People hold strong opinions on this topic so I wont delay in making my point. I firmly believe my children should be insured for the same reason my wife and I are insured – to protect income. You see, my wife would be emotionally unable to work for several years if my child died and I’d like to take a year off from work to spend time with the family. Our hearts would be torn to shreds and we’d need time to focus on each other. Everyone’s financial arrangement is different and I’m not suggesting all children should be insured, but I do believe this is overlooked by many.

Life insurance options for children are more limited than for adults. Term policies aren’t available so you can decide between whole life and universal life. There are several flavors of whole and universal available but I’ve chosen variable universal life (VUL) for each child. There are a lot of misnomers about universal life policies so allow me to explain how my policies operate.

Each of these policies have a $250K face amount. I currently pay between $780 and $840/year for each policy. It’s important to note that premium is not equivalent to cost. Over the first 20 years I’ll pay $16K in premium per policy, but contract charges are expected to amount to $6K. I’m contributing more in premium than contract charges amount to, which allows for cash value to accumulate. The cash value is then invested predominately in equities. My policies have variable death benefits, meaning the face amount and any cash value would be paid out. Most polices have a fixed death benefit that provide $250K as long as CV is under this amount.

Another way of assessing cost is calculating the opportunity cost of premiums being invested in a traditional investment account. Assuming the same net-investment rate of return the opportunity cost is about $10K over the first 20 years. Cash value in the life insurance policies is expected to grow to $22K in 20 years and within a traditional investment would grow to $32K. Opportunity cost amounts to more than $6K because a traditional investment doesn’t share the same fees as these life insurance policies. If you don’t consider the $500 average annual opportunity cost worthwhile, this probably isn’t the product for you. For now, I consider this worthwhile since it could make the difference between retiring my wife and going bankrupt. Mourning the loss of a child on top of financial stress seems like a bad combination. I’ll reconsider these policies if our financial situation ever changes enough that we have the financial means to retire within the next 20 years.

It’s also worth mentioning that I’ve opted to pay additional for a guaranteed increase option rider. This allows the face amount to increase by $100K on 10 different occasions, meaning the face value has the potential to increase to $1,250,000. It could allow them to protect their future spouse and children if they develop health issues later in life. This is definitely an emotional purchase. It pains me to see parents with health complications who’re unable to purchase the amount of insurance their family needs. I’ll encourage my children to apply for term policies as soon as they begin their careers. If they’re healthy and able to lock in term insurance I’ll drop this rider (and possibly the entire contract) but for the time being it’s costing me about $50/yr. on each policy.

To help wrap your head around fees, let’s dig deeper into costs – this is no simple matter. There are several different fees within these policies that add up to the previously mentioned amount. Some fees are fixed and some are variable. I’ve pulled the information on fees from my most recent purchase for my youngest child. As you’re reading through these you need to remember this is insurance and it provides a death benefit that traditional investments don’t. VUL insurance isn’t an efficient investment but traditional investments don’t provide a $250K benefit when you die.

Type	How it’s Calculated	First 20 Year Cumulative Costs
Premium Charge	5% of premiums	$780
Basic Monthly Charge	$7.50 per month	$1,800
Monthly Unit Charge	$0.01 per $1,000 of face amount	$600
Mortality & Expense Charge	0.70% – 1.10%/yr. of Cash Value	$546
Cost of Insurance	$0.15 – $999.96 per $1,000 at risk	$1,317
Optional Guaranteed Increase Rider Charge	$0.36 – $2.52 per $1,000 of rider amount	$975

If I wanted to increase premium the only change to fees would be the premium charge and mortality and expense charge. All other fees would remain fixed, so there’s an economy of scale to funding these with higher premiums. Long ago universal life policies were being highly leveraged by the wealthy because growth is tax deferred and death benefit was not taxed. The federal government decided to pull in the reins and limit how much premium can be made to these before policies lose some of their tax benefits.

My current objective with these policies is to provide peace of mind for $500/yr. This could turn out costing more though. Insurance companies have the option to increase fees if they deem necessary. I don’t like giving away control of my money when I can avoid it but it’s currently the best way of protecting my wife’s income. These policies will offer a few options in future years but I’ll likely either max fund them to make them as efficient as possible or cash them out and exchange them for term policies when my children are eligible to buy this coverage.

Variable universal life policies can be difficult to wrap your head around. It took me a couple of years to warm up to them and I completely understand people’s hesitation to these. Term policies are popular because they are simple and you know what you’re getting. Simplicity is important, and complexity isn’t always better. I’m a big proponent of term policies but term isn’t an option for infants and missing out on $10,000 over 20 years won’t break the bank, but being unable to work might.

