As the co-host of the Bogleheads® on Investing podcast, I interview Cody Garrett, CFP®, and Sean Mullaney, CPA on several tax topics. Watch the whole episode below.
Episode
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Show Notes
Bogleheads® on Investing #87: Ed Slott, CPA
2026 Premium Tax Credit Update
Bogleheads® Live with Sean Mullaney: Episode 40
Bogleheads on Investing with Cody Garrett: Episode 61
Transcripts
00:00:00 Cody Garrett: I think what’s happening with tax planning or really the fear based marketing commentary around tax planning is this idea of somebody who owns a service and a lot of their content is trying to convince you that you’ve fallen down and you’re stuck down in a well and they happen to be at the top of the well with a rope and they’re like, I’m the only one who can save you.
00:00:17 Jon Luskin: Let’s talk a little bit more about some of these maybe overblown tax considerations. I really like in the book how you frame IRMAA, for example, as a nuisance tax, right? This is a small percent of a tax on your wealth when you look at the numbers, when you break it down.
00:00:31 Sean Mullaney: The widow will have a less tax efficient situation. You have got to look at the numbers and there are other tools in the toolbox. Qualified charitable distributions can attack the problem. Something called asset location, where we hold all our taxable bonds in our 401(k) or IRA that can help attack the problem. Your own living expenses, right? One thing to keep in mind for all the worry about RMDs.
00:01:02 Jon Luskin: Welcome to the 89th Bogleheads® on Investing podcast. My guests are Sean Mullaney and Cody Garrett. We’ll be talking tax planning in this episode. If you haven’t already, be sure to subscribe to this podcast on your platform of choice. And if you’re not already, be sure to check us out on YouTube, where you can see the whole conversation on video.
Let’s talk about some zero hour tax planning for 2025, making a big one-time contribution to a donor advised fund, before we have some tax law changes next year. And for folks who do want to nerd out on that a little bit more, we did talk about this with Ed Slott on episode 85. I’ll link to that in the show notes. Cody and Sean, what are your thoughts? Is this something that folks need to be thinking about and acting on this late in the game?
00:01:46 Cody Garrett: Yeah, I’ll mention that a lot of people are on social media right now saying, hey, giving money to charity, even if you get a deduction, you still end up with less money at the end of the day. So I first wanted to like clarify. That like you’re only going to do these tax optimized charitable tactics if you’re already planning to give to charity anyway. Right. So this is the idea of next year there’s a little haircut on itemized deductions when given to charity.
And there’s also a next year there’s a non-itemizers deduction for charitable gifts. It’s limited, but yeah, it’s the idea that, hey, since you’re not limited, there’s no haircut in 2025. If you’re listening to this at the very end of the year, then you have an opportunity to potentially stack. Those, you know, multiple years of contributions, for example, that you’re going to give to your church, other charities, stack those, maybe give appreciated securities from a taxable brokerage account, maybe put those in a donor advised fund. That way you can put, let’s say, multiple years worth of giving in a donor advised fund and then give to your church or charity over time rather than giving up a gift all at once. So, I mean, you can still give your gift over time, but why not add some tax optimization to it? By getting maybe the full deduction this year for that, being able to itemize those deductions the next year, possibly take advantage of the non-itemizers charitable contributions.
00:03:03 Sean Mullaney: We love donating the appreciated securities because essentially you get two big tax breaks. One, you get the upfront tax deduction, and two, the capital gain in those appreciated securities gets washed away by a donor advised fund contribution.
What’s probably not going to be likely, although check the relevant deadlines, is going from institution A’s mutual fund or ETF or other, you know, brokerage account into institution B’s donor advised fund when we’re crossing the streams in terms of institutions. Oftentimes, at least what I’ve seen in the past is they want that done by November to be counted for the end of the year.
The other thing you could think about is cash, right? It’s not illegal and it might still be a very good idea to donate a bunch of cash this year. Get the higher deduction this year and then you have that donor advised fund out of which to donate in the future and combine that with the high standard deduction. Yeah, I’ll just throw in one thing as we think about year end, which is actually executing.
So if you’re listening to this in early December, you want to go to the particular donor advised funds website. They usually have a list of deadlines. And it’s sort of very interesting. If you’re going same institution to their donor advised fund, you tend to have more time if you’re thinking about the appreciated securities. Donor advised fund planning can be very impactful and 25 vis-a-vis 26. 25 could be very impactful because of this upcoming starting in 2026, 0.5% of income haircut that itemized charitable deductions are going to start getting.
