attaining financial independence. This recording is for informational purposes only and should not be construed as investment advice.

Sean Mullaney: Today I'm going to speak about tax topics, relevant for the most part, to those ages 50 to 70, those thinking about retirement, and those beginning retirement. Now there's going to be some nuggets in there for all ages, right. Hopefully all of us, even if we're under 50 years old, are thinking about retirement. So we're hopefully going to get to ages 50 to 70, and there will be some things in there for those who are a little further along in their retirement journey. Again my name is Sean Mullaney. Carol, Jim, thanks so much for the introduction.

And  I want to first of all say it's an honor to be presenting tonight. Really glad to have this opportunity to be in front of the bogleheads group. A real honor to be here  and thanks so much to Carol, Jim, Miriam, the entire team for putting this together. I know there's a lot of work that goes into it, so thank you so very much for that.  

Just a little bit about me and sort of my background there. Just, you know, we always do the disclaimers, right. So this is for educational and hopefully entertainment purposes. It's not investment advice, tax advice, legal advice for any one person. But hopefully this gives you some knowledge, this gives you some resources. And some more information and for some more power. 

So doing a text  presentation every now and then, it can be a little dry, so I wanted to think about, well what's sort of in the news in the tax world, especially as it applies to pre-retirees, early retirees, and to my mind in this investing environment, it's capital gains There are so many people out there right now with an old dog or cat in their investment portfolio. It did well. They essentially have a good problem, right. They have the problem of years ago I bought a stock or a mutual fund and that thing shot through the roof. Oh no, how do I access it  because capital gains are subject to federal income tax rates of potentially zero percent-- we'll talk about that--15 or 20 percent. And that's today's rates.

You never know what the future's going to hold, and then also for some of the higher  income people you're going to add on to that a 3.8% Net Investment Income Tax if your AGI [Adjusted Gross Income]  is over $200,000 for single, $250,000 married filing joint.

We've got this 3.8% Net Investment Income Tax to tackle, and then there's just the whole issue of AGI. As I'm sure most of you are aware, AGI is one of those things that really limits other benefits in the tax code. So maybe we're not even so much worried about this particular tax but we're worried about spiking our AGI because of a potential capital gain, but we want to access that money. 

And I will just give you a very simple example. In 1995 Candace purchased 200 shares of Acme Corp. for $100 a share. That means her stock basis for tax purposes is $20,000. Today that stock has gone from $100 a share to $500 a share. So we're talking about $100,000 of total value, and we're talking about an $80,000 capital gain. But Candace wants to access that. That's her money. How can she access that money in a tax efficient manner?

And so there are exit strategies out there. I'm actually going to just lead off before I get into the ones that I tend to favor, I'm going to mention too, quickly that I tend not to favor. And look, your mileage may vary, right. Just because it's not my favorite technique doesn't mean it couldn't work in your specific circumstances. 

One of them is the like-kind, 1031 exchange. Like-kind exchange however doesn't apply to Candace  because it only applies today to rental real estate. 1031 exchanges can work out really well but a couple drawbacks. One is it's not really an exit, all it is is a deferral. So the idea behind a 1031 exchange is I have rental real estate property. I exchange it for another piece of rental real estate. It could even be something called a Delaware Statutory Trust. But all I've done is I've deferred the reckoning on that. So now instead of rental property A  I either own rental property B or rental properties C and D. It doesn't have to be one for one. It could be two for one, or one for two, or I own something called a Delaware Statutory Trust. There are issues with 1031 exchanges and like I said they only apply to rental real estate. So limited subsection there.

The other potential exit is something called a Qualified Opportunity Zone. So Candace could sell this stock and then roll the gain into something called a Qualified Opportunity Zone Fund. These are new to the tax law. They came in  late 2017 and to my mind they're not optimal because they are an investment product that is very designed around tax rules. They have to invest in certain assets in these qualified opportunity zones and it's a very tax motivated investment and it has a bunch of tax rules. So I don't want to spend any time on those. We could talk about those a little bit, frankly it's not something I believe I've ever recommended to a client. So you sort of see where I am on these qualified opportunity zones. In the right set of circumstances maybe it could work but certainly not my go-to solution.

But what are some things that I tend to favor? Well the first one is something called tax gain harvesting, and you'll see why I favor this in a second. The idea here is that if Candace can keep her taxable income below $40.401 if she's single, $80,801 if she's married filing joint, she can dispose of some of this stock and be in that zero percent federal capital gains tax rate.

So capital gains tax rates now are progressive and below these levels of taxable income it's actually a zero percent rate. There is a drawback on that one. She's got to manage her taxable income, not going to be available to everybody. but if she is otherwise low income this could be a great way of slowly getting out of this stock in a tax efficient manner. She does need to remember though she's subject to state income tax on that sale. Now look, if she lives in Florida, Texas--I  believe there are nine states without a capital gains tax--not a big not a problem at all and in many states.It's going to only be a little bit of leakage because state income taxes tend to be progressive. So tax gain harvesting, if she's got the right level of income, could be a great answer. Maybe a little bit of state tax leakage, but no big deal there.

I like tax gain harvesting for two reasons. One would be I'm sitting on some appreciated securities I want to reset the basis on them. So it could be a mutual fund I like. It has a gain, I just want to reset that basis, and if I can keep my income below these thresholds, fine I just reset my basis. 

The other one is maybe more like Candace's situation. She's been in Acme stock for 25 years. She doesn't like it from an investment perspective anymore so she wants a tax-free exit, or at least a tax efficient exit, so she starts dripping it out in terms of some taxable sales, does this tax gain harvesting, manages her income and then she reallocates into her desired stocks, bonds, mutual funds, ETFs, whatever it is she likes.

So to my mind there's the tax angle to tax gain harvesting just resetting basis, or it's hey, I want to reallocate or get into cash in a tax efficient manner. So that's tax gain harvesting. A lot has been written about that. I myself have written about that. But you need to keep that income low enough.

Another exit is charitable gifting. This is for the otherwise charitably inclined. Charitable contributions are great but they're a real expensive way to get a tax benefit if you aren't otherwise charitably inclined. And there are plenty of people, hey you know I go to mass every week, I go, I donate to my church, or I have a charity I give to year in and year out, or maybe I’m just looking for a one-time donation. Something really hit my heart, something really pulls at my heartstrings. I want to give some money to them. This Acme stock in Candace's case could be a real win from a tax perspective.

And so what am I talking about?  There are plenty of 501c3 charities today that will accept appreciated securities as a donation. They have a brokerage account set up so they can  accept them. I believe most of the common, most popular brokerage platforms facilitate this. I myself have done this. And what you do is you just go into that account and transfer a certain number of shares to the charitable organization, and so what you're doing is you're taking this appreciated stock and you're making it currency to do something you probably would have otherwise done, which is make this charitable donation. So instead of sending $500 to her church she just goes into her brokerage account, grabs one, she says all right brokerage send one share of Acme, which is worth $500 to that charity. So instead of having to go into her checking account, she gets to make that same donation with the appreciated stock.

