Harry Sit's Blog, page 24

What If Congress Bans Backdoor Roth and Mega Backdoor Roth?

A reader sent me this article on CNBC:

House Democrats propose new retirement plan rules for the rich, including contribution limits and a repeal of Roth conversions

It linked to a summary of the legislation being considered by the House Ways & Means Committee. Among other things, the summary includes these changes with regard to retirement plans and IRAs:

Furthermore, this section prohibits all employee after-tax contributions in qualified plans and prohibits after-tax IRA contributions from being converted to Roth regardless of income level, effective for distributions, transfers, and contributions made after December 31, 2021.

However, this short description doesn’t match 100% the actual text of the bill (page 686 in the PDF). A more accurate description should be:

Furthermore, this section prohibits all employee after-tax contributions in qualified plans and prohibits after-tax IRA contributions from being converted to Roth regardless of income level, effective for distributions, transfers, and contributions made after December 31, 2021.

These changes, if they become law, will effectively ban backdoor Roth and mega backdoor Roth. Specifically, effective January 1, 2022:

Traditional IRAEmployer PlanNon-Roth after-tax contributionAllowedAllowedConvert after-tax contribution to RothNot allowedNot allowed

You can still make non-Roth after-tax contributions, but you can’t convert them to Roth. This ban covers converting from a traditional IRA to a Roth IRA, rolling over after-tax contributions from an employer plan to a Roth IRA, and converting to the Roth account within the employer plan.

What should you do if these proposed changes move forward and become law?

Backdoor Roth – Catch the Last Bus

If the proposals become law, you’re still allowed to make nondeductible contributions to a traditional IRA but you won’t be allowed to convert them to Roth after 12/31/2021.

If you’re planning to do the backdoor Roth for 2021 between January 1 and April 15 in 2022, hurry up. Make the contribution for 2021 now and convert it to Roth before December 31, 2021. If you wait until 2022 to make your nondeductible contribution, your contribution will be stuck in the traditional IRA.

If you’re planning to contribute to your Roth IRA directly and there’s any chance that you will exceed the income limit for 2021 ($125,000 single, $198,000 married filing jointly), make it a backdoor Roth now. When you find you exceed the income limit, normally you can recharacterize your Roth IRA contribution to a nondeductible traditional IRA contribution and convert it in the following year but you won’t be able to do that in 2022. So go through the backdoor now.

In either case, you have to do some work to prepare for the backdoor Roth. See Backdoor Roth: A Complete How-To.

For 2022 and beyond, even if you can’t do the backdoor Roth anymore when you exceed the income limit for contributing to a Roth IRA, you can still make nondeductible contributions to a traditional IRA and invest in bonds. Bonds are taxed as ordinary income outside tax-advantaged accounts. You still get tax deferral in the traditional IRA.

Mega Backdoor Roth

If your employer’s plan allows non-Roth after-tax contributions, make sure you contribute the maximum allowed in 2021 and converting them before 12/31/2021.

For 2022 and beyond, you can still make non-Roth after-tax contributions to an employer plan but you’re probably better off putting the money in a regular taxable account.

What If the Proposed Changes Don’t Become Law?

The proposed changes are only proposals right now. Many proposals don’t become law. However, the moves in anticipation don’t have much of a downside.

Proposals Become LawNo ChangesComplete backdoor Roth before 12/31/2021$$ in Roth$$ in RothPre-emptive backdoor if possibly 2021 income over the limit$$ in Roth$$ in RothComplete mega backdoor Roth before 12/31/2021$$ in Roth$$ in Roth

In other words, they are good moves regardless. You’re only doing them a little sooner in case you aren’t allowed to do them if the law changes.

A Big Loss?

Is it a big loss if the proposed changes become law and you can’t do backdoor Roth and mega backdoor Roth anymore?

It’s a loss because tax-free beats tax deferral on earnings or the lower tax rates on qualified dividends and long-term capital gains. However, the power of saving and investing comes from making the contributions to begin with, not from how the investment returns are taxed.

A taxable account always works. In the end, even if all the tax-advantaged accounts go away and all the returns are taxed as regular income, those who save and invest more will still succeed. You take advantage of all available tax savings but you can’t stake your success on specific tax breaks.

Learn the Nuts and Bolts I put everything I use to manage my money in a book. My Financial Toolbox guides you to a clear course of action.Read Reviews

The post What If Congress Bans Backdoor Roth and Mega Backdoor Roth? appeared first on The Finance Buff.

Relocating for Retirement: Buy or Rent – Old Rules and New Rules

By now it’s obvious I botched our relocation last year. The decision to relocate was correct but I executed it poorly due to my lack of experience. I also didn’t think through all the options when I only relied on some “rules” that were either outdated or didn’t apply to our situation. In the end, my poor execution cost us $300,000.

Many people may be considering relocation for remote work or retirement. I’m writing down the lessons I learned from my mistakes.

Rent First In a New City?

We thought we should rent because we heard the rule that you should rent first when you move to a new city.

The reason behind this rule is that if you jump directly into buying, you may buy in the wrong place when you’re not familiar with the new city. Renting gives you time to figure out where exactly you’d like to settle in.

That’s all good but it introduces two problems.

The first problem is availability. It may be easier if you’re willing to rent an apartment, but if you’d like to live in a single-family home as you’re used to, far fewer single-family homes are available for rent than the number of single-family homes for sale.

These two maps from Zillow show the single-family homes for rent and for sale in my zip code. You see a big difference in available choices.

For Rent

For Sale

This isn’t a new phenomenon due to the COVID pandemic. It was like this when we were looking for rentals in 2019.

The second problem of insisting on renting first is quality. The average qualify of the homes for rent is a step lower than the average qualify of the homes for sale. If you want to rent a single-family home you actually like, in terms of its location, cleanliness, ages of the appliances, etc., you have even fewer choices.

Because we only looked for rentals, it took us a full year to finally find one we liked. If we also considered buying, we could’ve moved and enjoyed our life in the new area much sooner. So:

Old Rule: Rent first when you move to a new city.
New Rule: Consider both buying and renting.

Research Remotely

What about the worry of buying in the wrong part of the town?

That old rule of renting first probably came out before the Internet era. Now locals get their information online anyway. You can get the same information when you’re remote.

You see where stores and other facilities are on Google Maps. You have satellite view and street view of neighborhoods. You see real-time traffic from DOT cameras. You see voting results, school test scores, air quality indexes, and whatever aspects you care about. You can read the local newspaper and watch the local television stations online. You can join local Facebook groups and see what’s going on there.

We’ve been here for a year and a half. I didn’t learn anything that someone remote can’t find out.

Buy a Rental and Rent It to Youself?

Another push toward renting is this other rule that says you should buy only if you’ll stay in the home long-term. Long-term is defined as five years, seven years, 10 years, or longer.

Thinking you must stay in the home long-term makes you pickier. Even though there are more homes for sale than for rent, the abundance of choices quickly disappears when you add all your requirements for staying in the home long-term. This home is a one-story and you want a two-story (or vice versa). This home is too old. That home isn’t in the most desirable neighborhood. This home is on a small lot. This other home requires too much work, etc., etc.

However, when you’re considering renting anyway, you may also consider buying a home of similar quality to a rental. Think of it as renting it to yourself until you find your ideal home. You don’t have to be too picky when it isn’t long-term.