00:04:40 Cody Garrett: Yeah, that’s right. I’m going to quickly add here that most American taxpayers will still take the significant standard deductions in 2025 and 2026. With that said, there’s a new, instead of $10,000 cap on state and local taxes as an itemized deduction, that’s capped now at $40,000. So especially if you’re doing these charitable contributions, I might go even further.
Let’s say you have some really high property taxes, et cetera. You might be able to go above that, what was a $10,000 cap. You know, in between, you know, $10,000 to $40,000. There is a threshold on income, but it’s very high around $500,000 reducing that $40,000 potentially all the way back down to $10,000. But most people listening to this thinking about itemizing their deductions will want to take advantage of that cap that’s been increased in 2025 and moving forward.
00:05:22 Jon Luskin: So more provisions of the One Big Beautiful Bill Act are going to be enforced for 2026. What should folks be thinking about for.
00:05:34 Sean Mullaney: Tax planning in the years ahead? I’ll give you two. One for the retirees in the audience and two is for the higher income accumulators in the audience. So for the retirees, there’s this new senior deduction. If you’re 65 or older by year end, it’s a $6,000 or up to, I should say, $6,000 per person deduction against your income on your tax return. It can be very powerful from a planning perspective.
Now it is subject to some phase outs. The phase outs are very generous for married couples. It phases out between $150,000 of income and $250,000 of income for singles. It’s less generous. It phases out between $75,000 of income and $175,000 of income. And so controlling income when we’re in or 65 or older is going to become more and more important.
Things I like to think about in that regard. One is delaying claiming Social Security. I think this new deduction, this new senior deduction of $6,000 per person, I think that’s something to really strongly consider delaying your Social Security. Also think about where do I hold my bonds? Do I really want to do a non-qualified annuity?
There are other things on the table where folks can control their income on their tax return when they’re in retirement. So that’s one thing to be thinking about. Now, that is temporary. It’s only for four years, but I suspect that may get extended in the future. Different conversation.
In terms of our accumulators, this is not a One Big Beautiful Bill change. This is a secure 2.0 change. Starting in 2026, those who had W-2 income, I believe the number is $145,000 in the previous year from that employer are not going to be able to deduct their catch up contributions to their 401k or other qualified plan.
It’s going to be the case that many 50 and older accumulators are in their highest earning years at work. And so losing the deduction for that catch up contribution is not good news. But one, you could still deduct even if your income is $1,000,000,000 from the W-2 job, you could still deduct the regular contribution to the 401(k) or other qualified plan. And two, all right, you still can make that catch-up contribution. It just needs to be in the Roth version of the account. Not the worst outcome, far from it.
So something to keep in mind for those who are on the border, you might want to think about lowering income a little bit, but it can be tough and it’s based on your W-2 income. So it’s not like, oh, I’ll have some deductions on the side. I mean, things you could think about is one traditional 401(k) contributions each year. Two is the HSA contribution that could lower income. But a lot of folks are just not going to be able to do much planning around that particular issue.
00:08:23 Jon Luskin: I’ve always been a huge fan of delaying Social Security until age 70 for the longevity management reason. You get that bigger benefit for as long as you live. That can be a helpful way to manage the risk of running out of money. What’s nice is there’s a little bit of a tax planning bonus with that strategy as well. Cody, thoughts on 2026 tax planning?
00:08:42 Cody Garrett: I will say that a lot of people are saying, well, health insurance is going to be too expensive. There’s no way I can possibly retire, especially retire early. In 2025, there’s still a nice cushion, even if you go above that 400% level. But in 2026, this is a big concern. One thing to keep in mind is that health insurance, including through the marketplace, those premiums change depending on age. Let’s say you’re retiring at age 50, right? That would be, you know, depending on where you live, between $6,000 and $9,000 per year per adult. So if you’re a married couple, that might be $12,000 to $18,000 a year in premiums.
If you’re not receiving a premium tax credit, you might add another $3,000 to $4,000 per year per child. 55, that number goes from $6,000 to $8,000. So $8,000 to $11,000 per year and then $10,000 to $13,000 per year per adult at age 60. Going into 2026, like Sean mentioned, there’s some opportunities potentially to reduce your modified adjusted gross income. One of those is in 2026, all bronze plans through the ACA will be HSA eligible. So making those health savings accounts contributions not only save for future qualified health expenses or qualified medical expenses, but those are also deductible above the line.
So they will count toward that eligibility for those premium tax credits. So a lot of the planning in 2026 is really roundabout. It’s saying, how can you maintain your desired lifestyle with as little income as possible if you’re trying to gain eligibility for those tax credits. But once you’ve met your lifestyle, there might be some additional strategies to increase the tax credit or avoid from going up above that 400% cliff that’s likely to continue.