What does she do from a tax perspective by doing that? One, the capital gain on that share of stock is forgiven. It's gone, it is never going to be taxed. And that benefit is not income limited, so Candace could be making a billion dollars a year. Maybe she's some big movie star or whatever, or venture capital, I don't know what. But the capital gain is forgiven, regardless of her other taxable income, no income limitation on that.

And then the second  potential benefit, which is income limited, is she could take an itemized deduction for that donation. So there is a limit. You can only take a current year itemized deduction of up to 30% of your so-called adjusted gross income  for donations of appreciated stock. And it may be that Candice--we're going to talk about this in a second in a little more detail--Candace may not be itemizing. 

That said, I think benefit number one is good enough. Who cares, maybe she's taking the standard deduction. Maybe she's married, so if she's married filing joint, her standard deduction is $25,100 this year, and it might be a little higher if she's over 65 and blind, and those sorts of things. But so maybe this is a $20,000 donation. Maybe she doesn't have enough taxes, mortgage interest, other donations, so she doesn't itemize. Well okay, that's fine. She avoided going into her checking account to make this substantial donation and she avoided a big capital gains tax. So with or without benefit number two, I think benefit number one is powerful enough that she might want to do this charitable gifting.

And like I said, in today's environment I believe there are plenty of retirees that should just never donate cash to charities again. Maybe you do ten dollars at your grandchild's raffle or something, but for the most part, the serious charitable donations should be made with appreciated stock that you don't, for whatever reason, don't want to have any more.

One big caveat on this. Stock, bonds, mutual funds, ETFs, securities with built-in losses, never donate those. What do you do?  So hey, I'm sitting on Acme stock, it's got a $10,000 loss. I want to donate some of that to charity. Don't do it. Sell the Acme stock first. Pop that taxable loss. It may be limited. I'm sure everybody on this call is very familiar with the $3,000 per return limit on taking the charitable deduction or taking capital losses against ordinary income.

So maybe you create a big gain. A big loss, it's deferred but that loss goes on for perpetuity, so for the rest of your life. So you create a capital loss. Maybe you can't use it this year because of other losses. Fine you use it the next year, the following year. But a loss is a terrible thing to waste. So do not donate built-in loss stock or securities to a charity. Sell them first, donate the cash.

Well all right, I don't want to donate directly to my charity. Are there other charitable things I could do with this appreciated stock?  I call this planning technique the hyper donor advised fund, because it essentially combines two planning techniques. Something called the donor advised fund, which I bet a lot of you are familiar with. With that first idea of skirting the capital gain by donating appreciated stock. So now what I do is instead of donating appreciated stock to a charity, I donate it directly to my donor advised fund. And what I'm doing there is I'm sort of stepping up this game of charitable giving with a tax advantage. I'm avoiding the capital gain, so you know I transfer $1,000 worth of Acme stock to my donor advised fund. First of all, subject to that 30% limitation, I get that deduction potentially and I avoid the capital gain on whatever I put into the donor advised fund. The donor advised fund will sell off that stock in all likelihood and then you can redirect it to invest in--you know usually donor advised funds are a little more conservatively invested-- but each brokerage will have a different investment menu for the donor advised fund.

The donor advised fund is a great timing play. So what it does is it says, okay I'm going to transfer some assets to the so-called donor advised fund I'm going to take a tax deduction for the fair market value of what I put in. I avoid a capital gain, and then I can donate to charities on my schedule. So maybe I have a big capital gain. There's let's just say I have a stock position. It's worth, let's just say it's worth $20,000 and I have a basis of t$10,000. I don't want to sell it and trip a $10,000  gain. So I just put it in a donor advised fund. It's gone.I can never use it again. I can't fix my roof, it can't install a pool. 

So I’ve got to be charitably inclined, but I might be saying, look I donate $5 000 a year to charity, well why don't I do this, why don't I do the donor advised fund for $20,000 in the year 2021, take that with other deductions as an itemized deduction this year. So let's say my other itemized deductions are $20,000. So now I take a $40,000 itemized deduction in  2021, and then in 2022, 2023, 2024 I get the standard deduction at $25,000 plus if I'm married. And over the next four years I donate $5,000 a year to the charity out of the donor advised fund. The charity's experience with me is not different at all. They just get $5,000 a year, every year from me.

Because people in real life rarely say I like to donate $5,000 a year to this charity, I’m just going to front load, do $20,000 a year and then not give them a penny for the next three or four years. People don't want to do that, so how do I optimize in this environment where I've got such a high standard deduction.

What I want to do is, I don't want to be giving $5,000 a year and it just goes away and I get my standard deduction. Why not take a bunch of money now. put in the donor advised fund and then get a one-time tax benefit and then rely back on those standard deductions every year after that. That could be a great timing play and a great way to avoid capital gains. 

All right, another one. So I had an AICPA conference [American Institute of Certified Public Accountants] this week and I will say in the advisor world, and I'm sure in the client world, people are starting to get a little  freaked out about future tax increases. I think it's very speculative and I certainly don't think it's going to be retroactive if it happens.But there are people out there saying, look you know Sean had that 3.8 %  surtax. Maybe these are the golden days. Maybe I should just sell now at 23.8% federal income tax rate and be happy I bailed out then, before capital gains rates increase.

I think that's very speculative so it is not my go-to technique. Look, every taxpayer needs to make their own decisions and I don't have a perfect crystal ball of the future. So  I'm not going to speculate as to whether or not the tax plan is going to pass or not. But I certainly don't think it's a slam dunk. So this is definitely not my favorite way to go about it.

But there are at least some people out there who are very worried about future capital gains tax rate increases and are looking to accelerate capital gains into the year 2021. Like I said, because it's so speculative I don't like it, but there's a second reason. Like I said, there are other planning techniques available, but there's a second reason that I don't like it. It has to do with this: that tax may never come due. 

Look I get it. Candace has an $80,000 built-in gain in her Acme stock. If she doesn't mind Acme then maybe that tax never comes due. If she's staying up at night because she's worried Acme is going to drop 50% then yeah, maybe she should just sell, get out, pay some capital gains tax or do one of these other techniques. But if she's okay with Acme or whatever, this built-in gain is an asset. Maybe she doesn't care.

So there is the ultimate planning technique and I'm sure most of you are familiar with this. This is the step up of basis at death right. So this is something in our tax law that I think administratively makes a lot of sense. And what it says is okay, at death, generally speaking, your taxable assets get a basis reset, generally speaking on the date of your death. And so what happens here is let's say Candace dies and her heirs inherit the Acme stock. Their basis, when they go to sell it, is the fair market value, close of business, I believe, on the date that Candace died.

