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Investing Blog Roundup: IRS Direct File to Be Made Permanent, Expanded

At the end of April, the IRS announced that their pilot program Direct File went very well by any measure. Now, they’ve announced that the program will be made permanent, and access will be expanded both in terms of available states and tax situations covered.

Without exaggeration, I think this is the best development we’ve seen in the tax world during my entire time in the industry.

Other Recommended Reading

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What Roth Conversions Are Likely (And Unlikely) To Achieve

The topic that I help clients with most often is retirement tax planning. And my approach to that work includes modeling different tax strategies in financial planning software.

When I do that, what I find is that a plan for tax-efficient spending (i.e., which dollars to spend each year in retirement) often has a significant impact on retirement safety. For example, it often has the result of:

  • Reducing the projected probability of portfolio depletion by several percentage points (e.g., from 20% to 14%), while also
  • Pushing back the date at which those depletion scenarios do occur (e.g., so that in the “unlucky” scenarios, the household now runs out of savings in their mid 90s instead of late 80s).

But once you have a tax-efficient spending plan in place, a Roth conversion plan does not usually result in any meaningful improvement to retirement safety. That is, conversions don’t typically improve either of those metrics above by a meaningful amount.

And that has been my experience with a broad range of clients — ranging from super financially secure to more borderline, with varying ages upon retirement, and with a wide variety of portfolio sizes and compositions. And that has been the case using a broad variety of assumptions (e.g. varying assumed lifespans, average investment returns, etc.).

Roth conversions simply do not tend to increase retirement safety.

Why?

This is a simplification, but I often think of Roth conversions as a tool for solving/alleviating two “problems.” (For more on these topics, please see this article: The 4 Effects of Roth Conversions.)

  1. Required minimum distributions (RMDs) from tax-deferred accounts (both during your lifetime and after your death).
  2. The ongoing tax drag that occurs in taxable accounts (i.e., by letting you use taxable dollars to pay the tax on a conversion — thereby effectively using your less-tax-efficient taxable dollars to buy very tax-efficient Roth space).

But neither RMDs nor tax drag in taxable accounts is on the list of “stuff that’s likely to cause portfolio depletion in retirement.”

RMDs simply do not cause people to go broke. (In fact, RMDs are often recommended as a strategy for spending from a portfolio.)

And in unlucky retirement scenarios (e.g., poor investment returns early in retirement or a major spending shock early in retirement), the problem of tax drag in the taxable account typically solves itself, because the taxable account usually gets spent down pretty quickly in those scenarios anyway.

So Why Bother with Roth Conversions?

Given the above, you might ask why a person would bother with Roth conversions. The answer is that, in cases in which Roth conversions are suitable (which, for many but not all households, is in the years after retiring but before collecting Social Security and before RMDs kick in), they provide a significant increase in the the after-tax bequest that is likely to be left to heirs. (Again, please see this article for a discussion of the mechanics.)

In other words, a well-crafted Roth conversion plan typically:

  1. Does not make the unlucky outcomes significantly better or worse and
  2. Makes the lucky outcomes significantly better.

When I say “a well-crafted Roth conversion plan,” what I mean is a plan that carefully considers whether conversions should be done each year, and if so, to what threshold. Roth conversions are not suitable for everybody. For instance, households with large charitable intent are much less likely to benefit from conversions, because they can use qualified charitable distributions to satisfy RMDs and because the after-death tax rate on their tax-deferred accounts will be 0% to the extent the balances are left to charity.

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Can I Retire Cover

Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less

Topics Covered in the Book:
  • How to calculate how much you’ll need saved before you can retire,
  • How to minimize the risk of outliving your money,
  • How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"Hands down the best overview of what it takes to truly retire that I've ever read. In jargon free English, this gem of a book nails the key issues."

Investing Blog Roundup: 2024 Bogleheads Conference Registration Open

Quick housekeeping note: I’m on vacation for the next couple of weeks. The regular posting schedule will resume in June.

I’m excited to announce that registration for the 2024 Bogleheads Conference is now open!

