Retirement Savings: Roth or Traditional? (Part 1) – Getting Started

Now that Tax Day has come and gone, let’s discuss planning for 2023 taxes. In Comprehensive Personal Financial Planning (as routinely takes place at Van Wie Financial), there are constant trade-offs, such as between current income and retirement savings, taxes paid now vs. taxes paid in retirement, prestigious colleges vs. practical schooling, and the list goes on. Because the future is unknowable, we have to make decisions based on circumstances.

Statistically, younger people earn less money that do their parents and older co-workers. For a majority of these young workers, the Roth-style Retirement Account (tax paid now, but not in retirement) is most suitable, due to their low Marginal Tax Rate (the percentage paid on the next dollar earned). As incomes rise over time, many will shift into Traditional (deductible from current income) Retirement Accounts, on which taxes will be due in retirement.

Problematic among these young savers is gaining access to qualified professional advice. For those who decide to pursue a relationship with a financial professional, many seek help first from insurance salespeople masquerading as financial planners. Often, this proves to be a costly mistake.

Certain high-earning younger people, such as medical professionals, technology experts, and other highly educated career people, can justify a long-term professional planning relationship that assumes a strong probability of steady growth in assets. Those in less lucrative positions are not beyond receiving assistance, but should utilize differing helpful opportunities.

Younger people can learn about money, investing, insurance, taxes, and multiple other financial topics, by using today’s wealth (pun intended) of free resources. For our part, Van Wie Financial (VWF) contributes to the body of free knowledge in several ways. First is the Van Wie Financial Hour, broadcast live every Saturday morning at 10:00 on WBOB radio, 600AM and 101.1FM. Questions for our firm can be asked while we are live on-air, and may also be submitted through our website email address. Once completed, our radio shows are podcast and distributed wherever podcasts are made available, and are always free.

Additional free VWF Resources include those on our website, strivuswealth.com, where information is made available to the public on a variety of topics, and Blog posts are added weekly. Topics range from A to Z, financially speaking, and are each short enough for a brief, but educational, read.

Next week we will discuss the dilemma posed by saving for retirement now vs. spending on the many priorities experienced by young taxpayers.

Van Wie Financial is fee-only. For a reason.

Our current Vice President is known for her “sincere” opinions and annoying speaking style. A recurring theme is her love of, and for, a big yellow school bus. Many of us have fond memories of yellow school bus rides, such as attending out-of-town football games on an autumn evening. But most of us are not prone to episodes of giddiness when the subject arises.

“Climate Change” proposals receive equivalent “sincere” treatment from the Vice President. Now the two topics are being interwoven, as Americans are being required to pony up for Big Yellow School Bus EVs (Electric Vehicles), and the results are (predictably) awful. Following are a few stories from recent media articles and newscasts. See if you can detect an underlying theme.

In Connecticut, an electric school bus burst into flames in a parking lot, causing the school district to employ diesel buses to assure students a safe ride to and from their schools. New electric buses now utilize specialized (and expensive) fire detection systems to alert bus drivers when immediate evacuation is required. Once a fire starts, it is difficult to impossible to stop the burning if the fire reaches the battery, as each cell contains its own fuel supply.

In Michigan, The Administration spent a Billion Dollars (9 zeroes) to electrify the Ann Arbor School District bus fleet. Each bus is about 5 times the cost of a traditional diesel bus, and they have suffered performance problems.

While there are many stories of burning EVs, including cars and busses, perhaps the greatest story of government gone “green crazy” is from the thriving metropolis of Wrangell, Alaska. The Biden Administration awarded the Wrangell School District (3 schools total) an electric school bus, but their private bus company was mandated to destroy a working bus to make way for the Big Yellow Battery-Powered Boondoggle.

The bus company did not agree that it would be in their best interests to destroy a working people hauler. So, the School District itself got permission to purchase a used bus, in order to destroy it and get the “free” EV bus. The EPA mandated several requirements, including that it must be an in-service, working, diesel bus, and it had to be made inoperable forever in an approved fashion. Working model used busses cost about $10,000.

Does anyone remember the 2009 Obama-era “Cash for Clunkers” idiocy, in which the government incentivized trading in working older cars for newer, energy-efficient models? Like the Wrangell bus, the “Clunkers” had to be rendered forever inoperable, destined for landfills. The net result was a spike in prices for used cars, rendering many people unable to trade up. Hey, government, STOP HELPING!

And, BTW, how does all that electricity get generated in the first place?

Van Wie Financial is fee-only. For a reason.