And so generally speaking, if Candace's heirs inherit this Acme stock and let's just say it was worth $100,000 on the day she died. They get it, the estate closes out three months later. It's now worth  $102,000. They only have $2,000 of capital gains. So this is a reason not to sell these assets because essentially this is not a tax that we ultimately know as due. It very well may be due, but it will, generally speaking, go away upon your death. And so that is the ultimate tax planning technique. Look, you've got this tax planning opportunity out there. You have to balance it with your other financial considerations. But if you're only motivated by tax then maybe you just let it ride out and get that step up basis.

A couple other comments on the step-up basis. One is it's great with rental real estate because your heirs get to use it.  So it's a great reason to hold rental real estate in a taxable fashion. Two, IRAs do not get the step up on the basis of death. So in some ways if the option is live on your IRA versus live on your taxable assets, and you're older in life, oftentimes, hey if I'm really concerned about my heirs, I might want to live off my IRA instead of my taxable assets because the IRAs get no step up the basis of death but my taxable assets do. And then three, apparently this is a little before my time, but in the year 1976 they actually got rid of the step up in basis, and they brought it back real quick.

So there was a year apparently and I’ve got to do a little more research on my tax history. But in 1976 the step up in basis went away upon death. Now back then the computing power was much less so it created nightmares because you would inherit stock or a house or whatever and you'd have to reconstruct asset basis. Today that's going to be a lot easier but still there's so many assets out there, particularly real estate, where I still think that would be a real headache. So we always have to think about Washington's looking for some more money, but I think this one is a very popular and administratively sensible tax rule. So I think it's going to be around for a while. But don't take my word for it, you have to make your own decision on those sorts of things. So yeah, capital gains. There are ways, like I said, to get out, but it's going to be an issue for folks now, and then there's the ultimate out.

This next one I think is just  a great opportunity. You do need to have a high deductible health plan. So this high deductible health plan is a type of insurance, of medical insurance. You need to be covered by one of these things and it needs to be your only health insurance. Generally speaking, for the healthy, a high deductible health plan, I think, is a really good coverage option. Not everybody has it so there’s going to  be some in the audience where this is just not going to be an option. If you're on medicare, no option. So you cannot have a high deductible health plan once you turn 65. 

The planning technique here is while you're still working and you're relatively healthy and have your high deductible health plan be your medical insurance and then max out your HSA [Health Savings Account]  and you're creating a tax advantaged account that can really serve you later in life. And I’ve actually got a blog post. I say this all the time. You should generally be spending down your HSA  in two situations. If you're in a dire medical situation, or you are elderly.

Let's talk about building up our HSA and then spending it down. How do we build it up? Generally speaking through our workplace. So we've got our medical insurance through our workplace. They offer a high deductible health plan that is insurance for us. We should then maximize our HSA  through payroll tax withholding. So the money that we take out of our paycheck to put into the HSA is excluded from tax. That's fantastic. Not only is it excluded from our taxable income, it doesn't show up in our FICA  income so we don't pay FICA tax on that at all. We don't pay Social Security, we don't pay the medicare tax on that. That's only if  we're well above that $142,800 FICA  cap on the Social Security cap. This is only a minor benefit, but you still get that medicare benefit, and if we're below the 142,800 we get a big benefit because we don't have to pay the 6.2% on Social Security on what we put into our HSA.

That's really cool. One caveat about that though. It has to be through payroll withholding for this payroll tax benefit. You can just not do it through payroll withholding and write a check to your HSA. You take a tax deduction on your tax return, that's perfectly fine. But if you can do it through your payroll withholding and get that FICA tax benefit, I say, why not?

So it's tax excluded on the way in, so we get a tax benefit the year we put it in, the investment income grows inside  HSA  tax free. So HSA is a great place to have investment growth. And then if we would draw it for qualified medical expenses at any time it's tax-free there. So it's tax-free on the way, in it's tax-free while it's in there, and then it's tax-free on the way out. That's a really powerful tool.

One thing for my fellow Californians. California does not recognize the HSA. Same thing with New Jersey. So in California, New Jersey, the HSA is a taxable account. No deduction on the way in, and the interest and dividends and capital gains that are generated on your HSA is taxable in California. So it's a little bit of a drawback for California and New Jersey residents but again, you get this federal tax benefit, which is so powerful. So I still recommend them even for those in California and New Jersey. In most cases, again, when I say recommend I mean that in a general sense not for anyone in this particular meeting.

Well okay, great. We work, we have our high deductible health plan, we have our HSA, we're building up this money in this tax sheltered account. When the heck do I withdraw it? You're saying it's tax sheltered. I should keep it in there as long as possible. When do I withdraw?

I would argue it's best to withdraw it at age 65 and later. A few reasons. One,we want to keep it in there as long as possible to generate as much taxable wealth, you know, tax-free wealth as possible.But the second thing is the HSA has a time limit, and it's basically the later of your death or your spouse's death. So let's talk about that for a second.

An HSA can be left to a spouse. No problem just becomes their HSA. But what if I leave my HSA to my parent, my sibling, my friend, anybody not my spouse. They can inherit the HSA. They'll take the money but the money becomes taxable income in the year of my death and it's also no longer an HSA. So an HSA is a really bad asset to leave behind.

So essentially there's this sort of pressure, and we're talking about  tax efficient  estate planning a little later, but there's a bit of a time clock there, and so it's this delicate balance of okay I'm 65 versus how long am I going to live. Am I only going to live to age 70, in which case I probably should start spending it in my late 60s, or am I  going to live to 95. And why am I going to start spending it down now right in my late 60s if I'm going to live to 95. I want to have it enjoy tax-free growth into my 80s and maybe even my 90s and then I'll spend it down. So there's a little bit of attention there. 

One thing you should do though, is before age 65 pay your medical expenses out of your checking account and then track it. Just track all your medical expenses and then at age 65 and later, you reimburse yourself tax-free for the weekend warrior injury you had at age 53, you're playing frisbee golf sprained ankle $300 medical bill. Keep that google sheet, whatever you’ve  got to do to keep a record of all that.  And then, bam in your 60s, 70s, or 80s reimburse yourself for that old medical expense. Fantastic tax-free distribution of your HSA. That's  some nice little tax planning.And generally speaking, before age 65 if you're not in a dire situation just let the money grow in that HSA.

HSAs also can pay medicare premiums. Generally they can't pay medigap premiums, but they can be used to pay medicare premiums tax free. But then this becomes well, wait a minute. Do I really want to pay my first and second and third premiums out of my HSA? Maybe I want to just keep records. So I pay my medicare premiums in my  65, 66, 67, 68, just keep these records and then reimburse myself in my 70s or my 80s for my medicare premiums from my late 60s and early 70s. 