Healthcare is a major socioeconomic issue for the Unites States and a hot topic within the political arena. This is for good reason. In 2019 U.S. healthcare costs increased 4.6% to $3.8 trillion or $11,582 per person – amounting to 17.7% of Gross Domestic Product (GDP). In the 60’s the cost of healthcare was closer to 6% of GDP. This increase seems largely the result of an aging population but I’m far from being an expert on this topic and realize there are many factors at play. Many people are concerned about and challenged by healthcare. I live in a relatively low-income area so I began taking an interest in government subsidized health insurance to learn if there’s any way I can help those struggling. What I discovered is worth sharing.

I live in rural Minnesota (for now), which is just one of two states providing a basic health program permitted by the affordable care act – New York also provides this. In 2019 just under 20% of Minnesotans were covered by Medicaid and only 1.35% of Minnesotans were covered by the basic health program. Nationwide, about 22% of people are covered by Medicaid.

The Affordable Care Act changed Medicaid qualification to be based on Modified Adjusted Gross Income (MAGI). “MAGI is the basis for determining Medicaid income eligibility for most children, pregnant women, parents, and adults. The MAGI-based methodology considers taxable income and tax filing relationships to determine financial eligibility for Medicaid. MAGI replaced the former process for calculating Medicaid eligibility, which was based on the methodologies of the Aid to Families with Dependent Children program that ended in 1996. The MAGI-based methodology does not allow for income disregards that vary by state or by eligibility group and does not allow for an asset or resource test.” – https://www.medicaid.gov/medicaid/eligibility/index.html

MAGI is the sum of your adjusted income. There are specific income sources and income adjustments used in calculating this. For most people, income will consist of wages, interest, dividends, IRA distributions and social security. The Affordable Care Act, however, allows for numerous income adjustments such as contributions to health saving accounts or deductible retirement accounts. (See full list here)

I briefly checked the MAGI limits in Minnesota and in New York for comparison. There were slight differences so be sure to confirm these numbers with your state. Here are the 2021 MAGI limits for Minnesota.

Size of Household	MAGI for Adults	MAGI for Children
1	$16,970	$35,090
2	$22,929	$47,410
3	$28,887	$59,730
4	$34,846	$72,050
5	$40,804	$84,370
6	$46,762	$96,690
7	$52,721	$109,010
8	$58,679	$121,330

Most people can’t cover bills with such little income allowed by Medicaid but there are circumstances that make this possible for a temporary period of time – especially if you live in a low-cost area and have little debt. I’m a family of 5 and I recently started tracking my expenses. It’s too early to say with complete certainty but it appears I could live off $30 – $40,000 without debt payments.

Imagine a married couple under age 50 who each have access to a 401(k) through work. They’d each be able to contribute $19,500 to a 401(k) and $6,000 to an IRA (depending on their income). If they have access to group health insurance through their employer, Medicaid would likely have them enroll in the plan and reimburse premiums. In this arrangement it’s possible to have access to an HSA, which could provide up to $7,200 in potential deductions. All in all, this married couple could have access to $58,200 in deductions between retirement and health saving accounts. In the right situation insurance premiums can be exchanged for contributions to retirement and health savings accounts. Although it’s likely not sustainable to remain on Medicaid for an extended period of time, it could provide a temporary boost to retirement and health savings accounts when the stars align.

Being young is challenging. There’s a lot of things pulling at the purse strings in your 20’s. Student loans, vehicles, houses and children make it difficult to contribute to retirement accounts. Yet, time value of money shows us the importance of establishing investment accounts early on. Think of the long-term impact of living a simple, inexpensive life early in your career and exchanging insurance premiums for 401(k) contributions. Aggressive contributions to retirement accounts early in life can reduce how much you need to save in future years.

I spoke with someone about this concept who expressed concern that Medicaid allows states to place estate liens for medical expenses. This being a major consideration led me to explore this concern. In my research I discovered this only applies in certain situations.

“State Medicaid programs must recover certain Medicaid benefits paid on behalf of a Medicaid enrollee. For individuals age 55 or older, states are required to seek recovery of payments from the individual’s estate for nursing facility services, home and community-based services, and related hospital and prescription drug services. States have the option to recover payments for all other Medicaid services provided to these individuals, except Medicare cost-sharing paid on behalf of Medicare Savings Program beneficiaries.

Under certain conditions, money remaining in a trust after a Medicaid enrollee has passed away may be used to reimburse Medicaid. States may not recover from the estate of a deceased Medicaid enrollee who is survived by a spouse, child under age 21, or blind or disabled child of any age. States are also required to establish procedures for waiving estate recovery when recovery would cause an undue hardship.