00:10:22 Sean Mullaney: I’m going to throw in one little thing here. We are up against the limitation of the podcast format. We are currently recording this in early November. You’re likely listening to this in sometime in December of 2025 or later. And this is an area of flux. So very much stay tuned in terms of what the exact contours of the 2026 premium tax credits are.
00:10:49 Cody Garrett: Just quickly on that, the HSA reimbursements and also Roth IRA distributions, HSAs and Roth IRAs, people get so excited about this long term tax free growth. Like it’s going to keep growing tax free forever. But keep in mind, even though HSAs and Roth IRAs are often last spend assets, we actually have a kind of a provocative take on that.
That HSA reimbursements tax free and Roth IRA distributions may be taking back some of your basis. Maybe if you’re over age 59 and a half, you’ve had the Roth IRA open for five years plus, maybe even tap into earnings. Most people won’t end up tapping into that for this purpose. But keep in mind that those tax free HSA reimbursements and Roth IRA withdrawals, they can really help you manage your gross income, especially in early retirement where you’re focusing on these credits. Keep in mind that a credit and a deduction are different, right?
These tax credits, even though, yes, healthcare is an expense in retirement, these are credits, not deductions, which mean that they are a dollar for dollar reduction of your tax liability. Yeah, I think that what will become more popular in 2026 are private plans, especially private PPO plans and also health sharing plans.
So I think a lot of people will be more maybe creative about how they think about health insurance moving forward. And the only kind of quote unquote advice I would give you is just ensure that, you know, maybe pun intended, just ensure that you have an out-of-pocket max. There’s like seven different ways to get health insurance in early retirement or if you’re self-employed, but really think outside the box if possible.
00:12:08 Jon Luskin: Yeah, a couple thoughts on that with respect to the health sharing ministry. Folks know that this is not health insurance. There certainly has been anecdotal evidence that the providers can just deny coverage on a whim. So I’d say be careful there. And then with respect to the private insurance, I know preexisting conditions can be a thing unlike an ACA plan, ACA plan, you don’t have to worry about those things now. It might not necessarily be the least expensive option, but certainly here is a scenario where you get what you pay for.
00:12:40 Cody Garrett: That’s right. So let’s say you’re retiring early or you’re self-employed and you’re young and healthy, at least for this year, you might consider some private coverage with underwriting. It might actually be cheaper than going through an ACA plan that cannot consider those preexisting conditions.
00:13:01 Jon Luskin: Let’s jump to do-it-yourself tools for tax planning for 2026 and the year ahead. This is a question we got from the community beforehand. What are some tools that folks should be using or you’ve looked at that are reasonable for doing their own tax planning?
00:13:12 Sean Mullaney: I’ll take that one, at least initially. I don’t have an answer for that one, John. I generally use Google Sheets. I look up the tax tables and manually compute an estimate of taxes. Now, I do think there are good tools out there in terms of estimating current year tax liabilities. I think that exists. I think folding premium tax credit into that could be very difficult, but I think there are really good tools out there that can estimate current year federal income tax liability and all.
Right, I do this Roth conversion or I don’t do this Roth conversion or I do a $10,000 versus $20,000, or I do tax gain harvesting instead of a Roth conversion. There are tools out there that I think are good. I’m just not your resource on those. The same thing with the longer term tools, the planning tools, I myself, they’re sort of not my cup of tea, meaning it’s somebody else’s prediction about the future that I’m not all that interested in, frankly. But that’s my perspective.
Cody, I’m curious your take on this question.
00:14:13 Cody Garrett: Yeah, so I like thinking about it like tax prep versus tax planning. You know, one’s about this year and last year, one’s about, you know, maybe decades moving forward. I’ll start with the kind of the current year. I build out my own 1040 calculator in Excel, which isn’t to like, you know, try to be super smart and I don’t try to, you know, put everything in there that could possibly be in there. But I really care about the customization of kind of thinking about, you know, normal IRA distributions differently than Roth conversions.
I also like putting my own things in my calculator, like you know, what is modified adjusted gross income for different purposes, such as the premium tax credit versus IRMAA, because those are different definitions of MAGI.
But I think for the average DIY investor or, you know, tax planner, I think for a current year, it’s called dinkytown.net as I’m speaking right now in November 2025, they have updated it for the new senior deduction, those additional standard deductions and those increases. But in 2026, I’m not sure how long it’ll take them. To kind of update the new version.