This is a bit of an art more than it is a science. We don't know the time nor the place so we’ve got to be a little artistic here. And then I've mentioned some of these concepts here definitely start at age 65. To let that tax free growth accumulate and then when, exactly at or after age 65, is really going to depend on your circumstances and just how long you think you're going to be around.

And basically HSAs are great to leave to your spouse. They're actually a good asset to leave to a charity because the charity isn’t going to pay a dime of income tax on it. But it's not a good asset to leave to anybody else because anybody else, any other individual is going--your estate, a trust-- they're going to pay income tax like crazy on that thing. So generally speaking, leave it to your spouse.Iif you don't have a spouse, look if if you have someone in your life you just need to leave money to fine, but there's a situation where there's some optionality and you're leaving it to an heir who perhaps doesn't need the money as much, and you have a charitable intention the HSA is sort of where I look first for where to leave money. 

Okay, Roth conversions. This is a real hot topic and we're going to talk about Roth conversions while we're working and then Roth conversions once we've retired. So while we're working to my mind there are two big planning techniques. While we're working the first planning technique is the so-called backdoor Roth IRA.  This is a two-step transaction, so we do two independent steps. The first step is a non-deductible contribution to a traditional IRA. And then the second step--I like to do this in the following month--the second step is we convert the money we contributed to that non-deductible traditional IRA to a Roth IRA.

And we do this, though generally speaking, only if we have no other traditional IRAs, SEP IRAs, and Simple IRAs. That's a big thing here so I like to say the backdoor Roth IRA is a great planning technique but it's profile dependent. For those of us who make too much to make a direct contribution to a Roth we do this backdoor Roth IRA, but if and only if, we have no other traditional IRAs, SEP IRAs and Simple IRAs. And when do we determine whether we have that? It's by 12/31 of the year of that second step, the Roth conversion step.

If we have other traditional  IRAs, SEP IRAs and Simple IRAs on that December 31st date most likely our backdoor Roth was not a smart transaction. We're going to  pay some tax on--not the end of the world, and the big thing I like to say is get clean by 12/31. So if we have other traditional IRAs and we want to do a backdoor Roth, move those out in a direct trustee-to- trustee transfer to our workplace retirement plans, our 401-ks, 403bs. But we only do that if we like the investment options inside those plans. If we do, great. It's a great way to get clean.

The other thing is the trap for the unwary. I do my backdoor Roth in January. New Year's day I make my $6,000 or $7,000 contribution into my non-deductible IRA. A few weeks, or at the end of the month, or beginning of the next month February, I do my conversion step. Great, backdoor Roth IRA, isn't this great.

Oh, but wait a minute. In September I left my job and in October I rolled my old 401-k to a traditional IRA. That creates a problem for your back-door Roth because at 12/31 you're going to have another traditional IRA. I've blogged about this so you can go to my fighttaxguy.com blog. I've written about it. So that's the first Roth conversion idea for the working.

The second one is the so-called mega backdoor Roth. This is using your workplace retirement  then shortly thereafter--could be automatic--what you do is you convert the after-tax contribution into the Roth 401-k or you roll it to a Roth IRA. Great little planning technique. 

The thing about the back-door Roth and the mega backdoor Roth you need to think about is that the choice is I either invest that money in a taxable brokerage account or I invest in a Roth account. This is not a deduction versus Roth, traditional versus Roth question. This is, am I going to invest that money into a brokerage account that I'll have a 1099 that'll have interest, dividends, and later capital gains taxes, or can I get that money in the Roth.

So, generally speaking, for those who make too much, a back-door Roth IRA is a great thing. The mega backdoor Roth has no AGI limits so you can be at the lower end of the income spectrum, you can make you can be Patrick Mahomes, you make whatever Patrick Mahomes makes, 40 million dollars as the quarterback of the Kansas City Chiefs. If the chiefs 401-k has this option he could do the mega back-door. Okay, well all right, that's like the most non-taxable Roth conversions while working, if it works for you, great.

What about while I'm working, so I'm working and I have an old traditional IRA. Should I do Roth conversions?  And I'd say in many cases, for the quote-unquote early retiree, I'd say no. The idea would be, look if you're going to be an early retiree and I have an old traditional IRA and I'm going to have to be fully taxable on the Roth conversion while I'm working, I probably should hold off now.

Your mileage may vary, but I would generally hold off because there's going to be this opportunity, hopefully in early retirement, and I'll let you define that. You're hopefully going to have artificially low taxable income and so why not do those Roth conversions while you have artificially low taxable income as opposed to now. So that's Roth versus traditional while working.

Now while we're retired. Okay now we're retired, hopefully early, but if now if we're retired the planning changes in terms of the backdoor Roth isn't on the table anymore, mega backdoor Roth isn't on the table because we don't have earned income. So don't worry about that, those are off.  But what we can do is we have old 401-k, old IRA, we can do Roth conversions that are fully taxable. 

And we have two goals here. One of them is just the artificially low tax rates. We're before age 70. So we don't have any and maybe we're delaying Social Security, hopefully.  So we may not have much taxable income. We have a little bit of interest, but we know it's a low yield environment so low dividends, low interest. So you look at our tax return and it looks like, at least initially, that we're poor. All it is, is that we're living off assets and we're not generating a lot of traditionally taxable income. So we take advantage of the progressive tax rates. So we do Roth conversions where our income is maybe only taxed at 10% or 12% for federal tax purposes. Maybe even 22% or 24%.

So that's the first goal, just to take advantage of the luck of the draw before age 70, we're not getting Social Security, we're only getting a little bit of interest and dividends. Let's throw some Roth conversion income, move money from our traditional account to our Roth account where it's tax-free while we're at a low tax rate. 

The second thing we're trying to do is at age 72, you're probably aware, you have to take taxable requirement distributions from your Traditional IRAs, traditional 401-ks, 403-bs etc So we want those to be lower, because if we can get that money from the traditional side of the ledger to the Roth side of the ledger we're going to have lower RMDs in our future.

We're happy with that outcome. The exercise here is to right size those conversions. People sometimes don't understand this. You can convert a dollar or you can convert every dollar or anything in between. There's no income limit on the ability to do a Roth conversion. Everybody, every American with a traditional retirement account can do a Roth conversion regardless of their income. 

But you want to right size it and this is a subjective exercise because you have to coordinate well, how much tax do I want to pay now because I'm going to have to pay tax later, either me or my heirs, somebody's paying tax on this IRA at some point. And I only want to pay so much tax today. Maybe I might be thinking, boy they're going to raise tax rates and my RMDs as I get older are going to start killing me. So what do I care about 24%, go for it. Other people are going to be a little more conservative.