In last week’s Blog, we explained potential tax problems arising from the purchase of certain assets in an IRA, only to find out that IRS has disallowed ownership in that form. One recent example involved the purchase of a Non-Fungible Token (NFT), which we explained in some detail. When an asset such as this is disallowed in IRAs, the purchase price of the disallowed asset becomes immediately taxable to the IRA owner. Should the asset have decreased in value, even if it becomes worthless, there is no relief granted to the taxpayer.

Other scenarios sometimes produce an even harsher result for the taxpayer, as IRS could declare the entire IRA invalid, with the entire account becoming immediately taxable as ordinary income. These events generally invoke the concept of prohibited self-dealing, often resulting from the purchase of real estate in an IRA. While not disallowed, IRA ownership of real estate must be and must remain, a totally arm’s length transaction. No interaction between the IRA real estate and the IRA owner is permissible. Generally, the IRA must be in the hands of a specialized Custodian, and costs are considerable.

Logically, this suggests a discussion of the definition of an arm’s length real estate transaction. Rules are actually quite simple—every facet of ownership and maintenance of the property while owned in the IRA must be handled only with IRA funds. The IRA owner is barred from using the property, performing repairs, maintenance, upgrades, or even cleaning. Any breach of this rule results in 100% of that IRA’s assets becoming immediately taxable as ordinary income.

Should the IRA real estate require funds beyond those available within the IRA, only qualified contributions and rollovers into the IRA may be used to satisfy the need. Injecting cash into the IRA above those limits constitutes self-dealing, and voids the tax-deferred status of the entire IRA. The resulting tax bill may necessitate the sale of the property to generate cash.

Another potential problem involves ownership of precious metals in IRAs, primarily gold and silver, due to their ready availability. Unfortunately, there are less than scrupulous salespeople everywhere, looking for a “one-up” on the competition. Some of these have adopted the pitch that you, too, can hold the shiny objects in your hand. That part is true until the sales pitch gets extended to the “ Gold IRA at home” fantasy, claiming that you can store your IRA gold in your home. As of this writing, we can find no valid exception to the IRS prohibition against storing precious metals IRA investments at home. In our opinion, based on plentiful research, anyone participating in the “at home” program is flirting with trouble. Learn more at Investopedia.com.

Protect your IRA funds. We can help you with the rules.

Van Wie Financial is fee-only. For a reason.

Move over Crypto Currency, there is a new, even harder to understand, “investment” in town. The Non-Fungible Token, or NFT, is even more ethereal than fake money residing in something called a “digital wallet” on a device that is part of a technology called “Block Chain.” Is Crypto actually currency? Not according to the IRS, as they consider it property. This “Seasoned Citizen” will keep my money in a form considered Legal Tender, in a wallet made of leather, until I remove some of it to pay for such frivolous items and food and gasoline.

While I’m not at all sure that I will ever truly understand the concept of the NFT (much less Crypto Currency), I’ll try to break it down and see where that leads. First, what is a Token? According to dictionary.com, a token is something that represents something else, which can be an object, a feeling, or a fact, or it can serve as evidence or proof of ownership.

IRS defines Collectibles to include works of art, antiques, precious metals (with some exceptions), stamps, coins, alcoholic beverages, and other intangibles, as the IRS alone determines. These items have their own rules for taxation and increasingly are not allowed to be held in IRAs. Increasingly, NFTs that are linked to Collectibles are being disallowed, creating an expensive problem for the IRA owner. When an IRA asset is disallowed, the purchase price of that asset becomes immediately taxable as ordinary income. If the market value has fallen, that is no saving grace. The tax bill may become due but with no supporting value. (Taxation without monetization, for loyal Blog readers).

Next, we look at the term fungible, and again from dictionary.com, fungible items can be easily replaced by, or interchanged with, cash, or items of similar value. But NFTs are not truly non-fungible, as they are able to be sold if the owner can find a buyer. Proof of ownership is a valid concept, and that is what an NFT represents.

Crypto was originally touted as being safe and sheltered from thieves, and yet Billions of Dollars’ worth has been stolen ($14 Billion in 2021 alone). However, changing IRS rules worry me more than potential cyber thieves.

If an NFT represents something that can be of benefit to the owner, such as a right to attend a concert or event, exercising that right will trigger the Prohibited Transactions rule for IRAs. Otherwise known as self-dealing, anything other than a hands-off financial relationship with your IRA assets triggers a 100% immediate loss of tax-protected status for the entire IRA. This can result in a large and unexpected tax liability for the owner. (Look for next week’s Blog to discuss this further.)