You’re the best landlord in the world when you rent to yourself. You won’t have to worry about breaking a lease or large rent increases. You don’t have to worry about disputes over damages or the security deposit. You can stay however long or however short. When you finally buy your ideal home, you either sell your transition home or keep it as a rental, whichever makes more sense at that time.

Dropping the requirement to stay in the home long-term opens up more choices. So:

Old Rule: Buy only if you’ll stay in the home long-term.
New Rule: Consider buying a rental and rent it to yourself.

What to Do with the Money?

If you end up renting or buying a transition home that’s much less expensive than the home you really want, what should you do with the money from the sale of your previous home?

Another rule says you should keep the money safe if you’re planning to use it in the near future, which is usually defined as five years or less.

If you sell a paid-off home, you may intend to buy your next home with all cash from your sale. You should keep the money safe if that’s your only source of funds to buy your next home. What if you can borrow?

You may intend to buy it with all cash, but you don’t have to. You only need the downpayment when you can borrow. The rest of the money can be invested in your normal portfolio allocation. If the market is up when you buy your next home, you sell for a profit. Paying taxes on the gain still beats getting 0.5% in a savings account. If the market is down, you borrow. You pay off the loan when the market recovers.

It’s a myth that you can’t get a mortgage if you don’t have a paycheck. Fannie Mae and Freddie Mac allow banks to qualify you for a mortgage with only assets, including retirement accounts. It’s called an Asset Depletion mortgage or Asset Dissipation Underwriting. You don’t have to actually sell your investments or withdraw from your IRA. The lender only uses the size of your accounts to calculate an equivalent income for the purpose of qualifying you for the mortgage.

We inquired with a lender earlier this year. They easily pre-approved us for a mortgage.

If you have a large taxable account, you can also get a loan using security-based lending. You use your investments as opposed to the home as collateral for the loan. Because the interest rate is variable and investments are more liquid than a home, the interest rate can be in the low 1.x%.

Having options to borrow at low rates allows you to invest the money while you wait to buy your next home. I wish I explored these options after we sold our previous home.

Old Rule: Keep the money safe at low returns if you plan to use it in the near future.
New Rule: Set up borrowing options and keep the money invested.

A Better Way

If we relocate again, we will do it this way:

If we see a home that we like for the long-term, buy it.If a suitable home is available for rent, rent it. Set up contigent borrowing options and keep the money invested.Also consider buying a rental home and renting it to ourselves. Keep it as a rental or sell it when we buy the next home.

If we stop at (1) and housing prices go up, great. If housing prices go down, we’re in it for the long-term anyway.

If we stop at (2) and housing prices go up, the gains on the investments can keep up or at least offset some of the increase. If the investments have losses, borrow and wait for them to recover. If housing prices go down, great, buy at the lower price.

If we stop at (3) and housing prices go up, the gains on the rental and the residual investments can keep up or at least offset some of the increase. If housing prices go down, great, buy at the lower price and keep the rental as a rental.

This setup is much more robust than the old rules of renting first and keeping the money in cash. The old rules work when:

Desirable rentals are widely available.Home prices more or less track infation.Returns on safe money keep up with inflation.

Under these assumptions, you can rent a year and take your sweet time to figure things out. If any one of the assumptions isn’t true, the old rules fail.

Learn the Nuts and Bolts I put everything I use to manage my money in a book. My Financial Toolbox guides you to a clear course of action.Read Reviews

The post Relocating for Retirement: Buy or Rent – Old Rules and New Rules appeared first on The Finance Buff.

Relocating: Buy or Rent – Old Rules and New Rules

By now it’s obvious I botched our relocation last year. The decision to relocate was correct but I executed it poorly due to my lack of experience. I also didn’t think through all the options when I only relied on some “rules” that were either outdated or didn’t apply to our situation. In the end, my poor execution cost us $300,000.

Many people may be considering relocation for remote work or retirement. I’m writing down the lessons I learned from my mistakes.

Background

I left my full-time job in spring 2018. We decided to relocate in early 2019. We chose Reno, NV because we had been coming to the Lake Tahoe area for hiking and skiing for many years. Becoming locals beats driving several hours every time.

Rent First In a New City?

We thought we should rent because we heard the rule that you should rent first when you move to a new city.

The reason behind this rule is that if you jump directly into buying, you may buy in the wrong place when you’re not familiar with the new city. Renting gives you time to figure out where exactly you’d like to settle in.

That’s all good but it introduces two problems.

The first problem is availability. It may be easier if you’re willing to rent an apartment, but if you’d like to live in a single-family home as you’re used to, far fewer single-family homes are available for rent than the number of single-family homes for sale.

These two maps from Zillow show the single-family homes for rent and for sale in my zip code. You see a big difference in available choices.

For Rent

For Sale

This isn’t a new phenomenon due to the COVID pandemic. It was like this when we were looking for rentals in 2019.

The second problem of insisting on renting first is quality. The average qualify of the homes for rent is a step lower than the average qualify of the homes for sale. If you want to rent a single-family home you actually like, in terms of its location, cleanliness, ages of the appliances, etc., you have even fewer choices.

Because we only looked for rentals, it took us a full year to finally find one we liked. If we also considered buying, we could’ve moved and enjoyed our life in the new area much sooner. So:

Old Rule: Rent first when you move to a new city.
New Rule: Consider both buying and renting.

Research Remotely

What about the worry of buying in the wrong part of the town?

That old rule of renting first probably came out before the Internet era. Now locals get their information online anyway. You can get the same information when you’re remote.

You see where stores and other facilities are on Google Maps. You have satellite view and street view of neighborhoods. You see real-time traffic from DOT cameras. You see voting results, school test scores, air quality indexes, and whatever aspects you care about. You can read the local newspaper and watch the local television stations online. You can join local Facebook groups and see what’s going on there.

We’ve been here for a year and a half. I didn’t learn anything that someone remote can’t find out.

Buy a Rental and Rent It to Youself?

Another push toward renting is this other rule that says you should buy only if you’ll stay in the home long-term. Long-term is defined as five years, seven years, 10 years, or longer.

Thinking you must stay in the home long-term makes you pickier. Even though there are more homes for sale than for rent, the abundance of choices quickly disappears when you add all your requirements for staying in the home long-term. This home is a one-story and you want a two-story (or vice versa). This home is too old. That home isn’t in the most desirable neighborhood. This home is on a small lot. This other home requires too much work.

However, when you’re considering renting anyway, you may also consider buying a home of similar quality to a rental. Think of it as renting it to yourself until you find your ideal home. You don’t have to be too picky when it isn’t long-term.

You’re the best landlord in the world when you rent to yourself. You won’t have to worry about the penalty for breaking a lease or large rent increases. You don’t have to worry about disputes over damages or the security deposit. You can stay however long or however short. When you finally buy your ideal home, you either sell your transition home or keep it as a rental, whichever makes more sense at that time.

Dropping the requirement to stay in the home long-term opens up more choices. So:

Old Rule: Buy only if you’ll stay in the home long-term.
New Rule: Consider buying a rental and rent it to yourself.

What to Do with the Money?

If you end up renting or buying a transition home that’s much less expensive than the home you really want, what should you do with the money from the sale of your previous home?