In addition to all of the regulars, as well as many first time speakers I’m excited to hear from, I think it’s especially noteworthy that the lineup includes:

  • William Bengen (who did the original study that resulted in the “4% rule”),
  • Jonathan Guyton (known for his research on the “guardrails” approach to retirement spending), and
  • Karsten Jeske (who has written no fewer than 60 articles on the topic of spending from a portfolio).

I can’t wait to see a discussion between them about retirement spending.

You can find more information (and register) here:

Other Recommended Reading

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Avoiding Miscommunications with the SSA

Over the ~13 years that I’ve been dealing with Social Security frequently, I’ve encountered hundreds of cases of critical miscommunications between the SSA and somebody contacting the SSA to apply for benefits or ask questions about their benefits. When I say “critical miscommunication,” I’m talking about cases in which the result is the person making a poor decision based on the resulting misunderstanding, cases in which the person completely misses out on benefits they could have received, or cases in which the result is a tremendous amount of administrative hassle in order to get the situation fixed.

There are, broadly speaking, two things you can do when interacting with the SSA to minimize the likelihood of such miscommunications:

  1. When applying for benefits, apply online (except for survivor benefits, for which you can’t file online).
  2. Be very careful about terminology (both yours and theirs).

Apply Online

In my entire time dealing with Social Security issues, I’ve never had any direct personal experience of an online application going wrong. I’ve encountered one story on the Bogleheads forum of such. In contrast, I don’t know how many people I’ve interacted with over the years who had a phone or in-person application not go according to plan. At least a hundred, I’m sure.

And really this shouldn’t be that surprising. Humans make mistakes. Computers, less so.

So, when applying for retirement or spousal benefits, please, apply online. And help your loved ones apply online.

Unfortunately, you cannot apply for survivor benefits online. You’ll have to make an appointment to apply over the phone or in person.

Exercise Caution with Terminology

Any time you’re dealing with anybody at the SSA, it’s important to be very careful with the terminology you use and pay careful attention to the terminology they are using.

I’ve encountered a lot of situations that followed a pattern like this:

  • Bob has a question about Social Security. Let’s call it Question A.
  • Bob visits his local SSA office.
  • Bob meets with an SSA employee and asks the employee his question. Unfortunately, Bob uses the wrong terminology and accidentally asks Question B instead, without realizing the distinction.
  • The SSA employee answers Question B.
  • Now Bob thinks that the answer to Question B is the answer to Question A.

Oops.

With something as complex as Social Security, there are infinite possible miscommunications and misunderstandings. But there are a handful that come up quite a lot.

Eligible vs. Entitled

You are eligible for a given type of benefit once you meet the requirements for that type of benefit but you have not yet filed for it. You are entitled once you are eligible for the benefit and have filed for it.

Example miscommunication: Bob asks, “Once I’m 62 and entitled to a retirement benefit, can I put off filing for my spousal benefit, or do I have to file for that immediately?” In Bob’s mind, in the example scenario he had not yet filed for his retirement benefit. He should have said eligible rather than entitled. If the SSA employee simply answers the question as stated (rather than trying to suss out what Bob might have meant to say), they will answer the question assuming that, in the scenario given, Bob has already filed for his retirement benefit, which can change the answer.

Monthly Benefit vs. Primary Insurance Amount (PIA)

Another common source of miscommunication is the distinction between a monthly benefit amount and a primary insurance amount. Your PIA is the monthly retirement benefit you would receive if you file for it exactly at your full retirement age. Your actual monthly benefit could be more or less than your PIA, depending on the age at which you file as well as various other factors (e.g., the earnings test).

Example miscommunication: Julie asks, “After I file for my retirement benefit at age 70 and Jimmy files for his benefit as my spouse, what will his total monthly benefit be?” The SSA employee responds, “Half of your primary insurance amount.” If Julie doesn’t recognize the distinction between her monthly benefit and her PIA, she may think that Jimmy is going to get half of her monthly benefit, when in reality he’ll receive less than that.

Spousal Benefits vs. Survivor Benefits

Spousal benefits (a.k.a. husband/wife benefits) are only applicable while both spouses are still living. Survivor benefits (a.k.a. surviving spouse benefits or widow/widower benefits) become relevant after one spouse’s death.