For now, my money is green, my wallet is black, and my tokens come in the form of stock certificates and bonds registered to me. Those registrations may be done electronically, but they are produced and held by a reputable custodian. Van Wie Financial follows trends, but we understand that our clients appreciate the security of the tried and true. Call us old-fashioned. Please.

Van Wie Financial is fee-only. For a reason.

It’s official. ZIRP (Zero Interest Rate Policy) is dead. In fact, the Federal Reserve (FED) has raised interest rates to levels not seen in many years. Car and home buyers are getting hit hard, and at this moment the average potential buyer cannot afford a new car. This is a result of higher interest rates, coupled with high inflation. New car prices average $48,008, and payments are generally over $700 monthly. Grocery prices are out of sight. Eat or drive?

Switching focus to the winners’ side of high-interest rates, lenders are now receiving better returns on loaned funds. Not everyone may realize their own status as a lender. If you own any Money Market shares, interest-bearing bank accounts, or investment bonds, you have loaned money to the issuer. In return, that borrower has promised to pay you interest until the money is repaid, or the bond either gets sold or matures.

Maximizing interest earnings on bonds requires an understanding of the “Yield Curve,” which is a graphical representation of market interest rates. On the graph, interest rates are on the vertical axis, and time is the horizontal component. Understanding a normal Yield Curve is easily demonstrated. Suppose you are buying a car, and you compare loan rates for differing lengths of repayment. You may get a quote like this; 2 years for 1.9%, 3 years for 2.9%, 4 years for 3.9%, etc. Longer repayment periods carry with them higher interest rates. That’s how bond yields work in a normal rate environment.

Plotting those various points on the graph, then connecting the dots into a smooth line, creates the Yield Curve. Normally, it will simply show an upward-sloping curve, looking from left to right. In 2023, we have been experiencing an “inverted” Yield Curve. This results from the perception in the market that current high rates are temporary, so short-term rates are unusually high. Expectations for long-term interest rates are lower than for short-term rates, and plotting those data points creates a Yield Curve with the “wrong” slope (inverted).

Why does this matter to the average American? For savers, elevated short-term rates provide an opportunity for investing in CDs and other short-term, interest-bearing instruments, at attractive rates. For borrowers, it means there is more pain in current (higher) repayment requirements.

Unfortunately, an Inverted Yield Curve generally foretells an economy in decline and signals an upcoming recession. While that result is not guaranteed, the correlation is very strong throughout history. When a recession is actually encountered, the overall state of the economy (and the job market) is unhealthy. Prudent Americans may delay plans for large purchases, in favor of future rate decreases. Economies run in cycles, and the Yield Curve will return to normal. Meanwhile, consumers should be cautious about making costly commitments.

Van Wie Financial is fee-only. For a reason.

As we explained last week, ZIRP is an acronym for the Federal Reserve’s Zero Interest Rate Policy, which tends to divide Americans into winners and losers. Borrowers love cheap money, whereas investors and lenders lose their ability to earn a reasonable return on cash and other short-term investments.

Frequently heard in our office is the pejorative, “I hate bonds.” We find that investors who express that sentiment are relatively uninformed as to the purpose of holding bonds, as well as the mechanics of the bond market.

Like stocks, individual bonds are traded on an Exchange, as are Bond Mutual Funds and Exchange Traded Funds. Market prices are determined by several factors, including time to maturity, the credit quality of the issuer, and market rates of interest. Values at any moment in time are a function of these factors and are quoted in financial media and through bond brokers.

Market prices for bonds are inversely related to interest rate changes. Rising interest rates directly cause lower bond prices. Holders of bonds in a rising interest rate environment experience losses from bond price declines. Logically, the opposite is true as well. A reasonable question to ask might be, “How much do bonds change in value?” The answer is that shorter-maturity bonds incur less price change than do longer-maturity bonds.

Over time, a 64/40 portfolio (60% stocks and 40% bonds) has returned about 7% annually. However, in 2022, that portfolio mix lost 15.3% of its value. Naturally, this caused a great deal of consternation among investors, exacerbating feelings in the “I hate bonds” crowd. This is unfortunate because that drop was unusual and unexpected. So far this year (2023), the same 60/40 portfolio has gained 4.69%.

Since bond pricing rules work in both directions, investors prefer to hold longer maturity bonds while interest rates fall, in order to capture increasing values. During times of rising interest rates (as we have experienced the past few months), savvy investors shift out of longer-maturity bonds, moving their funds into short-maturity bonds, and even to money market funds. When the FED’s rate-rising cycle ends, funds get moved back into bonds with longer maturities.