Another rule says you should keep the money safe if you’re planning to use it in the near future, which is usually defined as five years or less.

If you sell a paid-off home, you may intend to buy your next home with all cash from your sale. You should keep the money safe if that’s your only source of funds to buy your next home. What if you can borrow?

You may intend to buy it with all cash, but you don’t have to. You only need the downpayment when you can borrow. The rest of the money can be invested in your normal portfolio allocation. If the market is up when you buy your next home, you sell for a profit. Paying taxes on the gain still beats getting 0.5% in a savings account. If the market is down, you borrow. You pay off the loan when the market recovers.

It’s a myth that you can’t get a mortgage if you don’t have a paycheck. Fannie Mae and Freddie Mac allow banks to qualify you for a mortgage with only assets, including retirement accounts. It’s called an Asset Depletion mortgage or Asset Dissipation Underwriting. You don’t have to actually sell your investments or withdraw from your IRA. The lender only uses the size of your accounts to calculate an equivalent income for the purpose of qualifying you for the mortgage.

We inquired with a lender earlier this year. They easily pre-approved us for a mortgage.

If you have a large taxable account, you can also get a loan using security-based lending. You use your investments as opposed to the home as collateral. Because the interest rate is variable and investments are more liquid than a home, the interest rate can be in the low 1.x%.

Having options to borrow at low rates allows you to invest the money while you wait to buy your next home. I wish I explored these options after we sold our previous home.

Old Rule: Keep the money safe at low returns if you plan to use it in the near future.
New Rule: Set up borrowing options and keep the money invested.

A Better Way

If we relocate again, we will do it this way:

If we see a home that we like for the long-term, buy it.If a suitable home is available for rent, rent it. Set up contigent borrowing options and keep the money invested.Also consider buying a rental home and renting it to ourselves. Keep it as a rental or sell it when we buy the next home.

If we stop at (1) and housing prices go up, great. If housing prices go down, we’re in it for the long-term anyway.

If we stop at (2) and housing prices go up, the gains on the investments can keep up or at least offset some of the increase. If the investments have losses, borrow and wait for them to recover. If housing prices go down, great, buy at the lower price.

If we stop at (3) and housing prices go up, the gains on the rental and residual investments can keep up or at least offset some of the increase. If housing prices go down, great, buy at the lower price and keep the rental as a rental.

This setup is much more robust than the old rules of renting first and keeping the money in cash.

Learn the Nuts and Bolts I put everything I use to manage my money in a book. My Financial Toolbox guides you to a clear course of action.Read Reviews

The post Relocating: Buy or Rent – Old Rules and New Rules appeared first on The Finance Buff.

Create a Simple Revocable Living Trust with Software for I Bonds

I mentioned in the previous post How to Buy I Bonds: Soup to Nuts that we were creating a second trust with software to buy another $10,000 worth of I Bonds each year. A reader asked me to share more details on how we were doing it. For more on buying I Bonds in a trust account in general, please read Buy More I Bonds at TreasuryDirect in a Revocable Living Trust.

Please note I’m not a lawyer. I’m only sharing what we did for our own situation. I’m not recommending that you do the same. Please take this as only an anecdote.

Background and Purpose

Many married couples have two revocable living trusts — one for each spouse. We have only one joint trust. Both setups are perfectly valid. An attorney prepared the trust for us a few years ago. It has the two of us as both grantors and trustees.

This trust uses my Social Security Number as its tax ID. It already bought $10,000 in I Bonds this year. It also holds other assets elsewhere.

Because a trust can only buy $10,000 in I Bonds each year, we wanted a second trust that uses my wife’s Social Security Number as the tax ID. As a separate trust with a different tax ID, this second trust can buy another $10,000 worth of I Bonds each year. We will only hold I Bonds in this second trust. Our existing trust will still be our main trust.

Quicken Willmaker & Trust

Nolo (formerly Nolo Press) has been publishing DIY legal books since the 1970s. It publishes a book-and-software kit called Quicken Willmaker & Trust. Amazon sells the 2021 edition for $39.

The 500-page book explains what the documents do and how you should go about them. The included software on a CD uses an interview format that leads you to complete the documents based on your preferences. This approach is similar to how tax software works.

The software in Quicken Willmaker & Trust can create a will, a revocable living trust, a healthcare directive, a durable power of attorney, and some other documents related to estate planning. If we didn’t have an attorney prepare all those for us a few years ago, we would’ve used this software to create them ourselves.

I wanted to get this book-and-software kit from the public library but they didn’t have it. Instead, I found another book at the library that ended up working better for our specific situation.

Make Your Own Living Trust by Dennis Clifford

This other book, Make Your Own Living Trust, now in its 15th edition, is also published by Nolo. The author Dennis Clifford is an estate planning attorney. Amazon sells the book for $39.

As the title suggests, this book only covers living trust, which is fine for our purpose because that was the only thing we needed. Instead of interview-format software, it includes a link at the end to download fill-in-the-blank document templates. The book explains the different choices for the blanks in the templates.

The document templates in Rich Text Format are fully editable by Microsoft Word or compatible applications. This worked better for us because it’s more customizable whereas the software in Quicken Will & Trust only works through interviews.

Simple Structure

Because we wanted to keep this second trust really simple, we went with this structure:

A joint trust with the two of us as both grantors and trustees. Either trustee can act alone on behalf of the trust. We can amend or revoke the trust at any time. This is the same as in our existing trust. It’s also the default in the shared trust document template.The name of the trust mirrors our existing trust, only reversing the order of our names.When one of us dies, the deceased person’s share of the trust assets goes to the survivor. The survivor can amend or revoke the trust at any time.When both of us die, the trust assets dump into our existing (main) trust.

The document template has places for trust beneficiaries. We listed each other as the beneficiary when one of us dies and the main trust as the beneficiary when both of us die.

Notary Certificate

The document template says to attach a notary certificate after our signatures. Each state mandates specific language for what the notary certificate should say. I just Googled “[state] notary acknowledgment.” There’s a dedicated website for the notary acknowledgment language in each state but I prefer to get the language from an official state government site.

For example, here’s the link to the language in the Nevada state law, and here’s the one for California. The software in Quicken Will & Trust will probably automatically print the notary acknowledgment based on the state but we had to do this manually with the document template in Make Your Own Living Trust.

Our second trust became official after we signed the trust document and had it notarized. Because I got the book from the public library, our only cost was the notary fee. We can open an account for it at TreasuryDirect now.

***

If we didn’t already have estate planning documents prepared by an attorney, Quicken Willmaker & Trust is probably easier to use because the software uses an interview format. It’s also a better value because it covers more than just the living trust.

The document templates in Make Your Own Living Trust are like the “forms mode” in tax software. You can edit the document directly but you also have to be comfortable doing it. Having to find the correct notary acknowledgment language also adds another step.

Learn the Nuts and Bolts I put everything I use to manage my money in a book. My Financial Toolbox guides you to a clear course of action.Read Reviews

The post Create a Simple Revocable Living Trust with Software for I Bonds appeared first on The Finance Buff.

How to Buy I Bonds (Series I Savings Bonds): Soup to Nuts

I’ve been writing about I Bonds for many years. I only realized now I’ve been writing as if everyone already knew what they were and how they worked. The annualized interest rate on I Bonds is currently 3.54% in the first six months. If that’s not high enough to entice you, maybe you’ll be more interested when the rate in the next six months possibly goes higher than 7.5%. If you’re new to I Bonds, this post walks you through from soup to nuts.

