THE BEST (AND WORST) GIFTS THE GOVERNMENT HAS EVER GIVEN YOU
Ah Christmas. The most wonderful time of the year. Tomorrow morning kids all of the world will wake up to be surprised and delighted at the gifts that have been left for them under the Christmas Tree. Gift giving has become synonymous with the Holiday Season, and most of us look forward to both giving and receiving gifts. It can be fun to look back and remember some of your favorite gifts. Maybe it was a bicycle or, if you’re really lucky, a car. It can be equally fun to look back and have a laugh at some of the truly terrible gifts we have been given.
Today I wanted to have some fun with the concept of gift giving. Throughout the years, congress, and the IRS has given out plenty of gifts for us taxpayers. Some of them wonderful, and some of them terrible. I wanted to take a look at some of the best gifts the government has every given you, and some of the worst.
The Best
The Roth IRA
I didn’t want to dance around today, so I thought I would come right out with what is in my opinion, the greatest gift the government has ever given you. If you are not familiar with a Roth IRA, you need to be. They are specially designed retirement savings accounts, that allow your savings to grow tax free forever. Let me repeat that part. Tax free forever. The value of these accounts gets greater and greater the younger you are when you start using it. It is no stretch to say that someone starting investing in their mid-twenties will be able to amass over one million dollars, and only have paid taxes on about $100,000. That’s $900,000 that taxes were never paid on. It’s just simply incredible.
Sometimes I actually have to step back and marvel at just how short sighted the government was when they created these accounts. They are so desperate to get tax revenue NOW, that they are willing to let go of potentially thousands more dollars if they would have waited to collect. I also marvel at how many people do not take advantage of the government’s short sightedness. Roth IRAs are available to everyone, regardless of your income, though you may have to jump through a few hoops as illustrated in the next gift.
Backdoor Roth IRAs
Many people get excited about the prospects of opening a Roth IRA, only to find out that their income is above the threshold that will allow them to contribute. If it was the intention of congress to prevent high earners from using these accounts, they did a terrible job of it. They Left the back door open.
In order to get money into a Roth IRA when your income exceeds the limits, you must first contribute money into a traditional IRA, then (and this is the key) DO NOT deduct the contribution on your taxes. Once the funds are in the traditional IRA you can convert them to a Roth IRA by paying the taxes due. BUT, because you never deducted the contribution, the taxes have already been paid, so you will owe nothing upon making the conversion. Essentially this is the government forcing you to jump through a couple of hoops in order to make a Roth contribution. Is it silly? Yes. Is it archaic? Yes. It it worth it? Absolutely.
Roth Conversions
While we are on the subject, let us not forget that Roth conversions are a gift in and of themselves. The ability to move large chunks of money from your 401k to a Roth IRA allows for incredibly valuable tax planning opportunities that can save you hundreds of thousands of dollars over the course of your lifetime. If you work with a financial advisor, and they have never discussed this idea with you, click here to find a new one.
Qualified Charitable Distributions
If you have a 401k or a traditional IRA, you are probably aware that upon turning 72, you will be forced to start taking mandatory withdrawals from your accounts. Why? Because the IRS has decided that they have waited long enough to collect taxes on that money, and they would like it now. There is however a way to avoid paying the taxes on those withdrawals, provided you are a charitable person.
The QCD, or qualified charitable distribution, allows you to donate funds directly from your IRA or 401k to a qualified charity, and claim it as an above the line deduction. That means that even if you are claiming a standard deduction for the year, you can add your QCD to that amount to get your total deductions.
Now, to be clear here, if you had no plans to give away any money, and you don’t really want to, then a QCD will not help you. Giving away money just to avoid taxes is not a winning game in the end. If however, you are someone who already donates to charity, doing it this way can end up saving you a substantial amount on your tax bill.