States may impose liens for Medicaid benefits incorrectly paid pursuant to a court judgment. States may also impose liens on real property during the lifetime of a Medicaid enrollee who is permanently institutionalized, except when one of the following individuals resides in the home: the spouse, child under age 21, blind or disabled child of any age, or sibling who has an equity interest in the home. The states must remove the lien when the Medicaid enrollee is discharged from the facility and returns home.” – https://www.medicaid.gov/medicaid/eligibility/estate-recovery/index.html

I’m not an attorney and I encourage you to research with your state, but the State of Minnesota provides a clearer statement on their website. Note that Medical Assistance (MA) is the term for Medicaid in Minnesota.

“Estate recovery applies to MA members who: 

• at 55 years old or older receive MA long-term services and supports (LTSS)
• at any age permanently reside in a medical institution and receive MA services 

If either of these situations occur, a local agency must claim against an estate after the MA member dies to recover what MA paid for LTSS. In addition, if the MA member was permanently institutionalized, the claim must attempt to recover the costs of all MA services (not just LTSS) that the MA member received during the period of institutionalization.” – https://mn.gov/dhs/people-we-serve/adults/health-care/health-care-programs/programs-and-services/estate-recovery.jsp

My interpretation is that Minnesota’s estate recovery only applies in the case of permanent residency in a medical institution and for people over age 55 who receive long term services. I spoke with a social services employee in my county that agreed with my understanding of this. That being said, she is a case worker, and not an attorney. The Affordable Care Act has the potential to provide a temporary boost to your retirement accounts, but make sure to research the estate recovery program with your state before jumping on the train.

I hesitated to share this information because I don’t want to come across as encouraging people to leech off the government, but I didn’t write the rules and am just the messenger.

All DIYers must understand taxes because it offers some of the greatest areas for improvement. Tax treatment of retirement accounts is different than non-qualified accounts. Retirement accounts are subject to federal and state income taxes. Taxation of non-qualified individual and joint accounts is more nuanced. These accounts will likely generate dividends or interest income as well as capital gains. Dividends are taxed differently depending if they are qualified or ordinary. Capital gains are taxed differently depending if they are short term or long term.

Federal Income Tax: Not all income is taxable. We receive income adjustments and deductions which reduce the amount of income subject to income taxes. To discuss the possible adjustments and deductions is beyond the scope of this post. One deduction worthwhile mentioning in this post is the standard deduction. Whether you’re single or married, rich or poor, standard deductions represent an amount of income that’s not taxed.  The standard deduction amount in 2019 is $12,200 for single taxpayers and $24,400 for married filing joint taxpayers (MFJ). You can choose to itemize your deductions if they exceed standard amounts but few people do this.

Income net of adjustments and deductions is referred to as taxable income, and is progressively taxed in tiers called brackets. As it stands today, there are 7 brackets ranging from 10% to 37%, as such:

• 10% for incomes of single individuals up to $9,700 and up to $19,400 for MFJ.
• 12% for incomes of single individuals over $9,700 and over $19,400 for MFJ.
• 22% for incomes of single individuals over $39,475 and over $78,950 for MFJ.
• 24% for incomes of single individuals over $84,200 and over $168,400 for MFJ.
• 32% for incomes of single individuals over $160,725 and over $321,450 for MFJ.
• 35% for incomes of single individuals over $204,100 and over $408,200 for MFJ.
• 37% for incomes of single individuals over $510,300 and over $612,350 for MFJ.

Income is taxed according to the bracket it resides. For instance, a married couple with a taxable income of $200,000 would be taxed in tiers as follows:

Bracket	Taxable Amount	Amount of Tax Owed
10%	$19,400	$1,940
12%	$59,550	$7,146
22%	$89,450	$19,679
24%	$31,600	$7,584
Total	$200,000	$36,349

The couple in this simplified scenario paid a cumulative amount of $36,349 in federal income tax. The cumulative tax could be reduced by tax credits if they qualified for any but this is outside the focus of this post.

If this couple had decided to make contributions to an investment account they would most likely receive deductions for contributions to traditional retirement accounts (assuming no effect from income limits). Contributions to roth and nonqualified accounts would have no effect on taxable income.

State Income Tax:  Most states tax their resident’s income progressively, like the federal government does. These tax brackets are specific to the state and I encourage you to research them. Keep in mind there are seven states that don’t tax income and 11 that impose a flat tax. Prior to 2018 state taxes were deductible from federal taxable income but this was changed with the tax cuts and jobs act.

Taxation of Interest: Most interest will be taxable as income the year it is received or credited. There are a handful of exceptions but these are beyond the scope of this article and will be addressed in a future post.

Taxation of Dividends: Ordinary dividends are taxed as income the year they’re paid out. Qualified dividends are taxed at capital gains rates. This could turn into a lengthy conversation but I’ll only briefly address this. For dividends to be qualified they must meet the following three specific criteria:

• “The dividends must have been paid by a U.S. corporation or a qualified foreign corporation.”
• They are not specifically excluded from being qualified according to the IRS.
•  You meet the required holding period as specified by the IRS.