What Are I Bonds?

I Bonds are short for Series I Savings Bonds. They are bonds issued by the U.S. government directly to retail investors. Currently, I Bonds carry favorable interest rates over other CDs and bonds. This makes I Bonds the best bonds you can buy at the moment.

How I Bonds Work

Think of I Bonds as flexible-term variable-rate CDs.

You’re required to hold them for at least one year. After that, you can cash out at any time you’d like, or you can choose to hold them for up to 30 years from the original time of purchase. If you cash out within five years, you forfeit interest earned in the previous three months, whereas the early withdrawal penalty on a typical commercial CD is often six months or 12 months of interest. The flexibility to cash out after one year with a low early withdrawal penalty or to hang on for as long as 30 years makes I Bonds good for both short-term and long-term investing.

Similar to a CD, the value of I Bonds never goes down. Unlike a typical CD with a fixed interest rate for the entire term, the interest rate on your I Bonds changes in six-month cycles. You stay on the current rate for the full six months and then you go on a new rate for another six months, and the new rate after that for another six months, and so on.

The interest rate is guaranteed to at least match inflation. If inflation goes up, the interest rate on your I Bonds automatically goes up. Some older I Bonds earn a positive rate above inflation. The I Bonds you buy now only match inflation. Even merely matching inflation makes I Bonds attractive when other CDs and bonds don’t keep up with inflation.

Tax Treatment

You pay tax on the interest from I Bonds only when you decide to cash out, whereas you must pay taxes on the interest from CDs and bond funds every year even if you reinvest the interest. The interest from I Bonds is exempt from state and local income taxes. I Bonds are more appealing than other CDs and bonds because you have the tax deferral and the exemption from state and local income taxes.

Where to Buy I Bonds

There are two ways to buy I Bonds:

On a government website TreasuryDirect.govUse money from tax refund when you file your tax return (see details in Overpay Your Taxes to Buy I Bonds)

You can only use regular after-tax money to buy I Bonds. They are not available in any tax-advantaged accounts such as 401k-type plans, IRAs, or HSAs. Nor are they available through any brokerage firms such as Fidelity, Charles Schwab, or Vanguard.

Purchase Limit

I Bonds are such a great deal that the government puts a limit on how much you can buy each year. At current rates, you should get your full quota before you buy any other CDs or bond funds.

When you buy on the government website TreasuryDirect.gov, the limit is $10,000 each calendar year per Social Security Number as the primary owner in a personal account. When you buy using money from your tax refund, the limit is $5,000 per tax return (not per person when you file jointly).

If you have a trust, you’re allowed to buy another $10,000 each calendar year in a trust account. If you have a business, the business can also buy $10,000 each calendar year.

A married couple each with a revocable living trust and a self-employment business can buy up to $65,000 each calendar year:

$10,000 with Person A as the primary owner and Person B as the second owner$10,000 with Person B as the primary owner and Person A as the second owner$10,000 in the name of Person A’s revocable living trust$10,000 in the name of Person B’s revocable living trust$10,000 in the name of Person A’s business$10,000 in the name of Person B’s business$5,000 using money from their tax refund

We have only one trust now. We’re creating a second trust with software to buy another $10,000. For buying I Bonds in a trust account in general, please read the previous post Buy More I Bonds at TreasuryDirect in a Revocable Living Trust.

Open Account

If you never bought I Bonds before, you need to open an account at the government website treasurydirect.gov. You can buy more in the same account in subsequent years. Find the Open Account link on the top right.

Choose the first option for Individual/Personal. Go here for a trust account or a small business account as well.

Now you can choose an individual, business, or trust account.

Next, fill out the required information and choose a security image, a password (not case sensitive), and security questions. If you’re opening a trust account, see the previous post Buy More I Bonds at TreasuryDirect in a Revocable Living Trust for what to use as the name of your account.

The application also asks you to link a bank account. Important: Please choose a bank account you will keep using forever. Adding the bank account at the time of account application is super easy, but changing the bank account in the future may be quite difficult. Also, make sure you enter the bank routing number and account number correctly. They don’t send any random deposits to verify the bank account. If you enter a wrong number now, it’ll be difficult to change it in the future.

You will receive your account number by email. Important: save your account number. You’ll need it to log in.

Schedule Purchase

Log in with the account number. The system will email you a one-time password (OTP). Important: Don’t use the back button in the browser when you use the TreasuryDirect.gov website.

You enter the password you set when you opened the account on this virtual keyboard. It doesn’t have lower case letters. That’s why the password isn’t case-sensitive.

After you log in, go to BuyDirect in the menu.

Although we use TreasuryDirect only to buy I Bonds, the account can be used for other products as well. Choose Series I near the bottom of the list.

If you’re buying I Bonds for the first time in a personal account, you need to create a Registration, which means whether you want the bonds to have:

Just yourself as the only owner; orYou as the primary owner and another person as the second owner; orYou as the owner and another person as the beneficiary.

See the previous post I Bonds Beneficiary vs Second Owner in TreasuryDirect for the difference between a second owner and a beneficiary and How To Grant Transact Right on I Bonds to the Second Owner if you decide to have a second owner. Enter yourself as the “first-named registrant.” Enter the second owner or the beneficiary as the “second-named registrant.” Your second owner or beneficiary has to be a person. It can’t be a trust.

Trust accounts and business accounts can’t have a second owner or a beneficiary. The trust or the business will be the only owner.

Enter your purchase amount.

Choose the purchase date. Make sure you have money available in the linked bank account. They send out the debit the night before your scheduled purchase date. The debit will hit your bank account on the scheduled date first thing in the morning. They may lock your TreasuryDirect account if the debit bounces. It’ll be difficult to unlock it. Important: Don’t cut it too close to the end of the month, or else you may miss a month worth of interest. I give it a lead time of at least a week before the end of the month.

Check Balance

TreasuryDirect doesn’t send any account statements. You check your balance on the website. Your total balance is displayed on the home page after you log in.

You’ll see a list broken down by the Issue Date when you click on the Savings Bonds link.

If your bonds are still within 5 years from the Issue Date, the Current Value automatically excludes interest earned in the last three months. If you cash out today, you’ll receive the Current Value. That’s why the bonds bought three months ago didn’t show any interest in the current value.

Cash Out (Redeem)

Because I Bonds are better than other bonds and there’s a purchase limit, you should hang on to your I Bonds as much as you can until you have better choices. If you need to cash out some of them (called “redeem” in the government lingo), you use the ManageDirect menu.

The option isn’t really obvious unless you know what to look for.

You don’t have to cash out/redeem the full purchase. Redeeming just part of it is just fine. The money will be sent to your linked bank account.

Tax Forms

If you don’t cash out (redeem) any I Bonds in any year, you won’t get a 1099 form for the interest earned. You pay taxes only in the year you cash out.

If you do cash out (redeem) any I Bonds in any year, TreasuryDirect will generate a 1099 tax form for the accumulated interest since your original purchase. They don’t send paper tax forms. You’ll come back to the ManageDirect part of the website at tax time to get the tax form (see the screenshot above).

