Half Wrong
John Yeigh | Jan 15, 2019
I WAS SINGLE-TRACK mountain biking with two friends. We had stopped for a rest—which was when I discovered how completely wrong I’d been with most of my financial decisions. We had all recently retired from the same company and were debating when to claim Social Security. One buddy stated that he planned to start at age 70, so he would receive the maximum monthly payment possible. He defended his position by arguing that he was in good health, which could be indicative of a long life, and this strategy is promoted by the majority of financial pundits. The other friend said he was starting Social Security now, at age 62, the earliest possible age. He cited some recent studies—including one from the Social Security Administration—that indicated potentially greater wealth if payments are started early and then invested at a healthy return. On top of that, he noted some pundits are now suggesting that wealthier folks will likely face increased taxation on their Social Security payments in the years ahead. My two friends then looked to me as the de facto referee, asking which of the two approaches I planned. Rather than supporting either strategy, I replied that I planned to split the difference and claim Social Security at 66, assuming no change in overall health. I justified my position by saying that I didn’t have any idea when I would die or what future tax rates would be. One friend promptly retorted, “You’re committing to being half-wrong, no matter what.” We hit the trail for an additional hour of biking. Upon finishing, the conversation returned to financial topics. Our former employer allows retirees to take their pension as lifetime annuity payments, a lump sum payout or some combination thereof. A few retirees favor the company’s annuity option, which is far more…
Read more » Fleeing the Taxman
John Yeigh | Apr 4, 2022
NEW HAMPSHIRE’S STATE motto is “live free or die.” But for my wife and me, the first part might be better expressed as “live tax-free.” We just moved to New Hampshire from Maryland. The move’s main purpose is to be near our kids, enjoy lake and mountain activities, and experience cooler summers. But New Hampshire’s zero tax rate on earned income, pensions and capital gains is a major bonus. Eight states have no tax on personal income, capital gains or pensions: Texas, Florida, Wyoming, Alaska, Washington, Tennessee, South Dakota and Nevada. New Hampshire currently has a 5% tax on interest and dividend income above $2,400 for single individuals and $4,800 for joint filers. It’s scheduled to phase this out over the next four years, so it’ll be gone by 2027. Contrast this with our old home state of Maryland, which has a 5.75% state income tax, plus additional local levies on income. Result: On past Roth conversions, in addition to the federal tax hit, my wife and I have incurred 8.1% in state and local taxes. Most of our life’s savings were accumulated in tax-deferred accounts. Since retiring five years ago, we’ve been aggressively converting these to Roth IRAs to reduce our future tax burden. We hope to continue Roth conversions until our required minimum distributions start in five years, at age 72. That’s also around the time when federal income-tax rates are scheduled to rise, assuming 2017’s tax cuts are allowed to sunset. New Hampshire is also one of five states without a sales tax. Since we don’t buy much stuff, and our new home came furnished, zero sales tax is not a big deal for us. To be sure, New Hampshire has high property taxes. Still, the savings from zero income taxes can outweigh the property tax bite for those…
Read more » Bankrolling Roth
John Yeigh | Feb 21, 2020
IN EIGHT YEARS, my wife and I will be age 72—and we’ll be locked into required minimum distributions from our retirement accounts for the rest of our lives. Nearly all of our savings are in tax-deferred accounts. At that juncture, we’ll also have begun Social Security payments. The upshot: Our tax rate will jump significantly and, thanks to the combination of required minimum distributions (RMDs) and Social Security, our income will easily exceed our expenses. Meanwhile, we have relatively little money in taxable accounts. That means that, each year, we typically have to tap retirement accounts to help cover living expenses. That brings me to our dilemma. For folks with large tax-deferred accounts, a popular strategy to reduce future RMDs is to convert traditional IRAs to Roth IRAs before those RMDs kick in. But for my wife and me, those Roth conversions could trigger a big tax hit, because we also need retirement account distributions to help cover living expenses, and the one-two punch would push us into a higher tax bracket. To avoid that tax hit, we need to either live like paupers for the next eight years—or find some way to generate cash without driving up our taxable income. Our solution: borrowing. This is an aggressive yet potentially smart strategy for folks, like my wife and me, who are under age 72, want to make Roth conversions and know they’ll soon have more income than they need, thanks to RMDs. A loan might also allow retirees to delay the start of Social Security payments, thus capturing the 8% annual increase in benefits. To understand how this might work, let’s say you and your spouse have five years until RMDs begin and, in the interim, you need additional cash to help cover living expenses. You borrow $100,000 against your house, either…
Read more » Securing Lower Taxes
John Yeigh | Jan 5, 2023
