INCOME SHOULD BE ONE of the simplest concepts in financial planning—and yet it turns out to be one of the most confusing, thanks to the multiple ways it’s calculated depending upon whether it applies to income taxes, Social Security and so on. My goal today: Help you sort out income’s shifting definition across the U.S. tax code.
Gross income. This is the granddaddy—income from all sources, before almost any taxes or deductions.
I BEGAN TRYING TO figure out the laws related to retirement and employee benefits after the enactment of ERISA in 1974. I spent endless hours over many years in lawyers’ offices in Washington, D.C., as each new law or regulation came along.
TEFRA, DEFRA and COBRA are but a few of the many laws that now confound Americans. I bet most people think COBRA was only about health insurance. In fact, it’s the Consolidated Omnibus Budget Reconciliation Act.
WHEN I FIRST LOOKED at the issue of portfolio withdrawals more than two decades ago, many financial experts suggested retirees follow a simple strategy: spend taxable account money first, traditional retirement accounts next and Roth accounts last. That way, you’d squeeze more years of tax-deferred growth out of your traditional retirement accounts, and even more out of your tax-free Roth.
If only things were so simple today.
Why have portfolio withdrawals become more complicated?
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.
I HAVE A CONUNDRUM: In 2023, I’ll have ample opportunities for tax-free growth—but probably not enough cash to take advantage.
It doesn’t get much better than tax-free, right? I remember the excitement when Roth IRAs came into being, thanks to 1997’s Taxpayer Relief Act. But today, the Roth is just the tip of the tax-free iceberg. Indeed, for 2023, I’m eyeing four tax-free accounts.
I want to fund a health savings account and my solo Roth 401(k),
IT’S EASY TO GET overwhelmed by the number of documents we receive over our lifetime. Paper copies take up space, and even electronic records necessitate computer storage. Either type requires a certain amount of time spent organizing.
The sheer volume makes the question of how long to retain records a perennial topic for newspapers, social media and podcasts. For instance, many folks have heard the advice that they should retain all documentation for seven years after they file their taxes.
WHEN JANET YELLEN was nominated to be Secretary of the Treasury, the Senate Finance Committee staff went over her tax returns with a magnifying glass. Yellen, an economics PhD who taught at Harvard, always prepared the returns for herself and her husband, economics Nobel laureate George A. Akerlof.
“She discovered to her surprise that she had been doing the family taxes wrong for years,” reports Owen Ullmann in his excellent new biography of Yellen,
I EXPECT TO OWE some $8,000 to the IRS on April 15. On the surface, this might seem like poor tax planning. But I’d argue that it’s just the opposite.
Too often, folks are excited to get a large refund when they file their annual tax return. In response, you’ll hear financial advisors jumping in and saying, “That’s bad. You gave the IRS an interest-free loan.”
In theory, I agree. But until recently, savings accounts have been paying so little that it wasn’t worth the effort for folks to manage their tax liability that closely.
THE HOLIDAY SEASON is upon us. Our thoughts—or mine at least—turn to family, friends, wine, decorations, gifts, wine, food, fun and wine. But before I ring in the new year, I have a few financial questions I need to resolve.
Our 2022 income hasn’t been what I expected. I earn consulting income in two ways. I’m a part-time employee of a small engineering consulting firm. In this role, I’m an hourly employee with no benefits.
MUTUAL FUNDS ARE about to send their shareholders some dubious holiday gifts—in the guise of capital gains distributions. These distributions usually occur mid-December and they represent a taxable event for investors who hold funds in a taxable account.
Even in a down year for stocks and bonds, a mutual fund may realize capital gains, which are then passed on to shareholders. These could come as a nasty surprise to investors already smarting from 2022’s steep losses.
WHEN ROSS PEROT RAN for president in 1992, a pillar of his campaign was tax reform. Federal tax rules, he pointed out, had grown to more than 80,000 pages. His proposal: Start over and replace everything with a simple flat tax.
Perot’s campaign for tax reform didn’t make much progress, but many can sympathize with his frustration. Because of the complexity of tax rules, financial planning often ends up feeling like the children’s game Operation—with penalties for even the slightest misstep and confusion around every corner.
YOU KNOW IT’S BEEN a rotten year for investors when it’s time to brush up on the rules for tax-loss harvesting. It’s one way to turn negative returns to your advantage, provided you act before year-end.
If you have taxable investments that have lost value this year—and who doesn’t? —the basic idea is to sell them in 2022 to lower the taxes you owe. Realized losses can be used to offset any investment gains you’ve realized this year.
WITH THE FINANCIAL markets down sharply, this is a great time to fund a Roth IRA, with its promise of tax-free growth. But the rules can be tricky.
The basics: You place part of your after-tax earned income in a Roth, invest it and—ideally—just leave it to grow. As long as the money stays there until you reach age 59½, and you wait at least five years, you can tap the account without owing a dime in taxes.
MY WIFE SARAH AND I recently dusted off our old Scrabble board. We reviewed the rules and were reminded of the Scrabble Bingo—the 50-point bonus awarded to a player who figures out how to play every letter tile from the tray on a single turn.
Neither of us could remember ever achieving the Scrabble Bingo. That wasn’t surprising, we reasoned, because it’s rare for all the stars to align. You’d need the right combination of seven letters,
EXCHANGE-TRADED funds are popular, but their complex structure makes them difficult to understand. A question I hear frequently: Are exchange-traded funds (ETFs) more tax-efficient than traditional mutual funds?
The evidence suggests they are. One recent study found that ETFs distribute capital gains to shareholders much less frequently than traditional mutual funds and, when they do, those gains are smaller. It’s worth understanding why that’s the case.
Let’s first look at the mechanics of a traditional mutual fund.