It’s not uncommon that dividends are qualified and subject to capital gains rates but this is best-case. Worst-case they will be taxed at income rates.

Capital Gains Tax: The sale of capital assets could generate capital gains. These are either classified as short term or long term. This is another topic that could turn into a lengthy conversation. Generally speaking, an asset is considered short term if it was owned for less than one year. Short-term capital gains are taxable at ordinary income rates. Long-term capital gains are taxed at progressive rates and will either be 0%, 15%, or 20% depending on your taxable income. The capital gains rate is directly related to your ordinary income bracket as such:

•  0% tax for the amount of gains that fit in the first two income brackets, including other income. 
• 15% tax for the amount of gains that fit in the 3^rd – 6^th income brackets, including other income.
• 20% tax for the amount of gains that fit in the top income bracket (currently 37%), including other income.

For instance, let’s imagine a married couple with a taxable income of $60,000. Imagine they sold appreciated stocks which generated $25,000 in long-term capital gains. For calculation purposes, the IRS will take into consideration the amount of taxable income for the year and tax capital gains as follows:

• 0% owed on the amount of gains fitting in the 10% and 12% ordinary income bracket. The top end of the 12% bracket is $78,950. The amount of gain subject to 0% tax can be calculated the following way: $78,950 – $60,000 = $18,950 taxed at 0%.
• 15% owed on the remaining gains in excess of the first two brackets. If $18,950 of their $25,000 gain fit into the first two income brackets, this leaves $6,050 to be taxed at 15%. The total capital gain tax owed from this transaction would be $908.

As you can gather from this discussion, non-qualified accounts are generally taxed at lower rates than ordinary income rates. That being said, the value of retirement accounts comes from tax-deferred growth and the limited control they provide in manipulating taxable income. Investment growth in retirement accounts is sheltered from tax until withdrawals are made, unlike non-qualified accounts that are taxed the year gains occur. Although, as you noticed from the information provided above, taxes on non-qualified accounts can be modest. Generally speaking, you don’t need to be afraid of taxes on non-qualified accounts.

This isn’t a comprehensive guide to taxation but is important to understanding taxation. Understanding this information and being cognoscente of how taxes impact your current and expected situation allows you to plan and potentially reduce your tax liability. The practical application of this information is to optimally manage account allocations and being intentional with asset location, as will be discussed in an upcoming post.

Assets, including investment accounts, are taxed differently depending on their type. Taxation is a complex topic but is discussed in greater detail in Tax Knowledge is Table Stakes: An Introduction to Taxation of Income, Interest, Dividends, and Capital Gains. Understanding specific tax implications is helpful, but for the moment let’s consider how the timing of these will transpire throughout your lifetime. All your assets, including investment accounts, are taxed in one of three time periods. They are either being taxed annually, will be taxed in the future, or have already been taxed and will never again be taxed. 

Tax Annually: Investment accounts subject to annual taxation include individual and jointly owned nonqualified accounts. These accounts generate interest, dividends and capital gains, each of which is taxed differently. The reason these are considered annually taxable is because growth is not subject to tax deferral. Interest, dividends, and capital gains are taxed in the year they occur.

Tax Later: There are several versions of accounts that benefit from tax deferred growth. Since taxes are deferred, future withdrawals are often taxable. There are several versions of these accounts but the most common types include traditional IRAs, and employer sponsored retirement accounts such as 401(k)s, 403(b)s, and 457(b)s. Contributions to these accounts are usually deducted from income but future distributions from these accounts are considered income and subject to ordinary income tax.

Tax Never Again: Accounts that are never again taxable include Roth accounts such as Roth IRAs, Roth 401(k)s or Roth 403(b)s. Contributions to these accounts are not deducted from income. The trade-off being non-taxable distributions in future years. This is true for contributions to these accounts, as well as investment growth.

Knowing the tax diversification of your assets is important. As you’re taking inventory of your personal assets, you would be well served to consider how you’re diversified among these categories. The mistake I notice many people making is funneling the majority of assets into accounts that will become taxable in future years. It’s important to understand your options and the future tax implications of each because you have some choice in the extent to which you utilize each account type. Having the majority of your assets in tax deferred accounts isn’t always problematic. The precise timing these assets will become taxable is also important, but considering your general arrangement will help to gauge how closely this needs monitoring.

During a recent family gathering, some of the pre-retired folk began sharing their wisdom about social security – a timely topic for them. They were sitting among a circle of chairs in the living room, while sipping their black coffee. I was on the sidelines of this conversation tending to my sugar-crazed kids, but did my best to tune an ear to the conversation. Those engaged in the discussion were commenting on the social security benefit calculations they’ve ran and collectively decided it didn’t make sense for anyone to delay this benefit. Their rationale being “you have to live to 85 years of age before you break even”. I found humor in the conversation because their conclusion was predictable.