Learn the Nuts and Bolts I put everything I use to manage my money in a book. My Financial Toolbox guides you to a clear course of action.Read Reviews

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How to Buy I Bonds(Series I Savings Bonds): Soup to Nuts

I’ve been writing about I Bonds for many years. I only realized now I’ve been writing as if everyone already knew what they were and how they worked. The annualized interest rate on I Bonds is currently 3.54% in the first six months. If that’s not high enough to entice you, maybe you’ll be more interested when the rate in the next six months possibly goes higher than 7.5%. If you’re new to I Bonds, this post walks you through from soup to nuts.

What Are I Bonds?

I Bonds are short for Series I Savings Bonds. They are bonds issued by the U.S. government directly to retail investors. Currently, I Bonds carry favorable interest rates over other CDs and bonds. This makes I Bonds the best bonds you can buy at the moment.

How I Bonds Work

Think of I Bonds as flexible-term variable-rate CDs.

You’re required to hold them for at least one year. After that, you can cash out at any time you’d like, or you can choose to hold them for up to 30 years from the original time of purchase. If you cash out within five years, you forfeit interest earned in the previous three months, whereas the early withdrawal penalty on a typical commercial CD is often six months or 12 months of interest.

Similar to a CD, the value of I Bonds never goes down. Unlike a typical CD with a fixed interest rate for the entire term, the interest rate on your I Bonds changes in six-month cycles. The interest rate is guaranteed to at least match inflation. If inflation goes up, the interest rate on your I Bonds automatically goes up. Some older I Bonds earn a positive rate above inflation. The I Bonds you buy now only match inflation. Even merely matching inflation makes I Bonds attractive when other CDs and bonds don’t keep up with inflation.

Tax Treatment

You pay tax on the interest from I Bonds only when you decide to cash out, whereas you must pay taxes on the interest from CDs and bond funds every year even if you reinvest the interest. The interest from I Bonds is exempt from state and local income taxes. I Bonds are more appealing than other CDs and bonds because you have the tax deferral and the exemption from state and local income taxes.

Where to Buy I Bonds

There are two ways to buy I Bonds:

On a government website TreasuryDirect.govUse money from tax refund when you file your tax return (see details in Overpay Your Taxes to Buy I Bonds)

You can only use regular after-tax money to buy I Bonds. They are not available in any tax-advantaged accounts such as 401k-type plans, IRAs, or HSAs. Nor are they available through any brokerage firms such as Fidelity, Charles Schwab, or Vanguard.

Purchase Limit

I Bonds are such a great deal that the government puts a limit on how much you can buy each year. At current rates, you should get your full quota before you buy any other CDs or bond funds.

When you buy on the government website TreasuryDirect.gov, the limit is $10,000 each calendar year per Social Security Number as the primary owner in a personal account. When you buy using money from your tax refund, the limit is $5,000 per tax return (not per person when you file jointly).

If you have a trust, you’re allowed to buy another $10,000 each calendar year in a trust account. If you have a business, the business can also buy $10,000 each calendar year.

A married couple each with a revocable living trust and a self-employment business can buy up to $65,000 each calendar year:

$10,000 with Person A as the primary owner and Person B as the second owner$10,000 with Person B as the primary owner and Person A as the second owner$10,000 in the name of Person A’s revocable living trust$10,000 in the name of Person B’s revocable living trust$10,000 in the name of Person A’s business$10,000 in the name of Person B’s business$5,000 using money from their tax refund

We have only one trust now. We’re creating a second trust with software to buy another $10,000.

See previous posts How To Grant Transact Right on I Bonds to the Second Owner and Buy More I Bonds at TreasuryDirect in a Revocable Living Trust.

Open Account

You open the account at the government website treasurydirect.gov. Find the Open Account link on the top right.

Choose the first option for Individual/Personal. Go here for a trust account or a small business account as well.

Now you can choose an individual, business, or trust account.

Next, fill out the required information and choose a security image, a password (not case sensitive), and security questions.

The application also asks you to link a bank account. Important: Please choose a bank account you will keep using forever. Adding the bank account at the time of account application is super easy, but changing the bank account in the future may be quite difficult. Also, make sure you enter the bank routing number and account number correctly. They don’t send any random deposits to verify the bank account. If you enter a wrong number now, it’ll be difficult to change it in the future.

You will receive your account number by email. Important: save your account number. You’ll need it to log in.

Schedule Purchase

Log in with the account number. The system will email you a one-time password (OTP). Important: Don’t use the back button in the browser when you use the TreasuryDirect.gov website.

You enter the password you set when you opened the account on this virtual keyboard. It doesn’t have lower case letters. That’s why the password isn’t case-sensitive.

After you log in, go to BuyDirect in the menu.

Although we use TreasuryDirect only to buy I Bonds, the account can be used for other products as well. Choose Series I near the bottom of the list.

Enter your purchase amount.

Choose the purchase date. Make sure you have money available in the linked bank account. They may lock your TreasuryDirect account if the debit bounces. It’ll be difficult to unlock it. Important: Don’t cut it too close to the end of the month, or else you may miss a month worth of interest. I give it a lead time of at least a week before the end of the month.

Check Balance

TreasuryDirect doesn’t send any account statements. You check your balance on the website. Your total balance is displayed on the home page after you log in.

You’ll see a list broken down by the Issue Date when you click on the Savings Bonds link.

If your bonds are still within 5 years from the Issue Date, the Current Value automatically excludes interest earned in the last three months. If you cash out today, you’ll receive the Current Value. That’s why the bonds bought three months ago didn’t show any interest in the current value.

Cash Out (Redeem)

Because I Bonds are better than other bonds and there’s a purchase limit, you should hang on to your I Bonds as much as you can until you have better choices. If you need to cash out some of them (called “redeem” in the government lingo), you use the ManageDirect menu.

The option isn’t really obvious unless you know what to look for.

You don’t have to cash out/redeem the full purchase. Redeeming just part of it is just fine. The money will be sent to your linked bank account.

Tax Forms

If you don’t cash out (redeem) any I Bonds in any year, you won’t get a 1099 form for the interest earned. You pay taxes only in the year you cash out.

If you do cash out (redeem) any I Bonds in any year, TreasuryDirect will generate a 1099 tax form for the accumulated interest since your original purchase. They don’t send paper tax forms. You’ll come back to the ManageDirect part of the website at tax time to get the tax form (see the screenshot above).

Learn the Nuts and Bolts I put everything I use to manage my money in a book. My Financial Toolbox guides you to a clear course of action.Read Reviews

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2021 2022 401k 403b 457 TSP IRA FSA HSA Contribution Limits

[Updated in August 2021 after July inflation release.]

Retirement plan contribution limits are adjusted for inflation each year. Inflation has been at elevated levels in recent months. Most contribution limits and income limits will go up in 2022. Some limits will stay the same as in 2021 due to rounding.

Before the IRS publishes the official numbers in October or November, I’m able to make my own calculations using the published inflation numbers and going by the same rules the IRS uses as stipulated by law. Before I have the inflation numbers for all the months used in the formula, due to rounding rules I can project the contribution limit for next year with high confidence.

In most cases, the inflation numbers in the months to come just aren’t able to make the limits cross another rounding threshold. For example when the law says a limit must be rounded down to the nearest $500, and the calculated result comes to $6,200, I know even if it’s off a little, it isn’t going to go below $6,000 or go above $6,500.