Also keep in mind, if you’re self-employed, be very thoughtful about things like QBI, like qualified business income deduction. A lot of these free tools don’t include some of that more advanced analysis. I don’t know if Sean does any tax preparation with clients, but I certainly don’t. And at this point, I would say if you need help with that one on one, certainly there’s some hourly project based and ongoing access to financial planners who happen to also be experts in tax planning. They might even have the CPA, the EA designations. Show you that they have the basic fundamentals of tax prep and tax planning behind their belt.
00:15:39 Jon Luskin: Yeah, well certainly give him an exception to what I’m saying next, because he’s a professional and this is what he does all day long. I’m going to paraphrase Mike Piper here. His answer to this question, don’t use a spreadsheet. You’re going to miss something. You want to use tax planning software.
00:15:53 Cody Garrett: Right. I’ll just kind of a little plug in our recent book, Tax Planning to In through Early Retirement. It’s so important that before you use any tool, Chapter one of that book is the federal income tax formula. So you truly need to understand step by step, line by line, how to review a tax return before you consider trying to build your own tools along the way.
00:16:12 Jon Luskin: Going back to your book, which again, I just absolutely loved. Great job on this one. There’s so many important points in here. I’m not even sure where to start first, but I think one theme of the book, which I love and have had these thoughts for quite some time. Is that, and to paraphrase the way you say it, a lot of tax planning is fear based, right? I would argue a lot of tax planning is oversold, right?
Maybe you don’t necessarily need to do all these things, but it’s a way for someone to say, Hey, you know, you’ve got to do this thing or the world is going to end and you’re going to be in IRS jail and die of taxes. Tell me a little bit about your frame of reference when it comes to tax planning and putting this book together.
00:16:56 Cody Garrett: I think what’s happening with tax planning. Or really the fear based marketing commentary around tax planning is this is this idea of somebody who provides a service or product to consumers. And a lot of their content in terms of fear around taxes is trying to convince you that you’ve fallen down and you’re stuck down in a well. And they happen to be at the top of the well with a rope and they’re like, I’m the only one who can save you.
So I think first there’s kind of two parts of that one. Is that you’re being convinced that you have a problem that you might not have just because they don’t know anything about the unique financial situation before providing fear-based messaging. What bleeds leads in all forms of marketing. So when you tell somebody you’re not going to get crushed in taxes, that’s not going to get as many views as telling you that 50% of your money is going to go to the government. Act now and call me to help you do that as soon as possible.
So we kind of stepped back with this book and said, hey, how can we write something that’s. As fundamentally educational as possible, also objective, and not just its rules and concepts, but the practical application of how these rules play out in real life. So we, you know, we have over 120 step by step calculations in the book, not just saying we think it’s going to be this way, but we actually say what would happen if this happened. I think a lot of the rules and concepts are objective, but then the fear based commentary is subjective, but there’s not a, it’s not a clear delineation between when they go from facts to opinions and that commentary.
00:18:17 Jon Luskin: Let me read a line for your book that I love. Calling Roth conversions a need often overstates things. Now, I’m a worst case scenario guy. I always think about, hey, I don’t know what the future is going to hold, but even in your book, you do this exercise where you show that if tax rates go up by 50%, right, then you’re still going to be in a relatively fine spot with conventional strategy.
So I really appreciate how you not only, you know, gave your take on, hey, you know, here’s why we think this is going to happen. But even if we’re wrong, even in this extreme scenario, it still shows that your approach, conventional approach, can be quite reasonable when it comes to managing lifetime taxes.
00:19:11 Sean Mullaney: The book goes into depth about what taxation in retirement could look like with actual numbers. Right. How bad is it? And one of the things we find. You know, in our analysis is there’ll. Be some widows who are moderately financially successful. And the good news with that is if you’re moderately financially successful, your taxes tend to be very low in retirement and even the later part of retirement. So that’s some good news.
Well, what about those who are wildly successful financially? Well, there you are at risk for tax inefficiencies. Now, there are tax inefficiencies that hit on the ending part of the required minimum distribution that you have to take every year. And you’re going to find that you may incur, say, a 32% tax rate on that. Or, I mean, you have to be wildly financially successful, like very wildly financially successful to even get to 35%.
But the interesting thing about it is, one, it’s just an inefficiency, right? Some of that money comes out against maybe the 12% bracket, the 22% bracket, 24% bracket. But two, this incurring this tax inefficiency in one’s widowhood comes with a very good upside, and that is wild financial success.
It’s a trap that most Americans would gladly sign up for. Some of my RMDs are going to be inefficiently taxed, and so that will be a negative on the tax spreadsheet. But the positive is I’m wildly financially successful. And oh, by the way, I’m so old, I probably can’t spend it all anyway.