This really does depend on your circumstances. So that first bullet, marginal federal and state income tax rates are so important to consider in terms of whether you're doing these Roth conversions. Could also be, hey I live in California today and in three years I'm moving to Florida. well, maybe I want to hold off a little bit because maybe I don't want to get California income tax. I won't get Florida, where there is no income tax. So there could be plenty of considerations in this regard.

And then the other thing to think about is coordinating with tax gain harvesting. Gain harvesting, which we talked about earlier, is dependent on keeping my taxable income low. Well my Roth conversions could blow me out so now my capital gains are taxed at 15%. If I'm only motivated by tax and I can either do tax gain harvesting or Roth conversions, I'm generally going to tell you to do Roth conversions. 

And here's why. The tax on the traditional IRA is coming, due period, end of discussion. I might pay it during my lifetime, or my heirs are going to pay it. We'll talk about the inherited IRAs in a little bit. Somebody's paying that tax. The government's getting their piece.

My tax gain harvesting, on the other hand, maybe that tax is going to get forgiven with a step up in basis. So if my only consideration is tax, I'm going to favor Roth conversions. Now it might be that I have an investment allocation consideration. So I might have an old cat or dog. I invested in some tech startup years ago. It's got a huge capital gain I want to tax gain harvest out versus, in my traditional IRA I’ve got mutual funds that I really like. Maybe in that case I say, no I'm going to  do my tax gain harvesting instead of my Roth conversions and get a zero percent rate on tax gain harvesting and get my old tech stock, which I'm a little leery about now, into mutual funds that I like better from an investment perspective. So you know this is a tax planning presentation of course, no investment advice in this presentation, but we always have to consider all sides of our financial life, and this is where tax and investment really can intersect. 

Another thing to consider when we're doing Roth conversions is the Affordable Care Act premium tax credit. This is if you're on an ACA plan. So maybe I'm on Tricare or have other private insurance. I'm not on an ACA  plan. Maybe I don't care about the premium tax credit. What you want to do is think about, without Roth conversions do I qualify for a premium tax credit. And where this really is going to come into play for a lot of folks is in 2023 where you get a premium tax credit up to having adjusted gross income of 400% of your federal poverty level and the second you're a dollar over it, you lose the entire credit. 

So this is  something to consider in terms of managing your taxable income so that you optimize the premium tax credit. It only applies in those situations where you have an ACA plan. And by the way, once you go on medicare you're not going to have an ACA plan so this is not going to be that big a deal.

For those already going on to medicare you do want to think about IRMA. So that's the increase in medicare premiums that results from increasing your taxable income. This is a bit of a marginal concern because yes, this exists and yes, if you blow through one of these it's a little bit of a cliff. But it really only matters if you're right there. I believe the first IRMA bend point is $176,000 of adjusted gross income for a married couple. So you know you don't want a Roth conversion to ever take you from $175,999 over the line. But before the line and even within the line, it's a relatively modest increase and it does go up progressively. So it's something to consider but I wouldn't be losing too much sleep over it.

And then qualified charitable distributions. Well what the heck is a qualified charitable distribution, a QCD?  And what does that have to do with Roth conversions? All right, qualified charitable distributions, and for the charitably inclined another great planning technique, the idea here is you donate to charity up to $100,000 a year  with your traditional IRA instead of with your taxable accounts, your checking account, Roth IRA.

And why do we do this? If we're 70 and a half and older we can transfer up to $100,000 every year from our traditional IRA and the money is not taxed. The whole point of doing Roth conversions is to get money out of traditional IRAs so it's taxed when we want it to be taxed as opposed to later when we may not be able to afford that tax or that tax might be very high or whatever it is.

Okay the cool thing about the QCD is it's a way to bail money out of a traditional IRA and not pay tax. Now look, you’ve  got to be charitably inclined, but I might be saying, look in my 70s, I'm going to give a certain amount to my church, no matter what. Might as well do it out of your traditional IRA because what it does is it gets, it bails that money out of that traditional IRA  fully tax-free, up to $100,000 a year. You don't get a charitable deduction for it, but who cares. You're getting that big  standard deduction anyway.

And oh, by the way, QCDs do a couple things.They satisfy my RMD, so starting at age 72 I'm going to have requirement distributions. Guess what? If my RMD from my IRA is just let's say $50,000, and I do a qualified charitable distribution out of my IRA to my favorite charity for $50,000, I don't have to take my RMD. That satisfies it. It's a way to bail money out of the traditional IRA without taxes. And if I'm going to be given that $50,000 to charity anyway might as well do it out of my traditional IRA instead of taking my RMD myself, paying tax on it, and then giving money to the charity, right.

So this is just a great idea. And oh, by the way, so the reason I bring it up, if you're before age 70 and a half you definitely want to think about this in terms of right sizing your Roth conversions. Why convert every last dollar to a Roth if I'm going to be making some substantial charitable contributions in my 70s and 80s.

And then a little disclaimer. Just don't accept any remuneration or trinket from the charity. That can blow QCD treatment, a very powerful planning technique. I'm very fond of it. Only applies if you are age 70 and a half so but you need to be thinking about it before your age 70 and a half to right size those Roth conversions.

All right, tax efficient estate planning. What are we talking about?  What are we not talking about? We are talking mostly about income tax here. For most people the estate tax is not going to bite. Now that could change. I tend to doubt it right now. Your lifetime exclusion is 11.7 million dollars, so most of us are not going to die with 11.7 million dollars worth of wealth. Hate to break it to you, but that said, pretty much everybody with any sort of substantial assets needs an estate plan And we'll talk about some reasons why.

First thing is the elimination of the stretch IRA. The whole idea in the past was, oh I've got an IRA. My heirs have to take on required minimum distributions. I'm going to leave it to the two-year-old grandchild. he or she has to take  required  distributions but it's based on them being two years old, and then three years old, and four years old. So they have to take a pittance out of it every year and meanwhile it grows either tax tax deferred for an IRA or tax free for a Roth IRA. They used to call that the stretch IRA.  My grandchild could have like 90 years of tax efficient income because of the stretch. Boy isn't that powerful.

Congress, you know this was all over the news. People knew about the stretch IRA  and Congress said. no we want some more revenue, so here's what we're going to do. For most beneficiaries we're going to get rid of these RMDs, other than this one rule. We're going to say, for most beneficiaries you're going to now have to take the money out over 10 years. There's no required minimum distribution other than at the end of the 10th year following the original account owner's death. But otherwise it has to come out in 10 years. So there's no more stretch IRA. There's no more I leave it to my grandchild and they get 90 years of tax deferral or tax free growth. Not doing that you’ve got to take it out in 10 years, whether it's a traditional or a Roth.