Example miscommunication: Samantha is the higher earner in her marriage, and she’s trying to understand how her filing date could affect the amount her spouse could receive as a survivor benefit later, if applicable. She asks, “If I wait until age 70, does that increase the amount that Neil can receive as my spouse?” The SSA employee responds, “No, his benefit as your spouse does not depend on the age at which you file for your retirement benefit.” That’s true. But his benefit as her survivor (if applicable) would depend on the age at which she filed for her retirement benefit.

You Never “Switch from” a Retirement Benefit to a Spousal or Survivor Benefit

Another common source of miscommunications is the misconception that you “switch to” a spousal or survivor benefit after having received your own retirement benefit earlier. That never happens. You keep receiving your own retirement benefit, and you receive a spousal or survivor benefit in addition to the retirement benefit.

Example miscommunication: Frank’s PIA is $2,000. His spouse Betty’s PIA is $600. Betty is several years older than Frank. She files for her own retirement benefit at her full retirement age, and she asks what her spousal benefit will be after Frank files for his retirement benefit. The SSA employee replies, correctly, that it will be $400. Frank and Betty might misunderstand this to mean that Betty will only get her own $600 retirement benefit (i.e., the greater of the two amounts) or that her monthly benefit will even decrease to $400. In reality, she will get her $600 retirement benefit, plus her $400 spousal benefit, for a total monthly benefit of $1,000 (i.e., 50% of Frank’s PIA).

Do Not Use the Verb “Retire”

For some reason, the SSA often refers to filing for a retirement benefit as “retiring.” This is not a part of SSA technical jargon, but it is something that appears in various publications of theirs, and it’s the way that many SSA employees speak. (In other words, this is a case of the SSA being lazy/imprecise with their own wording, which frankly I find inexcusable given how complicated this stuff is even when we communicate with perfect precision.)

If you are providing a hypothetical scenario and you mean to say that you’ll stop work at, for example, age 64, use those words: “stop work at age 64.” If you say “retire at age 64” the SSA employee might think you mean “apply for retirement benefits at age 64.”

Avoiding Miscommunications and Mistakes

So, again, apply online (when possible), be careful with your wording, and pay close attention to the exact wording that the SSA employee is using.

I’ll also point out that, while this exercise of caution does become more difficult as more complicating factors come up (e.g., benefit calculations when WEP/GPO are involved), it also becomes even more critical. So take your time.

I think it’s often a good idea to put your question on paper. That way you can plan it out thoroughly beforehand, you won’t forget to state anything important, and (if it’s an in-person appointment) the SSA employee you meet with can read it and reread it as necessary.

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Social Security cover Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less
Topics Covered in the Book:
  • How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
  • How to decide the best age to claim your benefit,
  • How Social Security benefits are taxed and how that affects tax planning,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."

Investing Blog Roundup: IRS Direct File Pilot Program Results

For as long as I’ve been in the tax field (and probably longer, though I wasn’t aware of it), people have been saying that the IRS should create some easy, free way for people to file their tax returns online. And with the agency’s improved funding from the Inflation Reduction Act, the IRS has finally been working on doing exactly that.

This year the IRS ran a “Direct File” pilot program, available in just twelve states and available only to people with straightforward tax situations. Obviously that’s just a start toward what’s needed, but everything I’ve heard indicates that the program went very well. Of people who used the program and completed the survey afterward, 90% indicated that their experience with Direct File was “Excellent” or “Above Average.” And 86% said that their experience with Direct File increased their trust in the IRS.

Other Recommended Reading

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Should a Retiree Continue to Pay Their Life Insurance Premium?

A general principle in financial planning is that if nobody would be financially in trouble if you were to die tomorrow, you don’t need life insurance. The most common example of this principle is that an unmarried person with no children probably does not need life insurance.

A less discussed but still very common application of this principle is that, after you have retired (or reached financial independence), you probably do not need life insurance anymore. (I say “probably” because one noteworthy exception is that if you have a pension/annuity with a small (or no) survivor benefit, you might still need life insurance to support your spouse after your death.)

But once nobody other than you is dependent upon your income, you no longer need life insurance.