My family’s approach at comparing cumulative lifetime benefits is classic, and the same as the vast majority of people. When calculating cumulative benefits, most people are using pen and paper and ignore the impact of cost of living adjustments (COLA). Let’s explore the lifetime impact of this for someone with a $1,500 benefit at full retirement age. The numbers below were calculated using a social security planning tool. Technology is our friend.

Claiming Age	Age of Death	0% COLA	1.5% COLA	2% COLA
62	85	$292,581	$396,260	$438,928
70	85	$338,520	$484,944	$546,537
	Difference	$45,939	$88,684	$107,609

When accounting for COLA, the cumulative benefit from delaying social security becomes much more substantial. Even so, the truth of the matter is gross cumulative social security benefits often aren’t the most important metric to base this decision. The timing of social security is important but of greater importance is how this annual income fits into your overall plan.

It makes sense to want the most money possible from social security, but people allow emotion to influence this decision. The fear of losing out on income in the event of a premature death becomes more influential than the potential benefit of delaying social security. My encouragement is to remove emotion from this decision and instead, direct your attention to your long-term plans. The most important consideration when deciding what age to elect social security is how complementary this income is to your current and future income expectations. To determine the best timing for social security requires knowing your future plans.

The importance of social security varies greatly. For some it’s the backbone of retirement income and essential to make ends meet. For others, social security income is pure gravy being spent on non-essential extras. The more depended you are on social security, the more critical this irrevocable decision. If you’re dependent on social security to make ends meet and are unable to continue working you should claim benefits, assuming the inability to work isn’t temporary. There’s no sense delaying benefits if it means defaulting on your mortgage. If this is your situation, you really don’t have a choice.

Those who have a choice in the matter need to weight their options. To do this you first need to understand that social security is taxable income. The amount of benefit that’s taxable depends on your overall income, known as combined income. To determine combined income, add half of your social security income to all other income, including tax-exempt interest. The amount of social security benefits that’s taxable depends on combined income and filing status, as follows:

Taxable Benefit	Single Combined Income	Married Filing Joint Combined Income
Up to 50% of SS benefits	Between $25K – $34K	Between $32K – $44K
Up to 75% of SS benefits	More than $34K	More than $44K

You can elect social security between age 62 and 70. When weighing your options, consider your overall income during this time. One of my relatives involved in the social security discussion at the family gathering is in the process of selling a business and transferring ownership of another business to his children. I haven’t a clue how this will contribute to his taxable income but imagine these will trigger capital gains. This is an extreme example of why it could make sense to delay social security but my point is to consider what your income will look like during this window of time. There may be reasons for not wanting additional taxable income. When considering the impact of social security income, keep in mind federal and state income tax brackets, capital gains tax rates, and income limits on subsidized health insurance.

Those considering social security benefits are likely retired from their careers, and most won’t have a business to sell. More commonly, other income during retirement is coming from investments. If you were to delay social security and instead withdraw from investments, what would this look like? Would these accounts be depleted?  How would withdrawals from these accounts be taxed? How would this affect future income sources in terms of taxation, reliability, and continuation to your spouse after death?

Retirement planning consists of mapping out current and future finances and attempting to minimize taxes, reduce unnecessary expenses, and control risks. When planned properly, the likelihood of a successful retirement is enhanced. Many decisions can be mathematically solved for on an individual basis, but the equation is never the same for everyone, and never as simple as comparing gross lifetime social security benefits.

Buying life insurance is usually a selfless act, intended to allow your family to maintain their standard of living so they aren’t burdened financially while simultaneously grieving your loss. If your family depends on the income from your day job, you need life insurance and should consider it a necessity to your financial independence journey. This conversation can quickly become complicated by the several different types of life insurance. The most important consideration, however, is the amount of death benefit your family will receive when tragedy strikes, which is the focus of this post. There is no rule of thumb that works for everyone. The proper amount depends on what you want for your family.

My first time purchasing life insurance was not a positive experience. The agent I met with plugged some numbers into his computer and told me I needed a $350,000 term policy. After becoming more educated on the topic a few years later I was furious he risked the well being of my family by recommending such a small amount. My beloved bride and children would have been broke in less than 7 years. Now days I have nearly 6x the coverage originally recommended by this agent, albeit my finances have changed from five years ago.

As with several aspects of personal finance, there’s a disconnect between rules of thumb and individualized advice. My family would obviously be better off with $350,000 than nothing. My issue with this experience is that I was under insured because of taking the agent’s advice. This advice must have been based on rules of thumb because he didn’t ask very specific questions. My family is fortunate I didn’t die during this time. You should avoid any agent who recommends you buy a specific amount of insurance without first determining your intent for the insurance.