To my mind this makes Roth conversion planning for those thinking about their heirs even more impactful. There's not a lot that could be done to avoid this. You know you should leave it to your spouse. There are things that can be done. But if you happen to inherit an IRA you now have a real financial planning issue that you either have to tackle. 

You need professional help because here's what you don't want to do. you don't want to inherit an IRA, a traditional IRA. Roth is different. You don't want to inherit a traditional IRA, do nothing, wait 10 years and then have to take out the entire amount. That's going to be painful, You're going to want to plan your distributions every year.

One little potential planning technique here is to get the inherited IRA into a properly titled inherited IRA account in the year of the original owner's death. That is the function of giving you instead of 10 years you actually have 11 years, the year of death plus the next 10 years to empty that thing out. It's a way to spread out the tax hit just a little more.

Anyway, I will talk about IRAs a little more in terms of who you want to leave them to. Two important things from a tax and an estate planning perspective. Beneficiary designation forms, payable on death forms, make sure at all times you have up-to-date on-file beneficiary designation forms. Absolutely critical in terms of just the safe playing, in general, and tax efficient estate planning in particular.

And then revocable living trusts. I've blogged about this. I'm a big fan of revocable living trusts in the right circumstances. And they are great for real estate, and they can be good for retirement accounts, but if and only if, one of these two things applies. The intended beneficiary is a minor or the intended beneficiary has creditor protection issues. So if I'm 70 years old and maybe I'm a widow or widower and I  have three adult children. They're in their 30s and 40s and they're just regular people, they're competent, they don't work in high risk occupations. You know, they're just regular people. I'm not going to use, generally speaking, I'm going to try to not use a revocable trust to leave the retirement accounts, I’m just going to name them directly as the beneficiaries.

But in certain cases using a revocable trust can be good for the real estate though. The revocable trust can be very powerful. Think about your beneficiaries. Is it my elderly parents? Is it an out of state beneficiary? Because you could leave the house maybe through a will or through a trust. The trust can provide a lot of benefit to your loved ones. 

When you leave it through the trust let's just say I'll just give you one example. You own your own house and maybe you're single and you leave it to your elderly parents and maybe somehow you die early. Your elderly parents live out of state. Now your elderly parents have to come into your home state where they don't live. They have to get your will probated so that they can get get the house, and then get the house retitled, all out of state.

That is not a recipe for success. It's going to probably work a lot better if you put the house in the revocable trust and there are clear directions about how it should be disposed of. Going to make your beneficiary’s life a lot easier. Got to work with a lawyer, this is not a DIY type thing. But I definitely think there's some real advantages to the revocable living trust. 

And then let's think about our type of account and our beneficiary. So let's start off with spouses. Spouses are the law's most favored beneficiaries. These days they can inherit all types of assets in a tax efficient manner. So  for most people leaving most assets to the spouse in today's environment I think makes a lot of sense. For the ultra wealthy, yes there can be absolutely be planning around spouses, but for most people who would not be stars of reality television it's going to generally be spouses as the tax favorite beneficiary. And generally speaking how you might want to go. Let's talk about Roths. Roths are great assets to leave to any non-charitable beneficiary. Right, spouse.

They're particularly good for your upper income beneficiaries. So if you have a Roth IRA  and a traditional IRA and you've got one child who's a teacher and another child who's the quarterback of the Kansas City Chiefs. The Roth would be great to leave to the quarterback, the traditional would be great to leave to the teacher because the teacher is at a lower tax rate. Just some little nickel dime planning like that

Roths are not great to leave to charities. If you want to be charitable, don't have me tell you not to be for tax reasons. But if you're looking to be charitable and tax efficient, why waste the benefit of a Roth on a charity.

Most beneficiaries today have 10 years of tax free growth when they inherit a Roth IRA. Even without the stretch that's pretty good. If I inherit a RothI RA I can leave that in there for 10 more years of tax free growth. At the end of the 10th year take it out. And now, yes,  the money will now generate interest and dividends in my taxable brokerage account. But for 10 years it grew tax-free and I get a full step up in basis when it comes out.

So Roth is a great asset to leave. Don't waste that tax attribute on a charity. Where you might want to start thinking about charities, the traditional retirement accounts, right. So if you're thinking about I'm going to leave a bunch of stuff to my adult child and a bunch of stuff to charity, and I have a Roth and a traditional, leave the Roth to the adult child, leave the traditional to the charity. And traditionals are great for lower income beneficiaries because they pay less tax than your higher income beneficiaries.

And then, like I said earlier, on the HSA side. HSAs are great assets to leave to a spouse and they're a great asset to leave to charities because those are basically the only two categories of beneficiary that doesn't immediately pay tax on your HSA. Everybody else is pretty much paying a lot of tax when they inherit your HSA. So just some things to be thinking about from an estate tax plan.

Basically a lot of what you're thinking about is you're in your beneficiary's income tax situation. That bites in today's environment, that bites much, much, much harder than any estate tax is going to bite for 99.9% of Americans.

But here's one thing that should be on your radar, and maybe in our audience we have folks who are having parents now pass away. These things happen, deaths come. Essentially we all have one tax planning opportunity in our life. It's our death and it's common.

But one thing you do want to think about if you, or your parents, or your spouse dies with any sort of affluence, even though they don't owe any estate tax, so they own much less than 11 million dollars today, today's exemption is 11.7 million. You still might want to, if they're married, you may want to file an estate tax return. That's a form 706. And the reason is this portability. 

So what the heck is portability?  Portability means that if one, the first spouse dies, the second spouse can get their lifetime exemption. So spouse one dies in 2021. He or she has this 11.7 million estate tax exemption. They leave everything to the spouse, so they don't even use the estate tax exemption. The surviving spouse can get that 11.7 million from the first spouse if the first spouse's estate files this form 706.

So the form 706 is just going to report, hey you know Joe Smith died in February 2021. He had three million dollars worth of assets. He left it all to his spouse. Check a box the spouse inherits an estate tax exemption. Thirty years from now, spouse two dies. This happened in my own life. My grandparents on my father's side died 40 years, well yeah, about 40 years apart.

So these things happen. Who knows what that three million dollars is going to grow to by the time the next spouse dies, maybe that's 10 years, 15 years. And oh by the way, they're thinking about lowering the estate tax exemption, It's actually in the law right now. I think in 2025 or 2026 it will be lower. But it's only to the upside to leave this estate tax exemption to the surviving spouse. The way you do that though, you can't do that unless the form 706 is timely filed. So just a little thought there.

And then the last slide I’ve got is just when you approach your tax situation. I think more and more people are getting this, but it's just something that people haven't really locked into. There's a real distinction between tax planning and tax preparation and I think some people go to their tax return preparer they say, okay I'm engaging you to prepare my federal and state tax return for 2021 and they expect that they're going to get all this tax planning. Well I actually don't even think that's really that fair to the tax return preparer. 