THE TWO SECURE ACTS—2019’s and 2022’s—may inadvertently increase the federal and state tax rates on tax-deferred retirement accounts, such as 401(k)s, 403(b)s and IRAs. While well-intentioned, the laws result in required withdrawals being bunched into fewer years—which could push people into higher tax brackets. But there are ways this tax toll might be lightened or avoided, as you’ll see. With tax-deferred accounts, the normal advice is to delay taxable distributions for as long as possible to give more time for investment growth. That rule might need to be ditched. Why? For starters, the two SECURE Acts have raised the age when required minimum distributions (RMDs) must begin—from age 70½ in 2020 to age 72 in 2022, 73 in 2023 and 75 in 2033. Now, consider that the average lifespan of Americans fell during COVID-19. In practice, then, there might be just a decade or so of required withdrawal years before the balance goes to beneficiaries. And that could be quite a taxing event. Widows and widowers, for example, can owe higher taxes than married couples with equivalent incomes. Widows with taxable incomes between roughly $45,000 and $90,000 would pay a 22% top marginal tax rate, versus 12% for a married couple filing a joint return showing similar income. This is the so-called “widow’s tax,” which has been well-documented on HumbleDollar and elsewhere. Similarly, children or grandchildren who inherit might be hitting their peak earning years—and paying taxes at their highest marginal rate. Compounding the problem, 2019’s SECURE Act shortened the distribution period for inherited IRAs to 10 years for most beneficiaries. Previously, distributions could be taken over a beneficiary’s remaining actuarial lifespan—the so-called stretch IRA. If we assume that these heirs take equal annual distributions, they’d need to withdraw roughly 10% a year, instead of the 3% to 5% per…
Read more » Road to Nowhere
John Yeigh | Feb 13, 2022
I’M DEBATING whether my life is better described by Tom Cochrane’s Life Is a Highway or Eddie Rabbitt’s Driving My Life Away. In a recent article, I noted that our family has driven our cars about 1.9 million miles. Since I’m the family’s King of the Road, I’ve been along for at least two-thirds of that ride. I’m also, alas, the king of lost time. The average commuting speed in the Washington, D.C., area—where I live—has been estimated at 24 and 46 mph. Whatever the right number is, the roads here have been described as the nation’s most congested. Let’s split the difference and call it 35 mph. If I take my 1.25 million miles at 35 mph, I’ve been in a car for more than 35,000 hours. That works out to almost 1,500 days, or roughly four years. Four years out of a likely 65-year adult life translates to about 10% of my total waking hours. That’s scary. These estimates don’t count our six years living overseas or time spent in others’ cars. However you run the calculation, this much is clear: A lot of my life has been spent in a car seat. Despite this, I mostly didn’t mind my car time—as long as the car was moving. My long commute allowed us to live in a resort town, plus it gave my wife a shorter ride to work. I enjoyed audiobooks, practiced hundreds of work presentations to the windshield, pondered life’s daily challenges, worked by cell phone, listened to NPR and tuned into my favorite radio stations. My non-commuting car time—to get to family, friends or a vacation—were even less lamented. I’m not alone in my comfort with Washington commuting, despite the congestion. According to a 2019 study by the National Capital Region Transportation Planning Board, “Half of…
Read more » Pocketing Premiums
John Yeigh | Dec 14, 2021
INTEREST RATES HAVE been low for years, with 10-year Treasury notes now yielding some 1.4%. How about dividend-paying stocks instead? Many pay twice what Treasurys currently yield, though obviously with more risk. My strategy: Instead of a classic 60% stock-40% bond mix, I’ve landed at roughly 70% stocks, with another 15% to 25% in individual stocks against which I’ve written call options. By selling call options, I give the buyers the right to purchase the underlying stock from me at a specified price—the so-called strike price—at any time between now and when the options expire. Today, on my dividend stocks, traders might pay a 3% to 5% call premium for an “at-the-money” call option expiring in as little as 60 to 90 days. An at-the-money call option is one that’s sold with a strike price near the current share price, so both the option seller and buyer know there’s a decent chance the option won’t expire worthless. That 3% to 5% premium strikes me as generous for such a short period. Put another way, I’m getting paid a 3% to 5% return to provide traders with the chance to purchase my shares at the current stock price for perhaps the next three months. In the meantime, I should also collect a dividend, increasing my return by another 0.5% to 0.8%. If the stock price is above the strike price on the exercise date, the option’s buyer exercises the option, calling away my shares and paying me the strike price. Since the market has generally been rising, the majority of my call options have been exercised and the stocks called away. Still, I earned the call premium, plus one dividend payment, providing a 4%-plus return over three months or less—not bad on an annualized basis. If a stock rises only slightly…
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John Yeigh is an author, coach and youth sports advocate. His book “Win the Youth Sports Game” was published in 2021. John retired in 2017 from the oil industry, where he negotiated financial details for multi-billion-dollar international projects. Check out his earlier articles. 