I have been able to do early projections with 100% accuracy ever since I started doing them several years ago. Of course, we can always be surprised by the inflation numbers. I’ll update this post if I see a large surprise that changes these projections.

401k/403b/457/TSP Elective Deferral Limit

401k/403b/457/TSP contribution limit will go up by $1,000 from $19,500 in 2021 to $20,500 in 2022. This limit usually goes up by $500 at a time but higher inflation is making it go two steps in one year.

If you are age 50 or over, the catch-up contribution limit will stay the same at $6,500 in 2022 as in 2021.

Employer match or profit sharing contributions aren’t included in these limits. If you work for multiple employers in the same year or if your employer offers multiple plans, you have one single employee contribution limit for 401k, 403b, and TSP across all plans. The 457 plan limit is separate. You can contribute the maximum to both a 401k/403b/TSP plan and a 457 plan.

Annual Additions Limit

The total employer plus employee contributions to all defined contribution plans by the same employer will increase by $3,000 from $58,000 in 2021 to $61,000 in 2022. This limit usually increases by $1,000 at a time but now it’s jumping three steps in one year.

The age-50-or-over catch-up contribution is separate from this limit. If you work for multiple unrelated employers in the same year, you have separate limits at each employer.

Annual Compensation Limit

The maximum annual compensation that can be considered for making contributions to a retirement plan is always 5x the annual additions limit. Therefore the annual compensation limit will increase by $15,000 from $290,000 in 2021 to $305,000 in 2022.

Highly Compensated Employee Threshold

If your employer limits your contribution because you are a Highly Compensated Employee (HCE), the minimum compensation will go up from $130,000 in 2021 to $135,000 in 2022.

SIMPLE 401k and SIMPLE IRA Contribution Limit

SIMPLE 401k and SIMPLE IRA plans have a lower limit than standard 401k plans. The contribution limit for SIMPLE 401k and SIMPLE IRA plans will go up from $13,500 in 2021 to $14,000 in 2022.

If you are age 50 or over, the catch-up contribution limit will stay the same at $3,000 in 2022 as in 2021. Employer contributions aren’t included in these limits.

Traditional and Roth IRA Contribution Limit

The Traditional or Roth IRA contribution limit will stay the same at $6,000 in 2022 as in 2021. The age 50 catch-up limit is fixed by law at $1,000 in all years.

The IRA contribution limit and the 401k/403b/TSP or SIMPLE contribution limit are separate. You can contribute the respective maximum to both a 401k/403b/TSP/SIMPLE plan and a traditional or Roth IRA.

Deductible IRA Income Limit

The income limit for taking a full deduction for your contribution to a traditional IRA while participating in a workplace retirement will increase by $2,000 for singles, from $66,000 in 2021 to $68,000 in 2022. It will increase by $4,000 for married filing jointly, from $105,000 in 2021 to $109,000 in 2022. The deduction completely phases out when your income goes above $76,000 in 2021 and $78,000 in 2022 for singles; and $125,000 in 2021 and $129,000 in 2022 for married filing jointly.

The income limit for taking a full deduction for your contribution to a traditional IRA when you are not covered in a workplace retirement but your spouse is will go up by $6,000 for married filing jointly from $198,000 in 2021 to $204,000 in 2022. The deduction completely phases out when your joint income goes above $208,000 in 2021 and $214,000 in 2022.

Roth IRA Income Limit

The income limit for contributing the maximum to a Roth IRA will go up by $4,000 for singles from $125,000 in 2021 to $129,000 in 2022. It will go up by $6,000 for married filing jointly from $198,000 in 2021 to $204,000 in 2022.

You can’t contribute anything directly to a Roth IRA when your income goes above $140,000 in 2021 and $144,000 in 2022 for singles, and $208,000 in 2021 and $214,000 in 2022 for married filing jointly, up by $4,000 and $6,000 respectively in 2022. You can still do a backdoor Roth IRA in such case.

Healthcare Flexible Spending Account Contribution Limit

The Healthcare FSA contribution limit will go up by $100 from $2,750 per person in 2021 to $2,850 per person in 2022.

Health Savings Account Contribution Limit

The HSA contribution limit for single coverage will go up by $50 from $3,600 in 2021 to $3,650 in 2022. The HSA contribution limit for family coverage will go up from $7,200 in 2021 to $7,300 in 2022. These were announced previously in the spring. Please see HSA Contribution Limits.

Those who are 55 or older can contribute additional $1,000. If you are married and both of you are 55 or older, each of you can contribute the additional $1,000, but to separate HSAs in each person’s name.

Saver’s Credit Income Limit

The income limits for receiving a Retirement Savings Contributions Credit (“Saver’s Credit”) will increase in 2022. For married filing jointly, it will be $39,500 in 2021 and $41,000 in 2022 (50% credit), $43,000 in 2021 and $44,000 in 2022 (20% credit), and $66,000 in 2021 and $68,000 in 2022 (10% credit).

The limits for singles will be at half of the limits for married filing jointly, at $19,750 in 2021 and $20,500 in 2022 (50% credit), $21,500 in 2021 and $22,000 in 2022 (20% credit), and $33,000 in 2021 and $34,000 in 2022 (10% credit).

All Together 20212022IncreaseLimit on employee contributions to 401k, 403b, or 457 plan$19,500$20,500$1,000Limit on age 50+ catchup contributions to 401k, 403b, or 457 plan$6,500$6,500NoneSIMPLE 401k or SIMPLE IRA contributions limit$13,500$14,000$500SIMPLE 401k or SIMPLE IRA age 50+ catchup contributions limit$3,000$3,000NoneHighly Compensated Employee definition$130,000$135,000$5,000Maximum annual additions to all defined contribution plans by the same employer$58,000$61,000$3,000Traditional and Roth IRA contribution limit$6,000$6,000NoneTraditional and Roth IRA age 50+ catchup contribution limit$1,000$1,000NoneDeductible IRA income limit, single, active participant in workplace retirement plan$66,000 – $76,000$68,000 – $78,000$2,000Deductible IRA income limit, married, active participant in workplace retirement plan$105,000 – $125,000$109,000 – $129,000$4,000Deductible IRA income limit, married, spouse is active participant in workplace retirement plan$198,000 – $208,000$204,000 – $214,000$6,000Roth IRA income limit, single$125,000 – $140,000$129,000 – $144,000$4,000Roth IRA income limit, married filing jointly$198,000 – $208,000$204,000 – $214,000$6,000Healthcare FSA Contribution Limit$2,750$2,850$100HSA Contribution Limit, single coverage$3,600$3,650$50HSA Contribution Limit, family coverage$7,200$7,300$100HSA, age 55 catch-up$1,000$1,000NoneLearn the Nuts and Bolts I put everything I use to manage my money in a book. My Financial Toolbox guides you to a clear course of action.Read Reviews

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Roth Conversion and Capital Gains On ACA Health Insurance

[Updated with law changes and the new spreadsheet version for 2021.]

Most online tax calculators don’t include the effect on the premium tax credit when you get health insurance under the Affordable Care Act (ACA), also known as Obamacare. This is a major gap for millions of people who get a subsidy for health insurance from the ACA because their income affects the amount of subsidy they will receive. Getting a larger subsidy reduces their tax dollar for dollar; qualifying for less subsidy increases their tax dollar for dollar.