I think we have to step back. Because instinctively, we ought to know that when we’re not working for income, the income tax is going to hit us less. And that’s what our analysis tends to bear out.
00:20:50 Cody Garrett: So I want to share a quick math example of this. We’ve been talking about the difference between a marginal and effective tax rates. And I’m going to kind of go from an accumulator to a retiree example here. This kind of blew my mind when I really looked at the numbers.
Let’s say that there’s a single worker and they’re making over their income goes over $67,000 in 2026. That means that they’re now going into the 22% marginal tax rate. So all the income they earn over about $67,000 is going to be taxed at 22% or higher.
What’s fascinating though is let’s say that the next year that single taxpayer is retired and only distributing income from that retirement account. So they’re distributing income all as ordinary income. How much would they have to distribute from that 401(k), that traditional IRA to reach an effective average tax rate of 22%. So again, they hit the marginal tax rate of 22% when their income hit around $66,500. But in retirement, this is using 2026 numbers, they don’t hit the 22% average effective tax rate unless they have ordinary income over $286,000. Right?
So that’s kind of the idea that when you are contributing to a traditional retirement account. You’re deferring, you’re excluding, you’re deducting those contributions top down at your highest marginal tax rates. And when you’re retired, when you’re taking those distributions or converting to Roth, you’re going bottom up through some of those lower brackets.
And if you’re wondering if you’re married finally jointly, you hit the 22% marginal tax bracket when your ordinary income gets over $133,000 in 2026. So $133,000 to have a 22% average effective tax rate with all ordinary income in 2026, you need income of $567,000.
So you kind of ask yourself, if you’re earning around, you know, $150,000 or $200,000 as a married couple, like what are the chances of you distributing over $560,000 in retirement, all as ordinary income, which is kind of like the most inefficient way of doing things. So I think that’s one of those fundamental things in the book that we, we really hit on is I think a lot of people, their marginal tax rate is let’s say 32%.
And what they, what they’re telling others is, oh, all my income is being taxed at 32%, right? In reality, it’s being taxed at the significant 0%, you know, the standard deduction, maybe the additional standard deduction, senior deduction, 10, 12, 22, 24, then 32. And Sean has some fantastic examples in the book that he created where somebody might say they’re in the 32% bracket, but maybe only a couple thousand dollars is actually being taxed at that highest marginal rate.
Jon Luskin: Yeah, absolutely. And I think the extreme values in that example also speak to what I was really thinking about when I was reading the book is, you know, what if rates go up, right? And so even if rates do go up in your hypothetical scenario, still making those traditional contributions can still be a very valuable strategy where you can certainly have that tax arbitrage over your lifetime.
Let’s talk a little bit more about some of these maybe overblown tax considerations. I really like in the book, how you frame IRMAA, for example, as a nuisance tax, right? This is a small percent of a tax on your wealth. When you look at the numbers, when you break it down in your book, let’s jump to a question from Andrew T. that we got beforehand about the widow tax trap for surviving spouses.
He says, how do you think about planning for the widow tax when there’s going to be a long survivor period when one spouse has health issues, for example? Imagine a scenario where the couple’s in the 12% bracket and then the survivor is in the 22% bracket and might even be subject to IRMAA.
00:24:35 Sean Mullaney: So I’d start with if I really thought one spouse was going to die much sooner than the other spouse, I would prioritize lived experience while they’re both alive far over tax planning, right? If you’re prioritizing tax planning over living your life and enjoying it while you’re both alive, you’re missing the boat.
So that’s one thing. Now, the second thing is there are legitimate concerns around, okay, the widow will have a less tax efficient situation. And yes, there may be some good Roth conversions to consider. I would argue that it’s best considered after they’re off the premium tax credit. Now, maybe they’re off the premium tax credit because they have employer provided retiree health care. There are different reasons why they may not be on it, but for many Americans, that’s only going to happen the month we turn 65.
So once we’re off that, we might want to do more Roth conversions. But I’ll say this, it may be the case that those Roth conversions aren’t as impactful as one thinks, because even the widow may not suffer that high a tax incidence in their widowhood. You have got to look at the numbers. And there are other tools in the toolbox. Qualified charitable distributions can attack the problem. Something called asset location where we hold all our taxable bonds in our 401(k) or IRA that can help attack the problem. Your own living expenses, right?
One thing to keep in mind for all the worry about RMDs for those listeners in the audience who are born in the year 1960 or later, that means you’re 65 in the year 2025 or younger. Your RMDs don’t start till you turn age 75. It used to be RMDs, if we go eight years ago, RMDs started the year you turned 70 and a half. But now RMDs cover a relatively narrow slice of one’s life because they only start at age 75.