The Standard Deduction
Love him or hate him, Donald Trump’s Tax Cuts and Jobs Act did one good thing for most people in that it substantially boosted the standard deduction. While that alone, was a great thing for many people, the real value in this lies in how it can be used to your advantage by employing a tax strategy of bunching or lumping deductions. The basic idea in this concept is to be strategic in timing of certain activities to try and maximize your deductions in a single year. This is a fairly involved tax planning concept. It is also another item on the list of things your financial advisor needs to be talking to you about.
The 529 Account
College is expensive. That may be one of the least enlightening things you’ll hear all day. While the news is currently abuzz with talk about loan forgiveness, payment deferrals, and loan cancellation, let us not forget about the college savings account known as a 529. I could go on and on about why student loans are rarely worth it, and how students should do everything they can to avoid taking on debt. One of the best ways to avoid debt is to save early and often for college expenses. To facilitate that, the government signed into law what are known as 529 accounts. The best way to think of these accounts, is that they are Roth IRA’s but meant specifically for school. As long as the funds are used to pay for educational expenses, then the growth is tax free. If you have young kids, I highly recommend getting one of these started. If you need help doing that, click here.
I Bonds
So far, everything we have talked about has been related to the tax code. Now we will shift to good old-fashioned savings bonds. Not just any savings bonds though. I am talking specifically of I Bonds. What makes these so appealing right now is that the I in I bonds stands for inflation. Meaning that, part of the way the interest rate on these is determined, is by the rate of inflation. As of right December 2021, that rate is 7.12%. Find me anywhere else that you can get a 7.12% fully guaranteed rate.
The Worst
Social Security
I am probably not going to be telling you anything new, when I tell you that social security is a hot mess. What might surprise you is that when I say that, I don’t mean it in the way most people do. Most people say that referring to the fact that it is running out of money, and we don’t know if it will even be around. I am talking about the fact, that even if the system works, it is an absolutely horrendous system.
Rather than bore you with calculating the rate of return on your investment, I thought I would just put into real terms. If you were given the option to stop paying social security, with the conditions that the government could keep all of the money you have ever put in, and never give you a cent in benefits. It would be in your favor to take that deal all the way until you are 44 years old. If you are in your twenties, that may not seem that crazy. But that math is actually suggesting that you would be best off to let them have 25 years of contributions, for free, if it allowed you to simply get out of the system.
Quite frankly, Social Security is the largest Ponzi Scheme ever orchestrated. And we are all forced to do it. Unless you are a clergyman. They can opt out.
The 401K
Now, this one need some explaining. The 401k is not a bad thing. A large 401k account with no plan for the future taxes, is the bad thing. Make sure that as your account grows you are working with your financial advisor to put together a plan for how to deal with the impending tax bill that is coming.
Self-Employment Tax
If you are a w-2 employee, you probably get frustrated seeing FICA taxes taken out of every paycheck. Did you know that if you decide to start your own business that will actually be doubled? Your employer is currently paying half of your FICA taxes. But of course, if you are your own employer, well you can see how that works. If you are a self-employed individual make sure to talk with a tax pro about paying your taxes as an s corp. It can save you thousands in those FICA taxes.
The Estate Tax Exclusion
A married couple in the United States can currently pass on a little more than 11 million dollars to their heirs with no taxes being due. Why am I suggesting that that is a bad thing? Because the amount of people that is helping is so miniscule compared to the amount of people that could be helped by taxing a higher amount of those inheritances and redistributing the wealth.
Student Loans
Someone will hate me for this, but I have to ask, which came first, the chicken or the egg? What I mean by that is, did student loans balloon because college got more expensive, or did college get more expensive because student loans became so easy to get. If you want my opinion, as someone who despises the practice of student loans, I will argue that the latter is true. Access to easy money allowed more students, with more dollars, to chase a limited supply of college access. That is the textbook recipe for inflation. I think that the government created the beast when they first came out with student loans, and they are what enabled the costs of education to spiral out of control.
Thank you for letting me rant. Merry Christmas!