Tax Myths And Rules App

This is the 11th exercise in a series designed to walk you through an entire financial plan.  The exercise is embedded in an Excel spreadsheet you can download and save for personal use.  If you haven’t yet, please read the posts divulging the 5 Tax Myths and the 5 Tax Rules.  If you have, you’re ready to jump into the exercise with the short explanation below:

Tax Myths & Rules

Put your own tax acumen to the test by reviewing each of the Tax Myths and Rules to see how well you’re avoiding and applying them in your life.

With the aid of this spreadsheet, you’ll be able to examine your own posture toward each of the five tax myths and rules.  You can then determine what actions you can take to avoid letting tax implications lead instead of follow in your financial planning.

Click HERE to access the Tax Myths & Rules App!

The REAL Roth Story

There’s a battle underway in the financial realm. Those taking sides are academics, financial planners, personal finance bloggers and reporters as well as do-it-yourself investors. One side is from the country of Roth and the other, Traditionale (please read that with a French accent). At stake are your opinion and the home of your investment dollars. Who will win—the Roth IRA or the Traditional IRA?

You’ve probably heard or read something similar to this next statement regarding your prospective decision to contribute to a Traditional IRA or a Roth IRA:

If you expect to be in a higher tax bracket in retirement than you are today, contribute to a Roth IRA. If, instead, you are likely to be in a lower tax bracket in retirement, contribute to a Traditional IRA.

By this logic alone, if your tax bracket would never change, there’s virtually no difference between the two. But, like many personal finance one-liners and rules-of-thumb, this one falls woefully short of giving you the whole story.

Which is better—a dollar in a Roth IRA or a dollar in a Traditional IRA? As long as you’re expected to pay taxesi  the answer to this question is always – 100% of the time – the dollar in the Roth. This is because the Roth allows you (and your heirs) tax-free growth AND distributions free of taxes. The dollar in the Traditional IRA, on the other hand, is subject to taxation whenever you (or your heirs) remove it. So, if you’re in a 25% tax bracket, your Traditional IRA dollar is actually only worth 75 cents.  The higher your tax bracket, the less your Traditional dollar is worth.

So, what’s all that stuff about the Traditional being better if you’re in a higher tax bracket today than you expect to be in retirement? In order for that logic to work, we must assume you take the extra cash on hand, born from your tax deduction specifically associated with your Traditional IRA contribution, and invest it for your future retirement.  If you make a $5,000 contribution to a Traditional IRA and you’re in a 25% tax bracket, your deduction should be worth $1,250. In order for the Traditional to benefit you more than a Roth, you must not only to be in a lower tax bracket in retirement, you also have to save that additional $1,250 for retirement. But what do most people do with their tax refund? SPEND IT!

What if you use your refund as a down payment on a car or for a vacation? The Traditional edge is eliminated. What if you didn’t receive a refund at all? Unless you write a check to invest the amount you should have received as a deduction for your Traditional IRA contribution after you write Uncle Sam a check, the Roth wins.

One of the great frustrations in financial planning is that most of the planning is based on assumptions of things we can’t actually control or change—annual income, inflation, market returns and, of course, taxes. So, you can contribute to a Traditional IRAii, calculate the proportionate amount of tax deduction and invest itiii —every year—and then hope the $14 Trillion deficit and a wave of increased entitlement spending somehow doesn’t lead to tax increases OR you can take control of one of those factors and pre-pay your taxes using a Roth IRAiv.

Still thinking????


iThat’s where the Turbo Tax prompter would say, “Most people will fall into this category.” 

iiBy the way, if your company offers a retirement plan (like a 401k) and you make over $66,000 (in 2010 or 2011) as a single individual or $110,00 as a couple, married and filing jointly, you can’t DEDUCT your contribution anyway!  

iiiOf course, if you’ve maxed out your IRA contribution, you also have to invest the tax deduction proceeds somewhere else—likely in an account requiring you to pay taxes on interest, dividends and capital gains as they’re realized.  

ivIt’s quite possible that the most attractive features of a Roth don’t have anything to do with taxes.  Unlike a Traditional IRA or a 401k, a Roth allows you to take back your contributions at any time, at any age, for any reason without paying taxes or penalties.  Furthermore, you’re not required to take Required Minimum Distributions from Roth IRAs—ever.  So, unlike a Traditional IRA which forces you to accept fully taxable income after you reach your 70 ½ birthday, your money continues to grow in a Roth unimpeded.

Prolific Procrastination, Financial Time Travel…and the REAL Reason the Government Lets Us Do It

Even if you’re a prolific procrastinator, you can still make the most of your tax situation for 2010…even though it’s 2011.