So we’ve had this sort of over focus in American personal finance on this RMD issue. And now it’s time to step back and say, wait a minute, are we putting the cart before the horse? Yes, RMDs are an issue. They’re at least something worth considering and potentially mitigating, but there are different ways to do that. There are ways that are not all that impactful. And for many Americans accelerating and potentially increasing taxes through the Roth conversion mechanism may not be the right answer.
00:26:55 Cody Garrett: I think a lot of this concern about the widows tax trap, et cetera, is focused on kind of in that traditional retirement, like when RMDs are like really they’re either here or they’re coming soon. But I want to mention that, you know, at that age, let’s say you do actually at that age or before, let’s say you have taxable assets. So let’s say you’re married, one spouse passes away, those taxable assets, so like your taxable brokerage investments, for example, or maybe even some rental property examples, they might receive a step up in basis or reset in basis on maybe half or even all of the asset depending on what type of state you’re in, community versus common law property.
And also if the younger spouse is the survivor, that might reduce their RMDs because they’re able to use those IRS table factors for the younger spouse. So I think, yeah, certainly you can plan ahead of time if you do believe that it’s going to be, you know, a surviving spouse living for maybe a few more decades. In the book, we talk about pay tax when you pay less tax. Right. So if you look at your sources of taxable income and you say, hey, my surviving spouse is still going to get the 100% pension, right? Our income’s actually not going down that much. If something happens to me or something happens to them.
Yeah, maybe it makes sense to do some additional Roth conversions, but. But don’t assume, don’t assume just because there’s a surviving spouse that they’re going to be crushed with taxes. So certainly do the math behind it. Maybe a little bit different from Sean is I think that financial planning software, those long term software. Again, I don’t like going line by line and like all these assumptions built in, but I think directionally sometimes just going into the software, just saying, or even without a software, just saying, Hey, how much might my RMD be if my account, you know, grows at, you know, 5% over the next 10 years and then their surviving spouse.
You can run these numbers pretty easily. And I don’t like to get precise with those numbers, but I like to think directionally, Hey, is there a pretty good chance, right? And it’s not focused on the tax rates. It’s focusing on what will our and future surviving spouses sources of taxable income be? I think there’s too much focus on the tax rates and not enough focus on what might our gross income look like moving forward from our various income sources in retirement.
00:28:53 Sean Mullaney: I will add a caution though about using a tax planning software because say that’s that couple we’re thinking about, there’s 65 this year and they think one of them is going to have a short lifespan. So they run some numbers and what the computer software is going to tell them is, well, you could Roth convert this year at 24% to avoid a 32% RMD at age 85. And the computer software is telling them a lie.
So what do I what do I mean by that? Because 32% looks way worse than 24% on a spreadsheet. But think about the incidence of that tax and the ability to bear that tax in the early part of retirement, that 24%, I would argue, is worth a lot more than the 32% later on in retirement. What’s that widow going to do with those last $0.08 on the dollar, right? Either that widow’s in long term care and they just spend it all on long term care and they get a big tax deduction for that most likely.
Or they’re still healthy and affluent and living their life, but it’s going to be very hard to run up expenses that would somehow implicate the need for that last $0.08 on the dollar. So I think that’s part of the issue with these tax planning software is they assign the same value to taxes over time when maybe they shouldn’t be doing it. It’s not a net present value. I’m going to assume they get the net present value right. It’s not a net present value issue. The issue is the usefulness of that money when you’re 65 versus when you’re 95.
And it’s going to say 24 cents on the dollar one time, 24 cents on the dollar the other time. That’s equal. No, it’s not right, because it’s a lot more useful when you’re 65 and you still have some living to be done. So look, I’m not here to say never use tax planning software, but even assuming it has accurate judgment, which is a very difficult assumption to make, but let’s assume it just for now. I think it’s a little odd to assign even considering net present value, the same value to taxes paid when they’re 65 and have a living to be done versus when they’re 85 or 95 and they just don’t have the bandwidth or capacity to enjoy the money as much.
00:31:05 Jon Luskin: And Sean did an absolutely phenomenal presentation at this year’s Bogleheads® conference just on this topic, the widow’s tax trap, making those traditional contributions and more. If you want to check that out. Make sure to subscribe to our YouTube Channel where you can find that video.