I’ve spoken with several people about their intent with life insurance proceeds and the spectrum of conversations have ranged from wanting to cover their funeral expenses to being able to retire their spouse for life. There’s no rule of thumb that covers such a wide spectrum of intent.

This is a topic that can be quickly over analyzed but I’ll do my best to simplify the conversation. I like acronyms because they can help make concepts more memorable. The acronym for life insurance is LI. According to Google, this is also an acronym for laughing inside. Since this is a somber conversation I doubt any of you are laughing inside. The purpose for life insurance proceeds is typically to pay off loans and replace income. The acronym for loans & income also happens to be LI. In other words, the primary purpose for LI is LI.

L is for Loans: First, tally up your debts and write this number down. It will likely be advisable for your spouse to pay off debts, especially consumer debts. Paying off mortgages can be debatable but life is simpler and less stressful without debt.

I is for Income: Next, calculate the present value of the future income you want to provide your family. This is determined by deciding how much annual income you want to provide, and for how many years you want this to last. Using these figures and also assuming an average investment and inflation rate is all you need to calculate this present value.

Crunching numbers to calculate the present value of this future income can get a little messy. I’ve attempted to make the next steps in this exercise as simple as possible by providing a chart for reference. The intent for the chart is to help you easily determine the amount of death benefit required to provide future income. My approach at simplifying this exercise consists of providing one number in which to multiply the desired annual income. The idea being that anyone could quickly calculate an appropriate amount of life insurance based on sound mathematical and financial principals.

To use this table you must decide how many years you want to provide income, as shown in column A. As you’ll see, I’ve chose to illustrate this in five year increments. After choosing the number of years, you must decide whether you want future income to be static or to adjust for inflation as reflected in column B or C. The inflation adjustment is considering the years in which your family is receiving income and does not account for the years leading up to an insurance claim. In other words, if you unexpectedly die in 10 years it doesn’t account for the impact of inflation during the next 10 years while you’re alive. The inflation I’ve chose to base this calculation is 2.5%.

When you’ve decided the number of years to provide income and whether this is to be adjusted for 2.5% inflation, the hard work is behind you. Now, all that’s left to do is multiply the annual amount of income you want to provide your family by the corresponding number in this table.

Consider an example of someone who wants to provide $50,000 annual inflation-adjusted income for 15 years. The calculation for this would be $50,000 X 12.7 = $635,000. If this person wanted to provide a static $50,000 for 15 years the calculation would change to $50,000 X 10.9 = $545,000.

Behind the scenes, I’ve used excel to calculate the discounted value of future income, then converted the discount rates into multiples. I’ve assumed a 5% average rate of investment return and 2.5% inflation. The math is sound and cannot be argued. What is debatable is the assumed investment return and inflation rate. I consider these reasonable assumptions but actual results could be higher or lower.

(A) No. Yrs. Income	(B) 0% Inflation Income Multiple	(C) 2.5% Inflation Income Multiple
*5	4.8	5.1
*10	9.2	10.2
15	10.9	12.7
20	13.1	16.1
25	14.8	19
30	16.1	21.6
35	17.2	23.9
40	18	26
45	18.7	27.8
50	19.2	29.4
55	19.6	30.8
60	19.9	32.1

* The table above provides linear calculations but markets don’t provide linear returns. Due to the unpredictable nature of these returns, you shouldn’t heavily rely on them for any time horizon under 10 years. Throughout history there have been decades with substantially varying market performance. For this reason it’s best to consider potential investment gains a bonus to your family and not a necessity for the income they require. Therefore, the five and ten year multiples in the table above assume 2% investment return. I know there are readers who will disagree with this approach. Admittedly, this is a conservative approach. The reality is that managing money for spend-down requires a much different approach than for accumulation. This is especially true when the spend down period is fewer than 10 years. A recession while you’re accumulating investments is an opportunity but during your spend down years is a risk. As you can imagine, it’s beneficial to buy at discounted values but harmful to sell at discounted values.

Simply add your total debts to the amount calculated for income and you’ll arrive at the proper amount of life insurance. Whatever number you arrive at, keep in mind insurance companies often provide cost breakpoints in $250,000 increments. If you calculate needing an amount slightly less than these increments, such as $925,000, it’s not only conservative to round up to $1,000,000 it might actually be the same price. Life insurance companies will also limit the number of years worth of income you can purchase. The company I’ve looked into limits the death benefit to 30 times current income but it could be different with each company.

Keep in mind this post makes specific investment and inflation assumptions. Actual results may vary so it doesn’t hurt to be conservative in your estimates. For investments to generate the assumed growth requires thoughtful management. Even then, investment returns are never guaranteed.

For the technically minded folk, here’s a full comparison of Traditional and Roth accounts. This builds off the post from last week where I discussed the main tax differences with Roth and Traditional accounts at a high level – see Roth vs Traditional: A Simplified Approach. This was an accurate comparison but it ignored several additional aspects worth considering when weighing this option. Let’s dive in.!