But that doesn’t necessarily mean you should let an existing life insurance policy lapse.

If your own retirement security would be meaningfully improved by no longer paying the premium, then you should probably let it lapse. Why put your own well-being at risk, simply to pay for a policy that’s no longer needed?

But if your own retirement security is not really at risk at all (i.e., your assets and other sources of income, relative to your desired level of spending, are such that you’re extremely unlikely to run out of money during retirement), it often makes sense to keep paying the premiums.

In general, if you reach a point where your own retirement security isn’t at risk, then the impacts of the various financial decisions you make will primarily be felt by your heirs rather than yourself. The metric of interest is no longer “probability of portfolio depletion” (or other similar metrics) but rather “after-tax expected bequest” (or other giving/bequest-related metrics).

And when measured in that way, continuing to pay the premium on an unneeded life insurance policy can still look pretty good, in many cases.

Let’s Look at an Example

Bob is a 50 year old male who has never smoked. He’s in good health. Based on a quote from term4sale.com, Bob could buy a $1 million 15-year level premium term policy for a premium of $1,175 per year.

If we use the most recent (2017) CSO non-smoker super preferred mortality table, Bob has just a 0.18% chance of dying this year. This tells us that the probability-weighted payout for the policy this year (i.e., the “expected value”) is $1,000,000 x 0.0018 = $1,800. Right from the start, that’s more than the $1,175 annual premium.

Granted, Bob’s chance of dying in a given year is probably not exactly the same as the probability shown in any given mortality table. But we’re already looking at a table that reflects longer than average life expectancies. And with an $1,800 expected value for this year and a $1,175 annual premium, Bob’s chance of dying would have to be much lower (about 35% lower) than that shown in the table in order for the policy to be a “bad” deal.

And the policy only becomes a better deal each year, because the premium stays the same while Bob’s chance of dying grows as he ages.

For instance, let’s imagine that by age 60, Bob is financially independent and no longer needs the insurance. His premium will still be $1,175 each year for the last 5 years of the policy, if he chooses to pay it. If we again use the same mortality table:

  • Bob’s chance of dying between age 60 and 61 is ~0.36%. (Expected value of $3,610.)
  • From age 61 to 62 it’s ~0.40%. (Expected value of $4,010.)
  • From 62 to 63 it’s ~0.45%. (Expected value of $4,470.)
  • From 63-64 it’s ~0.50%. (Expected value of $4,980.)
  • And in the last year of the policy, from 64-64, it’s ~0.55%. (Expected value of $5,540.)

Those values are way above the $1,175 annual premium.

If paying the $1,175 premium would put Bob’s financial well-being at risk in any way, he should let the policy lapse. But if 1) he can comfortably afford to pay the premium and 2) he has even a modest degree of bequest motive, he should keep paying that premium.

A level premium term policy that you have already held for some years is kind of like a lottery ticket in that it offers a high probability of no payout, with a low probability of a high payout — but the critical difference is that in this case the odds are often weighted in your favor. The expected value each year can be quite a bit more than the premium being paid, whereas with a lottery ticket the expected value is generally considerably less than the cost of the ticket.

Another point in favor of continuing to pay the premium is that the death benefit is not taxable as income to the beneficiary. And, if estate taxes are a concern at all, if the policy is owned by an irrevocable trust, it may be excluded from your gross estate as well.

What Comes After Financial Independence?

Among people who read personal finance books, many save a high percentage of their income through most of their careers. One thing that eventually happens for some such people is that they reach a point at which they realize they have not only saved "enough," they have saved "more than enough." Their desired standard of living in retirement is well secured, and it’s likely that a major part of the portfolio is eventually going to be left to loved ones and/or charity. And that realization raises a whole list of new questions and concerns.

This book’s goal is to help you answer those questions.

More than Enough: A Brief Guide to the Questions That Arise After Realizing You Have More Than You Need

Topics Covered in the Book:
  • Impactful charitable giving
  • Talking with your kids or other heirs
  • Qualified charitable distributions
  • Deduction bunching
  • Donor-advised funds
  • Trusts
  • Click here to see the full list.
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