The FED meeting last week produced another ¼% interest rate hike. Whether this rate increase will be the final step in our current rate-increasing cycle remains to be seen. Most market watchers seem to believe so, but there are no guarantees, so long as inflation numbers remain elevated. My guess is a short-term pause on further increases, with an uncertain future. The FED’s top priority remains a 2% maximum rate of inflation. They have a long way to go.

Van Wie Financial is fee-only. For a reason.

ZIRP is an acronym for Zero Interest Rate Policy and, until recently, a major component of American economic policy for several years. Through the Financial Crisis in 2008 and the economic shock of COVID-19 in 2000, the Federal Reserve (FED) exercised the ultimate “easy money” stance of lowering interest rates to essentially zero. (I suppose we should be grateful they didn’t adopt NIRP, the Negative Interest Rate Program, tried by several countries with no apparent success.) ZIRP’s concept is simply to stimulate economic activity in slow economic times.

To what degree ZIRP has been effective is a discussion I will leave to the academics and politicians. However, one result we criticize is that ZIRP divides Americans into two groups: winners and losers. Winners are large corporations and entrepreneurs, who can borrow cheap money for projects that may otherwise not be justified. Losers include investors and lenders, whose ability to make safe money earning interest, is delayed.

Typical investors employ a long-term strategy of owning stocks, bonds, and cash, plus alternatives such as commodities. During good times in the stock market, the highest returns come from stocks. This phenomenon does not go unnoticed by investors, who reflect fondly on their out-sized stock gains over the years. These people look at the bond market, compare their relatively measly returns, and develop a visceral dislike of bonds.

In our financial planning practice, we hear constantly, “I hate bonds.” While common, this attitude sets up portfolios to experience more volatility than most investors find comfortable. One of the fundamental contributions of bonds is reducing that volatility. Bonds are also accretive to long-term returns, furnishing incremental growth and income throughout the bond’s holding period.

Bond issuers are borrowers. In return for loaning them money, issuers promise investors how much, and when, interest will be paid to the bondholder during the holding period. At maturity, the face value of the bond is returned to the bond investor. So, why do so many investors harbor a deep dislike for bonds? Aside from returning less than stocks (in “normal” times), investors are not aware of the long-term impact of bonds in well-diversified portfolios.

We can’t fault any investor whose experience with bonds has been negative. That is largely due to a lack of understanding of bond pricing and variability. Next week we will look at the effects on bond investing from changes in interest rates, including recent FED policy decisions, and discuss strategies to create successful portfolios that include bonds.

Van Wie Financial is fee-only. For a reason.

Americans aged 75 and over are re-entering the workforce in large numbers, with an expected increase of 96.5% by 2030. With 10,000+ people reaching traditional retirement age daily, a large and experienced talent pool is emerging in our economy.

Two general categories of post-retirement-age workers are emerging: Voluntary and Involuntary. Voluntary Senior Workers spent a lifetime planning and saving, eventually achieving true Financial Independence commensurate with their lifestyle desires. They could (or did) retire safely and comfortably, but many decide to continue (or restart) working for other reasons.

Involuntarily Senior Workers are what I call Retirement Wannabees. This group remains in the workforce to pay their bills, which becomes more difficult daily, due to elevated inflation. Either way, employers are grateful for the very existence of this growing workforce pool. Employers believe that experienced workers are generally more reliable than younger employees.

Retirement Wannabees are found in many situations. People who subscribe to the hype called “Financial Independence Retire Early (FIRE)” believe outlandish promises and ridiculous assumptions made by their gurus. FIRE supporters are instructed to live on a veritable shoestring while young, saving huge percentages of income for “retirement.” Perhaps this sounds enticing (and maybe even possible) to some, but it simply is not practical. Nor is the “do without” lifestyle needed to achieve the impractical goals of FIRE.

In fact, kick the tires on any of the FIRE guides, and you will find one universal similarity – they end up advocating working after retirement. So, the secret to stopping work at an early age is to ……. work? Why are we wasting time reading this tripe?

Aside from pure financial aspects of working later in life, stimulation of mind and body can lend meaning and interest to our “out years.” Getting back into society, interacting with people, exercising body and mind, all can and do contribute to the quality of life. The extra money is, of course, also welcome.

Obviously, arriving at the category of Involuntary Senior Worker is disappointing. Preventing this situation takes a long time, careful planning, and successful investing. Start saving early, work with a qualified Financial Planner, and avoid large, costly mistakes, and you will likely get your choice.

Either way, employers will be happy to meet you.

Van Wie Financial is fee-only. For a reason.