00:31:24 Cody Garrett: The software is only going to assume very linear things based on your assumptions and your inputs, plus their own assumptions. So I do think that’s why I go back to the software being really directional more than precise. Rather than just looking at the impact of RMDs, maybe you have five, 10 years where there’s your income is actually below the standard deduction. You know, those are some of the tactics we talk about. If you’re going to do Roth conversions, maybe they’re possible to convert. At 0%, maybe, you know, maybe 10 or 12, depending on if RMDs are actually going to be, I wouldn’t say a problem, but a consideration moving forward.
I use, I use tax planning software, but understanding that it’s just we should focus on directionally. And then as soon as I get a direction, I step out of that software and then start using just year to year, you know, focus on what’s in my control and what’s currently known.
00:32:02 Jon Luskin: Yeah, I certainly appreciate that take. I think certainly be it advisors or do it yourselfers alike, we tend to get focused on these little tiny figures fall into the illusion of precision. I really like how you framed it in the book. Too often in personal finance, we focus on the trees and miss the forest. And I just think folks can do that a lot when it comes to either their own proprietary spreadsheets or when it comes to any sort of tax planning or retirement planning software. Let’s talk about asset location.
00:32:32 Sean Mullaney: Very high level asset location. We want to hold stocks and bonds and we have Roth accounts, traditional retirement accounts, and so-called taxable accounts. And I’m particularly fond of holding, say, the bond holding inside the 401(k) or the IRA, the traditional.
And we can even go a little more precise. Maybe our international equities are a little more Roth or traditional versus taxable. That’s a marginal play. But the idea is to keep our income tax return as clean as possible.
So you think about bonds, they yield, say 4%, just throw out a number that’s directionally correct in today’s world. There’s no qualified dividend income on that versus US equities. Today, a well-diversified US equity index fund is going to yield in the neighborhood of say 1.2%, could even be lower. But let’s just call it 1.2%, 90 plus percent of which is likely to be qualified dividend income. So it could qualify for the 0% rate.
So if we’re going to have some equities and some bonds, boy, doesn’t it make sense to park the bonds in the traditional 401(k) or IRA, hold those equities in the taxable account? Because, you know, presumably we may want to have some there depending on our planning. Right. But let’s just say we do.
So keep the yield low on the tax return. And then there’s a secondary benefit, which is bonds have a lower expected return. So those holding the bonds in their instead of equities as a potential substitute potentially reduces future required minimum distributions because it artificially keeps our balance and those things low. Recall RMDs are computed as a percentage of the prior year, year-end balance of that account.
So we just like this idea of on the margins let’s use the Roth, traditional, taxable, these different buckets that are available to us to achieve essentially to keep that income low on our tax return, which then opens up more space for the Roth conversion planning, the tax gain harvesting planning, or simply taking distributions from the traditional IRA off which to live and obtain better tax results on those.
00:35:10 Cody Garrett: I just put a little example of my Excel spreadsheet here that. Let’s say somebody had $500,000 in their taxable brokerage account, $500,000 in their traditional IRA, and $500,000 in their Roth IRA. And they wanted a 60/40 total portfolio, 60% stock, 40% bonds.
What they could do is have a mirrored portfolio, keep it simple, right? Have like a balanced 60/40 fund in each of those accounts. And again, that would give you a 60/40 across the board. But again, you’d have, you know, you have, of course, bonds in the taxable brokerage account, which may be increasing your ordinary income. From that interest income.
If you wanted to kind of take an asset location approach, again, you don’t have to change your asset allocation. This person says, I still want to have a 60/40 portfolio altogether. What I might do is have my taxable brokerage account in 100% stocks, so all 500,000 in stocks. I actually have a 0% stock allocation in my traditional IRA, so 100% bonds. So Sean was mentioning that that will keep that ordinary income off the tax return and also, if we’re going to hold bonds anyway, why not keep our bonds, which are generally going to have a lower growth expectation than stocks? Why don’t we keep that in the accounts that we don’t want to grow as much in terms of those future RMDs or the need for Roth conversions?
And then lastly, to be able to get their 60/40 portfolio, they would actually go 80/20 in the Roth IRA. So still keeping those bonds off of their tax return. But again, what’s funny is the asset allocation in those examples are both 60/40. But in the second example, using tax location, you know, they could potentially be keeping thousands of dollars off of their tax return rather than it being forced on them by choosing a mirrored allocation.
I will just step back again and say, Jon, I’m a huge fan of simplicity, right? And also that this optimization is like, this is like kind of, you know, just doing the final turn of the screw, right? The asset allocation is like 90%, get that right. And the asset location is like the is the last 10% if that. So if you can’t live with your portfolio using asset location principles or have really a strategy for managing that over time, you might want to, you know, focus on simplicity instead and give up some of that tax optimization.