It's just they're distinct exercises. Preparing one's own tax return should be done correctly but it's not tax planning. And then I  do have a blog post here that actually talks about hey I just did my tax return for 2020. Could I use this as a tool to help facilitate my own tax planning? This little  blog post has some tips and tricks to take out your old tax return and use it as a springboard to do some tax planning.

Carol: Somebody did ask. Discuss distribution strategies from inherited IRAs subject to the 10-year rule. As if you're the person that got the inheritance..

Sean Mullaney: Great question. And let's start with upon death. You want to work with the executor, whoever's running the estate, around properly titling or the financial institution around properly titling an inherited IRA.  Generally speaking, there's a little magic language around it's you know:

 Joe Smith decedent, deceased 12/31/ 2021 IRA for the benefit of beneficiary name.

Don't use that exact language, but there are resources to find that. So you want to get that inherited IRA properly titled as an inherited IRA sooner rather than later. And then you want to think about your distribution strategies, and basically what you need to do is you need to say, all right I have a 10-year spread on this.

What's my income this year? Did I sell a business, do I have a big capital gain, are there things that happened in my life where I'm going to have more or less income this year versus other years in that 10-year window. And by the end of the year, take that right size distribution so that you get the distribution in those 10 years in the right marginal tax brackets. 

So you need to be thinking once you've inherited an IRA with this 10-year rule. You now have a lot more tax analysis to do than most Americans because you’ve got to say, oh I sold a business this year, I had a big capital loss this year, whatever it is and then take the right way. The one thing you don't want to do is just ignore the the issue on a traditional IRA and then in year 10 you’ve got to take all of it because that's going to be a tax time bomb.

Carol: So okay thank you for that and now there are two questions on minimizing taxes that are kind of related so I'm going to read them together. How to minimize taxes on a mostly fixed income stream during retirement and how do you determine a tax efficient order to withdraw assets in retirement.

Sean Mullaney: Yes great questions so on our fixed income in retirement  there's not a whole lot you can do around I'm assuming the fixed incomes like a pension. If that's true there's not a whole lot we can do to minimize tax there. Where we need to then shift our focus is deduction planning. So that could be things like doing a donor advised fund. So that we maximize our itemized deductions in one year and then go back to the standard deduction in later years, as opposed to just only being in the standard deduction every year. So deduction planning.

That person might have a traditional IRA so we might do QCDs and those sorts of things. I will say fixed income is a little bit of a tough one because it's just a little more difficult. The other thing you could do is delay. So it's the extent you can delay your pension. I tend to like that for clients because it does two things. One it buys us some early retirement years where we could do tax planning like Roth conversions. And two, it gives us more longevity insurance on the pension. Now the pension is going to have credit risk so the more you delay your pension the more credit risk you take on. But there is the Pension Benefit Guaranty Corporation that's not going to fully replace your pension. But anyway, that's sort of my thoughts on fixed income.

And then order of operations in terms of retirement distributions. To my mind it depends on when you retire. If you're retiring early I actually like taxable. Just living off the taxable early is something I tend to like because that limits us to interest, dividends, capital gains, from a tax perspective, and then we could do Roth conversions. So we sort of use the taxable accounts in an early retirement as our life raft while we're doing Roth conversions. And then we get you know maybe we spend down those taxable assets and what we do at that point is we've got a lot more in Roths, and then we sort of toggle between Roth and traditional, managing our tax rate. So that I will say this is one of those your mileage may vary. It really depends on your particular circumstances.

I mean it happens and I would say it's going to happen less and less, but it certainly happens that there are plenty of Americans who get to age 56, they're done with work mentally maybe, and oh what do you have? I have 2 million in an IRA or a 401-k and I've got my house and I've got 10,000 in my checking account. well you're basically going to be taking taxable distributions and we could talk about 72-t, we could talk about separation from service at age 55 or after. I mean there are things we can do but you're definitely, your planning landscape is a lot more limited. 

Carol: Okay thank you. Is there a better way to handle estimated income tax payments, instead of just doing 110 percent, especially when there's uneven investment returns which makes planning difficult?

Sean Mullaney: Yeah, so great question. For the year 2021 I'm actually very fond of the 110 percent.. Here's why for retirees. So 110 percent for the uninitiated  is as long as I make equal estimated tax payments at 110%  of last year's tax, so the 2020 tax liability, for 2021. I can win the lottery, no problem. I pay no more. It doesn't matter, I can make all the money in the world in 2021. I make that 110% of 2020 estimated tax payment. I'll have to write a big check in April. No penalties.

I like that for this year. Here's why. Last year, think about it, I've seen this on clients tax returns. Dividends, interest, way, way down. Capital gain distributions way, way down and no RMDs. So we have a lot of taxpayers out there whose income was artificially low in the year 2020. So let's do that 110%  in 2021 and then we write our big check in April of 2022 for 2021.

I will say outside of that you have to go into that 90% safe harbor. And you just have to be a lot more precise because you have to estimate this year's taxable income as opposed to last year's, which I just grabbed off my tax return. So 110% is not, as especially in a low yield environment, where maybe I gave the government a little bit of an interest-free loan. But it's a low-yield environment. It's not that bad of an outcome. 

So for this year I really like the 110%. And then in the future the only alternative is the 90% or if you have W-2 income, you can use your W-2 to get those payments in. Yeah, there's no real magic bullet other than if I can really well estimate my 90%.

Carol: Do you have any suggestions for retirement tax planning software for consumer use?

Sean Mullaney: I actually don't. So a couple things on this piece. And I get it, folks love analytical tools. So I believe projections are sort of a necessary evil of the financial planning world and the tax world. That said, if we're doing the right things we don't need to worry about projections so much.

Let's think about Bill Belichick of  the New England Patriots. Now yes, they have some analytics people predicting behavior and predicting what will happen on third down. But what they're doing is they're doing the right behaviors, the right preparation. You know Bill Belichick's not in his office agonizing over whether the Patriots are going to be 14-3 or 13-4 or 12-5 this year. Do the right things and the projections become a lot less meaningful.

Jim: Okay thank you, okay now we're going to move on to some of the questions that were submitted during the chat. Miriam do you have any from the chat?

Miriam: Yes we have one question from Ben, he said, I have a former employer traditional 401-k, a personal Roth IRA, and also a Simple IRA. Can I  partially convert my traditional 401-k to the Roth IRA..Does the ownership of a separate Simple IRA cause any issue.

Sean Mullaney: So if you're looking to convert a traditional IRA or traditional workplace plan, a 401-k to a Roth IRA it's possible but you're going to have to work with your plan administrator. So one thing you could do is if the plan has a Roth 401-k and allows Roth conversions, which I believe they generally do, it’s probably going to be easier to do an in-plan conversion. 