The most accurate way to project taxes is to use the downloaded tax software. However, tax software for the current year won’t be available until November or December. My favorite tool for tax planning is the Case Study Spreadsheet, which is created and updated by MDM on the Mr. Money Mustache forum. MDM releases several updates each year to add new features and keep up with tax law changes.

It’s an actual spreadsheet file, not an online one. You will need Microsoft Excel or compatible software to open it. As with anything downloaded from the Internet, you will have to trust the source. The author MDM puts a lot of work into this spreadsheet. I was invited to test it. As far as I can tell, it’s reasonably accurate.

With 17 tabs, this spreadsheet does a lot of things. It looks overwhelming if you are only looking for one feature out of many. I will show you how this spreadsheet can help calculate the effect of Roth conversion or realizing long-term capital gains when you also receive a subsidy for your ACA health insurance. I used version 21.09 released on July 11, 2021.

Scenario

A retired couple, both age 60, Nevada residents, married filing jointly, with no dependents. They live on $40k pension income and $5k qualified dividends. They have no other income or deductions. The full price of the second lowest cost Silver plan from the ACA marketplace is $2,000/month. They chose that plan, paying $250/month out of pocket. The government pays $1,750/month to the insurance company as an advance subsidy.

Their questions:

How does it affect their taxes if they convert additional money from their traditional IRA to Roth?How does it affect their taxes if they realize some long-term capital gains?The Spreadsheet

After you download the spreadsheet, open it in Microsoft Excel or a compatible program. Click on Enable Editing and Enable Content in the yellow ribbon you see in Excel. Go to the Calculations tab. First, you enter your filing status, number of dependents, and your ages starting at cell G2.

You go down to cell H35 to enter your state of residency.

Next, you enter your income. Because the couple in our scenario are retired, we skip the paycheck items and we go down to non-paycheck income starting at cell D23. You only input into cells in green. Use annual numbers here.

Income before Roth Conversion or Capital Gain

Then you go down to the monthly average expense section and enter the full price health insurance premium and the advance subsidy in cells B113 and B114. Remember to enter the monthly numbers here. Enter the advance subsidy amount as a negative number. If you mouse over cells B113 and B114, you will see some instructions there.

Now scroll to the far right to cell AC88 or use the find function in your spreadsheet software to locate “Form 8962.” Enter the full price of the second lowest cost Silver plan in cell AE100. Use the annual number here. You may notice it shows “Other 48” in this area. If you live in Alaska or Hawaii, make sure to enter “AK” or “HI” in cell H35.

Finally, we go back to the tax calculation area starting at cell F11. This shows their baseline estimated federal income tax.

As you see from above, the spreadsheet estimates that this retired couple will pay $1,490 in federal income tax and receive $1,002 in additional ACA premium tax credit on top of the advance credit already paid directly to the health insurance company. With $45,000 in AGI, that’s average tax rate under 4%. Normally they would be good candidates for converting a part of their traditional IRA to Roth to take advantage of their low tax rate before they start Social Security and before RMDs start.

Roth Conversion

What happens if they do Roth conversions? Now comes the really neat part of this spreadsheet. You see a chart near cell F81.

The X-axis represents different amounts in Traditional IRA withdrawals whether the withdrawals are converted to Roth or not. The Y-axis shows the marginal and cumulative tax rate on such withdrawals. The chart for our example shows this couple pay 25% to 30% tax on their withdrawals/Roth conversions up to about $22,000. Tha marginal tax rate bounces around a little bit and then settles down to about 20%. Then it gets on a small plateau before it flatlines at 30%.

The couple can decide how much they want to convert based on the marginal tax rates in the chart. If 25% to 30% feels too high, they don’t convert. If they want to convert $20,000, they might as well convert some more because the marginal tax rate comes down between $22,000 and $60,000.

Long-Term Capital Gains

What happens if instead of Roth conversions they realize some long-term capital gains? We can change the X-axis in the chart from Traditional IRA withdrawals (conversions) to long-term capital gains. The area under the chart tells us how to do that.

The list tells us Long-Term Capital Gains (LTCG) is D27. So we choose D27 in the dropdown for cell G107. Then we click on that button to update the chart.

The shape the chart is similar to the one for Roth conversions but the rates are different. It shows they pay 15% to 18% on realized long-term capital gains up to about $22,000. Then the marginal tax rate goes down to slightly below 10% before a bump to above 20% when they realize more than $60,000 in long-term capital gains.

Again, if 15%-18% feels too high, they shouldn’t realize those gains. If they will already realize $20,000, they might as well realize $40,000 more.

Adjusting Chart Scale

By default, the Y-axis in the chart goes between -50% and +50%. If we want to use the space in full, we can adjust the Y-axis scale. Select the Y-axis, right-click, and click on Format Axis… Choose a different number for the minimum and the maximum. It will make the chart easier to see.

The range in the X-axis is adjusted by changing the numbers in cells P83 and P84.

Making the first number in green smaller will make the chart show a narrower range. For example, the Roth conversion chart looks like this after changing the number in P83 from the default 220 to 100 together with adjusting the minimum for the Y-axis from -0.5 to 0.1.

It gives us a closer view of what’s happening for conversions up to $50,000 instead of $100,000.

***

This exercise shows that converting to Roth or realizing long-term capital gains while receiving the health insurance subsidy from ACA will incur higher federal income tax than if you are not receiving the health insurance subsidy.  The Case Study Spreadsheet does a great job in displaying the effect. It has a learning curve when you go all over the place to find the right spot for your inputs and look at the results, but it works wonders once you know where to enter things and what to look for. The interactive chart shows what-if’s better than any tax software. I thank MDM for the hard work. The more I use it, the more I’m amazed at how neat the spreadsheet it. It’s my go-to tax planning tool.

The same spreadsheet can be used to show the effect of Roth conversions without the complications of ACA health insurance. I’ll do an example with Social Security and Medicare in another post.

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Don’t Choose 2021 Advance Child Tax Credit Opt-Out

The American Rescue Plan Act of 2021 increased the Child Tax Credit in 2021 for taxpayers whose income falls under a qualifying cutoff. The implementation calls for the IRS to send out monthly direct deposits/checks in advance so that you don’t have to adjust your withholding or wait until you file your tax return to get the money.

Because the IRS doesn’t know how much income you’ll have in 2021, they only use your income from the previous year to calculate your monthly payments. When you file your tax return, you re-calculate your child tax credit and you reconcile between what you should receive and what you actually received from the monthly payments.

The IRS already sent letters to people to notify them of the upcoming payments, which are scheduled to start on July 15. If you received the letter but you don’t think you will qualify for the child tax credit in 2021, the IRS provides an opt-out tool for you to tell them not to send the monthly payments. If you fall into this situation because you expect your 2021 income to be higher, you may be tempted to opt-out. Don’t do it.

I made this mistake when I enrolled in ACA health insurance for 2020. The ACA health insurance is set up similarly to the advance child tax credit in that the government can pay a subsidy to the insurance company in advance and you’ll reconcile on your tax return between what they paid during the year and what your income ends up qualifying for.

I refused the advance subsidy in 2020 thinking that I may not qualify for it in the end, and if I did qualify, I would just get it at tax time the following year. That refusal made me miss out on over $8,000 worth of tax credit when a new law enacted in 2021 made everyone keep the advance subsidy received in 2020 whether their income qualified for it or not. I had nothing to keep because I refused the advance subsidy.