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- Tax-free growth when used for qualified education expenses
- High gift-tax contribution limits: $19K per contributor per year (indexed)
- New ability to convert up to $35K into a Roth IRA for the beneficiary
Cons- Relatively complex with penalties and taxes on non-qualified withdrawals
- Limited, state-approved investment options
- Risk of underutilization if the child does not pursue qualifying education
Caveats- Technology and AI could significantly reduce education’s cost structure in the future
- Roth conversions are capped at $35K lifetime
- The 529 must be open 15 years, and contributions must age 5 years before conversion
- Conversions require the beneficiary to have earned income (i.e. they could Roth anyway)
- Annual Roth contribution limits still apply (e.g., $7.5K in 2026), so completing the full $35K conversion would take five years
UGM Custodial Accounts Pros- Brokerage account where up to $2.7K of unearned income can be tax-free each year
- High gift-tax contribution limits: $19K per contributor per year (indexed)
- Broad investment flexibility — stocks, bonds, funds, etc.
- Few restrictions on how funds may be used for the child’s benefit
- Potential for low taxes on capital gains, but subject to marginal “kiddie tax” at parent’s rates until tax-independency or age 24
Cons- Higher income or capital gains could trigger the kiddie tax at the parents’ marginal rate
- Assets count as the child’s for financial-aid purposes
Caveats- Custodians have some ability to spend down the account for legitimate child expenses if the child is a wild-child in the later teen years
Coverdell Accounts Pros- Tax-free growth for qualified education expenses
- More flexible investment choices than most 529 plans
Cons- Low contribution limit: $2K per year plus income limits restrict who can contribute
- Essentially irrelevant today given the expanded options within 529 plans
Trump Accounts Pros- $1K government seed deposit for children born 2025–2028
- Contribution limit of $5K per year in 2026, indexed to inflation
- Parent employers may contribute up to $2.5K per year (also indexed)
- Tax-deferred growth with Roth-conversion opportunities beginning at age 18
- No earned-income requirement for Roth conversions
- Roth conversions are ideal in low-income years starting after age 18 once the child has transitioned to tax-independency of parents or at age 24 when “kiddie taxation” ends. Early tax independence could even be a combined Roth plus student financial-aid strategy
- Potential to convert large account values over several years at relatively low tax rates (potentially marginal 10-12% tax-rates, but averaging less due to the standard deduction).
Cons- Investment options limited to low-cost indexed stock funds (not necessarily a drawback)
- Penalty-free withdrawals must wait until age 59½, but the accounts could be advantageous even including penalties
- Limited custodian control and intervention possibilities if the teen is a wild-child
Caveats- If Roth conversions are not undertaken during the child’s low-income years, a UGMA invested to capture long-term capital gains tax-rates may outperform a Trump Account taxed at ordinary income tax-rates
- Watch this space as future adjustments or eligibility changes are possible
In effect, the 529 is a two-decade college savings program having some complexity and withdrawal limitations; the UGM is a reasonably flexible, 18-30-year college or house downpayment savings program; and the Trump account is a somewhat inflexible, sixty-year retirement accelerator. Resulting Playbook Here is our family’s intended playbook for tax-advantaged accounts in the grandchild's name:- Parents’ retirement account fundings remain their top priority - 401K’s at a minimum up to the match, HSAs with their triple tax advantages, and Roths as long as eligible within income limits.
- A Trump account has already been initiated to secure the free $1K government seed contribution – grows to potentially $2.6K at age 18 after penalties and taxes.
- Limited 529 funding has also been initiated to start the 15-year clock for potential later Roth conversions.
- The family’s next priority is to fund the Trump account which starts at $5K later this year. Maximizing the Roth conversion opportunity will require ~$116K of contributions (at 3% inflation) over 18 years which we grandparents intend to help fund. I estimate the Roth converted Trump account could grow to ~$2 million of tax-free money at age 60 (6% growth) assuming early-age Roth conversions, and the Wall Street Journal projects as much as $3 million (link likely paywalled).
- The subsequent priorities are to start UGM taxable account and 529 account contributions in parallel to perhaps initial levels of about $35K each. This may take our family some years depending upon available resources for contributions.
For the UGM account, a balance of $35K should capture a sizeable chunk of the annual $2.7K tax-free income limit by investing in high-yield income alternatives. For the 529 account, $35K aligns with the Roth conversion limit. On a personal note, we had extremely positive UGM outcomes with our children. We saved taxes for two decades, and each child used the ~$60K balance as down payments on their first house shortly after college. Due to the 529’s withdrawal rigidities and potential technology impacts, we are unlikely to fund the 529 to the max.- We will skip Coverdells as the alternatives offer ample savings opportunity in the child’s name ($200K+).
- Depending upon spare resources available for gifting, we can always reassess future contributions.
That’s our plan, and we’re sticking to it…. until something changes.The reality of Social Security and Medicare- My real life experience.
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