00:36:55 Jon Luskin: Cody, thanks for bringing that up. I’m a huge fan of simplicity. As you know, my concern is that this complicated approach folks aren’t going to maintain it. And let me add, the reason I’m a fan of simplicity is I’ve worked with hundreds of do-it-yourself investors, and I’ve seen that they’re not even maintaining something like a three fund portfolio, let alone something where they have to maintain that across multiple accounts.
What are your thoughts with respect to someone maintaining this sort of complicated approach? Is this something that you guys are seeing your own clients implement successfully? Maybe you guys are working with different people than I am.
00:37:50 Cody Garrett: Yeah, what’s funny is these tax optimized approaches like asset location, if I’m working with somebody who’s retiring next year, I usually won’t even propose that they use more complex tactics to start. I might actually say, hey, let’s start with just a basic mirrored portfolio that’s really focused on giving you clarity and confidence to actually start spending money in retirement.
That flip of the switch from accumulation to drawdown is very scary to begin with. So why add a complex topic? Like right when they’re at their most scared moment. And then maybe two, three years into retirement where they feel like they’ve gotten, you know, into the rhythm of retirement. Maybe then we can practice some tax optimization once they feel more comfortable with the, just the basic idea of even retiring to begin with.
00:38:15 Sean Mullaney: Yeah, I guess I have a bit of a different take on it. I just don’t see it as being all that complicated. Let’s just assume it’s a three fund allocation. Well, you have three funds in three different buckets, right? It’s like we’re Hollywood squares, right? Nine, you know, three by three is nine.
So yeah, I just don’t see it as being all that complicated, especially in this era where people could pull out their phone and reallocate and it’s just not that big of a deal. That’s just my take.
00:38:40 Jon Luskin: I’m going to find to agree. I don’t think it’s that complicated either. And that’s why when I first started working with do-it-yourselfers, this is something I would suggest, but wouldn’t having done this for a few years now and working with hundreds of folks, folks are coming back to me and then they come back and I see they’re not maintaining their portfolio. So I guess my question is, if you guys are doing follow up engagements in your own practice, do you see that folks are successfully maintaining this sort of asset location investment approach?
00:39:05 Cody Garrett: When I’m working with clients, I’m not just looking at the potential complexity of their situation financially, but I’m also really gaining an understanding of their financial literacy. Also, you’re not just the time that they’re willing to spend on this, the talent that it takes to like click the buttons and make those trades and rebalance. Maybe we have our own calculator for that. But also the temperament, like sometimes I’ll work with one, you know, one spouse is a spreadsheet spouse and the other one is like, I don’t even understand any of this stuff.
Like, I mean, I really think about the long-term play, but most clients I work with, they come back annually, right? The plan, you know, goes from a noun to a verb ongoing, this planning. Yeah, if somebody were only going to work with me once and I was like, I knew, you know, they’re never coming back again. I’d be very hesitant to give them complex stuff that they might not be able to keep up with. If they’re not already doing that in their spreadsheets to begin with.
00:39:48 Sean Mullaney: I will also say, I have this little saying that life itself tends to be a rebalance. I think sometimes in the financial planner world, we overemphasize rebalancing. So what I mean by that is, if stocks are up this year and bonds are down, well, just wait till next year. It’ll correct itself and/or distributions, right? It’s rare that our portfolio is just sitting there. It’s either getting contributed to or being distributed from.
So you have, you know, what the tide comes in, the tide goes out. You have contributions being made, and then later in life you have distributions made. You have all these different mechanisms that can help achieve rebalancing. For those investors who want to be 80-20, 70-30, 90-10, 60-40, how often do they go a hundred to zero? I’m just not seeing this as being that big of an issue in the financial planning space. That’s just my take.
00:40:45 Cody Garrett: Yeah, and that idea of dynamic rebalancing. So if you’re contributing or taking money out of your portfolio, you can naturally get closer to that ideal asset allocation across your total portfolio. And yeah, I think it does take a little bit of time, temperament and talent, but yeah, just be careful. You’ll really have clarity before you can gain confidence with the advanced tactics.
00:41:04 Jon Luskin: Thank you for joining us for the 89th episode of the Bogleheads® on Investing podcast. For more from Sean and Cody, make sure to check out our previous episodes of the Bogleheads® on Investing Podcast and Bogleheads® Live. We’ve got an episode where Sean talks about the solo 401(k) or the individual 401(k) for solopreneurs. And we’ve got an episode with Cody where he talks about tax planning for early retirees. I’ll link to those in the show notes for folks to check out.
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