Tax Day 2023 has arrived, albeit a little later than usual, due to a calendar-based adjustment. Unless an Automatic Extension has been granted, which is as simple as filing Form 4868, Individual Returns are due by April 18, 2023. Regardless of Extension status, any tax owed from 2022 is also due. Adding insult to injury, the 2023 Quarter 1 Estimated Tax Payment (Form 1040-ES) is due on the same date for taxpayers who do not have sufficient withholding along the way.

April 18, 2023, is also the drop-dead date for 2022 IRA deposits. These can be made from your tax refund, if available. It is also possible to purchase iBonds from the Treasury with your refund, simply by asking.

Rather than blindly accepting the work of your tax preparer, even if you did it yourself via TurboTax or another online service, April represents the best opportunity to learn from your Individual Return. There are many line items in every Return that can provide insight to help us manage (legally) the amount we are required to pay.

Fundamentally, here is how the Tax formula works: (a) compute Gross Income from all sources; (b) apply specified adjustments on Form 1040 to arrive at Adjusted Gross Income; (c) compute Itemized Deductions, or use the Standard Deduction, whichever is higher, to determine Taxable Income; (d) find your Gross (preliminary) Tax from the Tables or Formulas from IRS; (e) Apply Tax Credits if you are eligible. From there, compare the total amount owed to total payments made along the way, resulting in either a refund or money owed to IRS.

America’s Tax Code is a nightmare of complexity, constantly changing, and seemingly doling out punishment for the simple act of being a hard-working, successful American. As disgusting as that is, we are forced to live with it, and we may as well figure out how to do the best we can for ourselves.

In a few days (or even less), your Tax Return will be filed away, or stored on your computer hard drive. While it is fresh in your mind, learn from current information, and apply the lesson going forward.

Tax Preparers, who are generally in the midst of a hectic and high-pressure time of the year, don’t always have time to ask probing questions and explore options for a reduced tax bill. As Certified Financial Planners®, Van Wie Financial offers Tax Planning services.

Please note that we are not Tax Professionals or Preparers. Our role is in Tax Planning and working with your Tax Preparer to help you save money on taxes while investing for eventual Financial Independence.

Van Wie Financial is fee-only. For a reason.

“People get the government they deserve,” observed Alexander Hamilton, long before his story hit Broadway. Ben Franklin also chimed in. When asked what kind of government the Founders had given the people, he responded, “A Republic, if you can keep it.” Franklin’s classic line is often disputed, but the conclusion is obvious. Starting in the 1770s, Americans were charged with a great responsibility.

Government of the people, by the people, and for the people is a hands-on process, requiring citizen participation in the system. Fundamental to success is casting an individual ballot periodically. Citizens are charged with keeping up on issues affecting our country, and determining where individual candidates stand on these issues. Hardly a burden on the citizenry, in my opinion.

After Iraq was liberated from Saddam Hussein, elections were held in 2005, with a reported 70%+ turnout among eligible voters. Remember beaming faces and purple “I voted” stains on the fingers of Iraqis? Voting was a new privilege, and Iraqi citizens were eager to exercise their newfound rights. Surely this enthusiasm would last a lifetime, making up for decades of oppression.

Not so fast. In recent elections, Iraqi turnout has been estimated in the range of 41% – 43%. A majority of voting-age Iraqis are no longer decision-makers. Rather, they are doomed to live under the policies of a minority of (voting) citizens. The non-voting majority is to blame for any result they don’t like.

Recent important elections in both the City of Chicago (Mayor) and the State of Wisconsin (Supreme Court “swing” Justice) featured extremely polarizing candidates. In both cases, one candidate was an extreme “Progressive,” and the other politically moderate. In each case, crime and punishment were on the ballot, and in each case, the safety and security of citizens were lost to the ”defund the police” crowd.

Is a continuation of “soft on crime” leadership what a majority of citizens actually want? I doubt it, based on escalating crime rates across America. If public safety is that important to citizens, what went wrong?

Turnout. Participation. Responsibility. Apathy. Call it what you like, but for whatever reason(s), only about 1/3 of eligible (and therefore affected) citizens, chose to express their own personal sentiments by voting. No claim of ignorance is now acceptable, given the record spending by both campaigns in the runup. Failure to take individual responsibility has now exacerbated the crime spree in the Midwest. Quality of life will continue to deteriorate, and people will vote with their feet instead. Hello Florida, Texas, and Tennessee.

It was so preventable.

Both Chicago and Wisconsin got the governments they deserve. “Soft-on-crime” candidates secured office with a majority vote from a minority of eligible voters. An apathetic public has only themselves to blame.

Van Wie Financial is fee-only. For a reason.