The other option would be so you couldn’t do an in-plan conversion, you might be able to do a partial, all right 401-k send this to a Roth IRA.  You'd have to look at your plan rules to see if they'll allow a partial withdrawal like that. Depends on your age, depends on their rules. 

The other option would be to roll over the old 401-k into a traditional IRA. Now you want to be careful about that though. If you have employer stock in there, that may not be a good idea if you're relying on the separation from service at age 55 exception. That may not be a good idea, so you want to be careful about that.

That's not just a slam dunk but that could be an option as well and by the way the Simple maybe the other option is convert the Simple IRA to a Roth IRA. Don't do that if the Simple is only two years old or younger, but once that Simple is over two years old, generally speaking you can convert the Simple IRA without a penalty into the Roth IRA.

And to answer the question. No, having a Simple IRA is no impediment to doing a Roth conversion. It's just a little tricky when you have a traditional IRA, traditional 401-k into a separate Roth IRA. That's where it can get a little tricky but maybe an in-plan conversion would be a potential answer there.

Miriam: Two points on that. Could you explain the two years on this Simple for those who may want to know that, and second what about the pro rata with the Simple IRA?

Sean Mullaney: Yep, so couple things on that. So Simple IRASs have this nifty little rule that says if within two years of creation you move it to any other account other than a Simple IRA you pay a 25% penalty. It's just this onerous rule out there. It's a trap for the unwary, so it's just, oh don't like, you know that is, that's just annoying.  Look, if you had the Simple for 10 years don't worry about it, but yeah, so you don't want to be doing Roth conversions out of a Simple if it's under 2 years old. Be careful there. 

And then the other question was the pro rata rule. And the answer there is pro rata rule if you have a Simple IRA you generally don't have non-deductible contributions inside a Simple IRA. So if we had a Simple IRA and only a Simple IRA, no SEP, and no traditional IRA, then there is no pro rata rule. Every dollar you convert or take out is just 100%  taxable.

But let's say we had an old IRA with non-deductible contributions.The Simple IRA would actually attract some of that historic basis. So I'll give you an example. You contributed 10 years, $5,000 a year to a non-deductible IRA. So you have $50,000 in basis in the non-deductible IRA and that's now worth $100,000. And then you have a Simple IRA that's worth $100,000. So $200,000 total. Every dollar that comes out of the Simple IRA, 25 cents of it will be non-taxable under the proratable. 

So I mean this illustrates how complicated this can get but basically if you only have a Simple IRA don't worry about the pro-rata rule it's just all taxable but if you have other traditional IRAs or SEP IRAs the pro-rata rule could come into play generally in a favorable way it'll track some of that old basis and some of the Simple IRA distribution or conversion will be non-taxable.

Miriam: Could you explain in one or two sentences what a Simple IRA is that's not the same as a traditional IRA.?

Sean Mullaney: That's right. Simple IRA is an employer-sponsored plan, self-employed or actual worker, where it's an IRA  that you can defer money into. I believe the limit is $13,000 right now, and then a $3,000 step up, or an additional contribution catch up contribution, if you're 50 years old. So it's a combination. It's almost like a hybrid between a 401-k and a traditional IRA. You need an employer, whether it's self-employment or another employer, and it's $13,000 a year is the, I believe, the current cap. And then $3,000 a year additional catch-up contributions. It's only deductible, no Roth Simples. And it's for small employers where it's just an easy plan to maintain.

Miriam: What are your thoughts about using a non-qualified deferred compensation plan for high income earners, targeting  an early retirement?

Sean Mullaney: Yeah, it can be a really good thing. I mean those things usually have a 10-year payout. Sometimes I think I've seen it with five-year payouts. So the idea is basically what you're doing is you're moving income from a higher earning year to what is hopefully a lower earning year. I mean it's really that. Especially for the early retiree, hopefully that's what you're doing. And generally speaking I think for the very high earners, yeah, why not defer while you're very high earning. I mean you may then come into some not so pleasant surprises with things like premium tax credit.

But it may be-- I mean I've done the analysis--I think premium tax credit is like a 13% or 14% tax. What's coming to mind, if you blow through that, maybe you wouldn't have qualified anyway. And then it's not really a tax. So I have to look at any one particular deferred compensation arrangement and plan. 

The other thing you want to think about is creditor protection. So this is not that big a deal but on the deferred comp sometimes there could be some issues if your employer were to have a credit issue, they get sued for something. Theoretically it depends on the nature of the plan. There are some plans where that could be an issue, where the creditor could actually access it. So you just want to be a little careful with that. Understand what you're getting into, but otherwise they can be good plans.

Miriam: In the tax harvesting example, I guess that you gave Sean, does the $40,000 taxable income include the income from the sales of the stock?

Sean Mullaney: Yeah, that’s a great question. And generally speaking, yes. So it's not like, oh I had no income. I have no interest, no dividends. I'm really retired, oh I’m in the zero percent capital gains bracket, so what  I'm going to do is I'm going to  sell, I'm going to trip a $200,000 capital gain. No, you've got to manage the gain with all your other income. And that's why that is a bit of a governor on it. But look if you're married and $80,000, you’ve got a $10,000 capital gain you're looking to wash away. You know it can be very powerful, but yes it is not a mechanism to be washing away $500,000 worth of gains.

Miriam: Maybe time for one more one more. Any suggestions for a consumer version of tax forecasting software to use to optimize the Roth conversion and other tax planning issues?

Sean Mullaney: Yeah, like I said I don't endorse any particular product in that I think,Ii mean some of it is quite mechanical. I mean literally what you do is you pull out the tax brackets for the year and then you look at are you being the itemized deduction or standard deduction--by the way 90% of Americans are our standard deduction. So that's a great guidepost. And then I just say be a little conservative. The other thing too, is people sort of misunderstand this, it's this is an issue of degree. So what I mean by that is let's say I've got $9,000 left in the 12% tax bracket and I think I have 10 or 12 thousand left, so I do a $10,000 Roth conversion. The first nine is taxed at 12% federal, and then the last one thousand is taxed at 22%.

To my mind that's not that big of a missed--okay I went a little over, some of it got into 22%--by the way I mean this is another thing to keep in mind too, is your future self is never going to be annoyed that you paid a little too much tax on a Roth conversion. Your future self is going to be thrilled that they have a ton of tax-free income to draw on retirement and they are not going to be angry that oh you did some Roth conversions that weren't 100% optimized. You paid a little bit of tax in the 22% bracket. How dare you! 


Slides and chat

The Slides and chat sessions to this presentation are available for download at the following links:

  • The slide presentation: Link
  • Chat from the recorded meeting: Link


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