Income Taxes: Contributions to Traditional accounts are deductible from your income and future distributions are taxable. Alternatively, contributions to Roth accounts are not deductible from your income and future distributions are non-taxable. The Federal government progressively taxes income with 7 different tax brackets. States tax income in various ways. Most states progressively tax income but some institute a flat tax and others don’t tax income altogether. A detailed article on taxation is in the works, so keep posted for this.

Let’s briefly revisit the example provided in the last post. Imagine a 25-year-old contributing $500 monthly to a retirement account for the next 40 years. Over this time, they would have contributed $240,000. Assuming a 7% average rate of return the value of this account would grow to about $1,200,000. The same would be true for the IRA and Roth. The most common consideration when weighing the differences of these two account types is to compare your current tax bracket to your expected future tax bracket. There is some merit in this consideration but it largely ignores the breakdown between contributions and investment growth. You can choose to receive $240,000 of tax deductions during your working years and in turn have a $1,200,000 pile of taxable money or you can choose to pay tax on $240,000 during your working years and have a $1,200,000 pile of non-taxable money.

Everyone’s tax situation is different so imagine this 25-year-old is square in the 22% federal bracket. Because contributions to Roth accounts aren’t deductible from income, they would have paid 22% federal income tax on their $240,000 contributions, or $52,800. This seems like a large amount of tax and it doesn’t even account for state taxes. Because state taxes vary, we won’t address them but this exclusion won’t change the conclusion.

$52,800 in taxes is a large sum of money but it only represents about 4.4% of the $1,200,000 account value 40 years from now. In retirement, people typically make systematic withdrawals from their retirement accounts for the remainder of their lifetime. If these distributions were coming from a Traditional account and were taxable, they would be spread out over three or four decades. There’s a high likelihood the effective tax on future systematic distributions would be greater than 4.4%. Keep in mind that after 40 years when there are no longer contributions being made to this account it’s value should continue to grow, compounding this tax difference.

One Step Further: This is a fair comparison but it doesn’t tell the whole story. Roth accounts seem to be the shining star in the above calculation but let’s take this one step further before drawing any conclusion. If the 25-year-old in this example opted for the Traditional account, their federal income tax would be about $1,320 less each year contributions were made. If these tax savings were invested similarly, earning 7% average annual growth, they would grow to about $265,000, increasing the future value of your investments by 22% (imagine that!). An employer sponsored plan can accept more than $6,000 annual contributions but an IRA for people 49 and younger cannot. If this money were deposited into a non-qualified account the investments growth would likely be taxed through the years and net less than $265,000. Invested with tax efficiency in mind this could be a modest impact, but to understand this complicates the scenario beyond the scope of this article.

On a stand-alone basis and exclusively considering future account values, the benefit of Roth accounts can be largely made up for by reinvesting the tax savings provided by Traditional accounts. When considering how these accounts will play into your overall plan, however, there’s more to consider. Roth and Traditional accounts are tools. How and why you utilize these tools constitutes a plan. Let’s take a look at some planning considerations pertaining to these tools. Keep in mind some of these considerations pertain to contributions as well as distributions. It’s important to keep the end result in mind so the remainder of this post will address considerations of both.

Survivorship Income and Taxes: Income limits on tax brackets are higher for those married and filing joint returns than those who are single. In fact, the difference is two-fold. To clarify this, the first federal income bracket for 2019 is 10% for incomes of single individuals up to $9,700 and up to $19,400 for married couples filing jointly. Your bracket influences the tax rate you pay on income and affects the rate you pay on capital gains. The standard deduction is also worthwhile addressing. Whether you’re single or married, rich or poor, there’s an amount of income that is not taxable, called deductions. The majority of people claim the standard deduction, which is $12,200 for singles and $24,400 for married couples.

After the first death, the surviving spouse will almost always lose income. Additionally, the survivor will lose $12,200 in deductions if they claim the standard amount. Let’s assume the surviving spouse’ income is reduced to 80% of what it previously was because the lower of the two social security incomes was lost. You don’t have to stretch your imagination too far to realize the tax consequences of the combination of 80% survivorship income accompanied by tax brackets and standard deductions that are reduced to half what they previously were. What this can translate to is less income and higher taxes for the survivor – a one, two, punch.

Tax Control: When you defer taxes with a Traditional account you’re surrendering some future control of the taxation of these assets. The timing of future distributions as well as the tax rate applied to these distributions are both partially controlled by the government. Beginning the year you turn age 72 you’re required to begin taking annual withdrawals from these accounts, even if you don’t need the income. These distributions are appropriately called required minimum distributions (RMD). The tax rate on these distributions will depend on the bracket you find yourself in during retirement but there’s no certainty how these brackets will be structured in the distant future.