Back to the Future That’s correct!  The government lets you go back in time—financially speaking—to take advantage of 2010 opportunities all the way through April 18, 2011.  For example:

  • If you’re an individual with earned income in 2010—or even the spouse of an individual who had earned income in 2010—you should be able to make a contribution to an IRA right now and label it a 2010 contribution.
  • If you’re an individual who made less than $56,000, or a married couple who made less than $89,000, you are able to make that contribution—and deduct it on your taxes, a single act that will decrease your taxable income for 2010 and increase your retirement savings for the future. 
  • If you’re under 50, you can contribute $5,000 per person—if you’re 50 or older, they let you drop in $6,000 per person.  If you fall under those income limits, you can pull money right out of Uncle Sam’s hands and drop it into your retirement account—not a bad deal.
  • If you made more than the aforementioned deductible IRA limits, but less than $105,000 as an individual or $167,000 as a married couple, you can instead exercise the option to contribute to a Roth IRA.  In this case, you won’t improve your tax refund or payment for 2010, but you will never again pay taxes on that money as long as you…and your kids… and maybe even your grandkids live (assuming, of course, the government doesn’t go back on its word… which it would never do… right?).
  • If you happen to be a business owner who had a great year in 2010, you may be able to legally “hide” up to $49,000 of your net profit (after expenses, not taxes) from the roving eye of the IRS in a SEP IRA.  

To what do we owe the pleasure of these little extensions?  When, you ask, has the IRS been known to make life easier on us?  The answer is this…they’re sending us a message.  The message is: WE don’t want to take care of you in retirement, so we’ll make it easier for YOU to do it YOURSELF.  

When the IRS let’s us go back in time, we should take advantage of it.

Wag The Dog

Let’s face it: the topic of taxes is just… plain… boring!  Boring, but IMPORTANT.  Here’s the most important rule to remember about taxes in your personal financial planning in the least boring way I could muster.

From The Financial Crossroads Chapter Thirteen of, Wag the Dog:

There is an alien in our house.  Even though we willingly invited this being into our midst when it was very young, it’s become abundantly clear that it does not fully understand the cultural norms of the human realm.  For example, when left to its own devices, it will pillage our human food stores even though it subsists on its own specialized alien food.  It seeks to re-create the style and substance of our outdoor landscaping by relocating the dirt and mulch of our purposefully designed flower beds onto our sidewalks, and creating anew trenches and holes in parts of our yard that were previously flat and covered with grass.  And despite our munificent creation of an alien habitat inside of our home, it seeks to live in, and often bring destruction to, our human habitat, furniture, and creature comforts.  It’s…a dog.

Tim’s dog can’t catch a Frisbee with her mouth, but tries with her paws!

She is, as much as it pains me to say it, our dog, and unless she hears Jack London’s Call of the Wild, she will be for quite some time because she’s still only a puppy.  She was a shelter puppy—an adorable, lovable mix between a German Shorthaired Pointer and a Labrador Retriever (at best guess).  An especially strong case can be made for the pointer, because as she grew, she became so tall and lanky that her youthful coordination simply couldn’t keep up with her growth.  The result was an hysterical few months of physical comedy.

After a February winter storm, she looked like Bambi scrambling to find her footing on the ice-covered snow.  If she made it up a flight of stairs, she’d have to be carried down to avoid tumbling over her stilt-like legs.  And her tail grew to a point where it seemed to double her overall length.  That tail is a weapon capable of clearing off an entire coffee table.  And she’s so annoyingly happy that her tail is always in motion.  I have, on more than one occasion, seen her lose control of her overjoyed tail, collapsing her entire awkward frame into a heap on the floor.

“Don’t let the tax tail wag the dog.”  In college, I heard that quote for the first time from the professor that made the greatest impact on me in those years, Dr. Daniel Singer.  He was—and is—that professor that unnerves students because he’s not predictable.  One semester, he’d teach a class with three tests and two quizzes in between; the next semester, your entire grade was based on only one presentation.  But it was his unpredictability, his passion, and his depth of conviction that drew me to him, and I aimed to take as many of his classes as possible.  It is now my privilege to teach alongside Dr. Singer as an adjunct faculty member at the university from which I graduated.

Dr. Singer would not claim to have been the first ever to say, “Don’t let the tax tail wag the dog,” but to me, in my junior year of college, it was groundbreaking, and it still is.  Too many people, too often, make poor economic decisions because their judgment is clouded by tax concerns.  In most financial decisions, the tax consequences are a secondary or tertiary—at best—consideration.  Drew Tignanelli, a Certified Public Accountant and Certified Financial Planner™ practitioner with 30 years of experience balancing tax planning within the framework of good financial planning put it to me this way: “First, forget about taxes!”

How could he make such a claim?  It’s not because he sees taxes or tax planning as irrelevant or unimportant.  He simply recognizes that in the realm of personal financial planning, you should make decisions first based on the wisdom of the investment, insurance, retirement, or estate planning strategy, and then take a look at the taxes.