Although right now there’s no law that says you’ll get to keep any advance credit that you don’t qualify for, you never know what will happen in the future. If you accept the advance payments, the worst case is that you’ll have to pay it all back, but you aren’t out anything because you already got the money in advance. If you opt-out of the advance payments and the government becomes extra generous, you’ll totally miss out on the generosity.

Most people will simply accept the advance payments. They are the mainstream. There’s safety in the mainstream. When the mainstream wins, you win. The mainstream won’t carry you if you try to be clever and step out of the mainstream. Don’t make the mistake I made in 2020. Go with the mainstream.

Last but not least, it isn’t easy to opt-out anyway. News reports said the opt-out tool requires hoops of ID verification. You have to verify your mobile phone number but that often doesn’t work. You have to upload a photo of your driver’s license but that often doesn’t work either. And if you’re married filing jointly, each of you has to go through the process separately. The easiest thing to do is simply not to go out of your way to opt-out. Do nothing. Accept the money. If it means you have to pay it back next year when you file your tax return, so be it.

Learn the Nuts and Bolts I put everything I use to manage my money in a book. My Financial Toolbox guides you to a clear course of action.Read Reviews

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2021 2022 Medicare Part B Part D IRMAA Premium Brackets

[Update on June 14, 2021: Include projections for 2022. My projections for 2021 matched 100% the official numbers. ]

Seniors age 65 or older can sign up for Medicare. The government calls people who receive Medicare beneficiaries. Medicare beneficiaries must pay a premium for Medicare Part B that covers doctors’ services and Medicare Part D that covers prescription drugs. The premiums paid by Medicare beneficiaries cover about 25% of the program costs for Part B and Part D. The government pays the other 75%.

Medicare imposes surcharges on higher-income beneficiaries. The theory is that higher-income beneficiaries can afford to pay more for their healthcare. Instead of doing a 25:75 split with the government, they must pay a higher share of the program costs.

The surcharge is called IRMAA, which stands for Income-Related Monthly Adjustment Amount.

I haven’t seen any numbers that show how much collecting IRMAA really helps the government in the grand scheme. I’m guessing very little. One report said 7% of all Medicare beneficiaries pay IRMAA. Suppose the 7% pay double the standard premium, it changes the overall split between the beneficiaries and the government from 25:75 to 27:73. Big deal?

The income used to determine IRMAA is your AGI plus muni bond interest from two years ago. Your 2020 income determines your IRMAA in 2022. Your 2021 income determines your IRMAA in 2023. The untaxed Social Security benefits aren’t included in the income for determining IRMAA.

As if it’s not complicated enough for not moving the needle much, IRMAA is divided into five income brackets. Depending on the income, higher-income beneficiaries pay 35%, 50%, 65%, 80%, or 85% of the program costs instead of 25%. The lines drawn for each bracket can cause a sudden jump in the premiums you pay. If your income crosses over to the next bracket by $1, all of a sudden your Medicare premiums can jump by over $1,000/year. If you are married and both of you are on Medicare, $1 more in income can make the Medicare premiums jump by over $1,000/year for each of you.

* The last bracket on the far right isn’t displayed in the chart.

So if your income is near a bracket cutoff, see if you can manage to keep it down and make it stay in a lower bracket. Using the income from two years ago makes it a little harder. Now in 2021, you don’t know where exactly the brackets will be for 2023. Still, you can make reasonable estimates and give yourself some margin to stay clear of the cutoff points.

2021 IRMAA Brackets

The IRMAA income brackets (except the very last one) started adjusting for inflation in 2020. Here are the IRMAA income brackets for 2021 coverage and the projected brackets for 2022 coverage. Before the government publishes the official numbers, I’m able to make projections based on the inflation numbers to date. Rounding rules make it such that the inflation numbers for the upcoming months are unlikely to affect the final results. For example, when a number is rounded to the nearest $1,000, it doesn’t matter whether the number is really $90,200 or $90,300 before rounding. Remember the income on your 2020 tax return (AGI plus muni interest) determines the IRMAA you pay in 2022. The income on your 2021 tax return (to be filed in 2022) determines the IRMAA you pay in 2023.

Part B Premium2021 Coverage (2019 Income)2022 Coverage (2020 Income)StandardSingle: <= $88,000
Married Filing Jointly: <= $176,000Single: <= $90,000
Married Filing Jointly: <= $180,000Standard * 1.4Single: <= $111,000
Married Filing Jointly: <= $222,000Single: <= $114,000
Married Filing Jointly: <= $228,000Standard * 2.0Single: <= $138,000
Married Filing Jointly: <= $276,000Single: <= $142,000
Married Filing Jointly: <= $284,000Standard * 2.6Single: <= $165,000
Married Filing Jointly: <= $330,000Single: <= $170,000
Married Filing Jointly: <= $340,000Standard * 3.2Single: <= $500,000
Married Filing Jointly: <= $750,000Single: <= $500,000
Married Filing Jointly: <= $750,000Standard * 3.4Single: > $500,000
Married Filing Jointly: > $750,000Single: > $500,000
Married Filing Jointly: > $750,000

Higher-income Medicare beneficiaries also pay a surcharge for Part D. The income brackets are the same. The surcharges are relatively smaller in dollars.

2022 IRMAA Brackets

As of June 2021, we have 9 out of the 12 required monthly inflation numbers to calculate the income brackets for 2022 coverage. I made the projections above based on a reasonable range of inflation numbers for the remaining three months, but of course we can always be surprised by the actual numbers. I’ll update the projections if I see big surprises that affect the projections.

The standard Medicare Part B premium is $148.50/month in 2021. A 40% surcharge on the Medicare Part B premium is about $700/year per person or about $1,400/year for a married couple both on Medicare. In the grand scheme, when a couple on Medicare has over $176k in income, they are probably already paying a large amount in taxes. Does making them pay another $1,400/year make that much difference? Nickel-and-diming just annoys people. People caught by surprise when their income crosses over to a higher bracket by just a small amount get mad at the government. Rolling it all into the income tax would be much more effective.

Oh well, if you are on Medicare, watch your income and don’t accidentally cross a line for IRMAA.

IRMAA Appeal

If your income two years ago was higher because you were working at that time and now your income is significantly lower because you retired (“work reduction” or “work stoppage”), you can appeal the IRMAA assessment. The “life-changing events” that make you eligible for an appeal include:

Death of spouseMarriageDivorce or annulmentWork reductionWork stoppageLoss of income from income producing propertyLoss or reduction of certain kinds of pension income

You file an appeal by filling out the form SSA-44 to show that although your income was higher two years ago, you had a reduction in income now due to one of the life-changing events above. For more information on the appeal, see Medicare Part B Premium Appeals.

Not Penalized For Life

If your income two years ago was higher and you don’t have a life-changing event that makes you qualify for an appeal, you will pay the higher Medicare premiums for one year. IRMAA is re-evaluated every year as your income changes. If your higher income two years ago was due to a one-time event, such as realizing capital gains or taking a large withdrawal from your IRA, when your income comes down in the following year, your IRMAA will also come down automatically. It’s not the end of the world to pay IRMAA for one year.