With Roth accounts, you maintain control over taxes. You’ve already paid the tax bill on Roth accounts and there is no question what the net value is. $1,200,000 is worth $1,200,000, and not some unknown amount net of some unknown tax rate. Roth accounts also avoid required minimum distributions and future distributions you make will not be considered income (as long as you follow the rules.)

Also, worth your consideration is how likely it is that our country will experience higher overall future taxes. The likelihood of this is up for debate but I fear the likelihood is high. Should this occur, I’m of the belief the middle class will not be excluded from the affects.

Qualified Charitable Distributions (QCD): The only way for tax deferred retirement account distributions to be considered non-taxable is to donate them to charity. This is an appealing way to donate surplus retirement funds. After age 72, the government will impose RMDs and people with tax deferred retirement assets will be required to make distributions from their accounts. It’s common practice for people with charitable intent to donate retirement distributions to charity to avoid taxes. This is considered a non-taxable event since charities don’t pay tax on this distribution.

Inherited IRA Rules:  When someone with a retirement account dies, this passes to their beneficiaries as an inherited account. Owners of inherited retirement accounts are still subject to RMDs. If the owner is a spouse, the RMD schedule will be based off their own distribution period.

For non-spouse beneficiaries, there’s a couple additional considerations. If the original owner was subject to RMDs prior to passing, the inherited owner will be subject to RMDs based off the beneficiary’s distribution period. If, however, the original owner died before the RMD beginning date, the non-spouse inherited owner will be required to liquidate the account within 10 years. Having to liquidate this in a short period of time could result in significant tax liabilities.

The second special consideration applies to Roth accounts. These accounts aren’t subject to RMDs unless they become inherited by a non-spouse beneficiary. Fortunately, distributions from Roth accounts most likely won’t be taxable.

Controlling Taxable Income: Social Security is a taxable income but the taxable amount depends on other income sources. Likewise, Medicare premiums and social programs such as medical assistance, state run health insurance and tax credits are often means-tested and based on your adjusted gross income (AGI) or modified adjusted gross income (MAGI). Contributions to Traditional accounts are considered above the line and can reduce your AGI & MAGI, making you eligible for these benefits. Likewise, future distributions from Traditional accounts can increase AGI & MAGI.

Special Situations: If you find yourself in a situation with temporary high income and expect this to be lower in the near future it could be beneficial to reduce income with contributions to IRAs and convert these at lower rates in the future. The most significant difference in federal income tax rates is from 12% to 22%, and from 24% to 32%. It might make sense to capture the difference in these by contributing to a Traditional account and converting these contributions to Roth when your tax bracket is lower. A conversion of these funds will create a taxable event and if the stars align it could be considered an arbitrage opportunity.

Conclusion: It’s easy to get bogged down when weighing all the considerations discussed here. The key takeaway is that a generic statement about one type of IRA being better than the other is not accurate or responsible. The matter of fact is it depends on your situation and your priorities, which can change throughout life. The reality is that a diversified approach to Traditional and Roth could be the best approach by allowing you to benefit from aspects of both account types. Also, if you contribute to a Traditional account you have the option to convert this into a Roth account in the future. This flexibility could become a part of your overall plan, but also adds to the complexity of this discussion and will be address in a stand-alone post in the near future.

My intent is not to inundate you with information without helping weigh these considerations. I want this information to be helpful and applicable to real life so allow me to provide some generalities:

Young people: The longer your money will be invested, the more appealing Roth becomes. Try making initial contributions in your early career to Roth. The exception to this is if you find yourself in a very high tax bracket, or are attempting to reduce AGI.

Single people with no expectation of ever being married have fewer reasons to consider Roth, but other aspects such as tax control could still be beneficial.

Charitably inclined people who plan to have excess assets should take advantage of deductible contributions to Traditional accounts and utilize qualified charitable distributions to avoid future tax on distributions. This is a rule that could change in the future.

If you are far enough along in life to know you’ll have a survivorship concern, the survivor will be less crippled by owning Roth assets. The financial effect of losing a spouse varies greatly and needs to be determined on a case by case basis but it certainly crosses my mind when considering my wife. This likely isn’t an exclusive reason to show favoritism to Roth accounts unless there is a known health issue.

If early retirement is in your future it’s likely you’re in a high tax bracket during your working years, live well within your means, and are making maximum contributions to retirement accounts. If this is true it could present a future window of opportunity for conversions from Traditional to Roth prior to receiving social security or RMDs. You will be taxed on money that’s converted, which could be at a lower bracket in the early retirement years.

Gifting to another person: If you plan to have excess retirement assets and gifting to another person is front of mind you should consider how your tax situation compares to your beneficiary’s tax situation. If they are younger and expected to inherit this while at the peak of their career it could make sense for the original owner to pay tax, as opposed to the inherited owner.