Self directed IRAs under attack in proposed tax bill
advantaira.com
advantaira.com
Highlights:
1. You can't add new contributions to tax-advantaged accounts if their total value exceeds $10 million and you make over $400K for single filers, amounts indexed to inflation.
2. There are required minimum distributions if you have tax-advantaged accounts over $10M and make over $400k. There's a more rapid drain if you have over $20M.
3. Closes the backdoor Roth IRA (https://www.bogleheads.org/wiki/Backdoor_Roth) only for people making over $400k. Closes the mega backdoor (https://www.bogleheads.org/wiki/Mega-backdoor_Roth) for everybody.
4. Prohibits you from using a tax advantaged account to invest in securities that require "accredited investor" status (hedge funds, etc). You also can't use the tax advantaged account to invest in businesses where you have 50% or more of an interest.
Unless you're super rich, were using a tax advantaged account to invest in your business, or were using the mega backdoor, which isn't available to everyone and still does require a pretty high income (investing more than ~$20k/year in a 401k), this doesn't really impact you. You can also still do whatever you want in a taxable account, so to me this just seems like a roundabout way of increasing taxes on wealthy people's investments.
I do wonder how much revenue this will raise, though. I can't imagine there are a ton of people with retirement balances over $10M. Maybe the expectation is that revenue will compound over time as more and more assets are held in taxable accounts.
EDIT: I think I was wrong about the backdoor Roth still being available to folks making under $400k (point 3) since you can't convert any after tax funds to a Roth with the proposal. So, this does affect people above the Roth ceiling ($140K single income, $208K married), if you were maxing out pretax contributions and making after-tax conversions to a Roth. I think pretax contributions to a traditional IRA for 401k can still get converted to a Roth.
Sec. 138314. Prohibition of Investment of IRA Assets in Entities in Which the Owner Has a Substantial Interest.
To prevent self-dealing, under current law prohibited transaction rules, an IRA owner cannot invest his or her IRA assets in a corporation, partnership, trust, or estate in which he or she has a 50 percent or greater interest. However, an IRA owner can invest IRA assets in a business in which he or she owns, for example, one-third of the business while also acting as the CEO. The bill adjusts the 50 percent threshold to 10 percent for investments that are not tradable on an established securities market, regardless of whether the IRA owner has a direct or indirect interest. The bill also prevents investing in an entity in which the IRA owner is an officer. Further, the bill modifies the rule to be an IRA requirement, rather than a prohibited transaction rule (i.e., in order to be an IRA, it must meet this requirement). This section generally takes effect for tax years beginning after December 31, 2021, but there is a 2-year transition period for IRAs already holding these investments
Not mainstream but not a secret either.
It just refuses to give you a tax break when you do it.
Your theory is that for 250 years America's entrepreneur class has been primarily driven by raiding their own tax-advantaged retirement accounts?
Also if your neighbor story is for real what happened there is he took a loan against his retirement account or did some kind of ROBS transaction. It's already illegal for him to interact with plan assets as part of a self-directed IRA, so he didn't use one to invest in his own business and buy vehicles. Hence this story has nothing to do with the topic at hand.
Bingo! Wall St wants a monopoly on ALL your retirement funds. Your typical employer 401k plan offers only mutual funds run by Wall St. No investing in alternate assets such as real estate or crypto. The big boys get their cut AND make sure you are not crowding the field in lucrative investments.
We probably shouldn't encourage the general public to gamble their retirement funds in a casino. I understand many believe this is an "asset class", but there is ample evidence crypto has no place in someone's retirement asset mix. Such investment in a taxable account is reasonable compromise.
No? Should we prohibit them from investing in mutual funds since bonds are so much safer? Or maybe mutual funds are OK but individual stocks should be illegal? Or maybe just certain, whitelisted stocks above a certain market cap that the 'professionals' decide are too big to fail?
Or maybe we should let individuals decide the correct mix of yield and risk that suits their age and risk tolerance?
The entire point of our IRA/401k laws is to give people incentives to save money for retirement in the hopes that they will have a nest egg of stable assets that will allow them to leave their jobs, making room for the next generation and reducing the burden on families and social services.
The whole system was created because penniless old people are a corrosive social problem. These reforms just illustrate how much we've lost the plot on the original idea.
I have a single member LLC and a simplified employee pension plan (SEP), but don't understand how one gets crypto into a SEP without buying something like Grayscale (GBTC) through the open stock market.
E.g. Mass Mutual Trust Company, Directed Trust Company, etc
The LLC is owned by the SEP (the trust). Anything owned by the LLC is in the SEP.
The maximum value cap should be indexed to your age (and inflation), such that the maximum allowed is enough that if left alone can support a very well funded retirement anywhere in the country with very high probability.
I’d recommend checking out Mike Konzcal’s recent book Freedom From The Market https://thenewpress.com/books/freedom-from-market
People are perfectly capable of trading with each other on a voluntary basis without requiring any restrictions or regulations or any other form of violence. And if violence does occur people are perfectly entitled to respond in self-defense without depending on any government to intervene.
Trade takes the form of exchange of the rights of ownership, and this is a right enforced by government.
For example, if I own a house, the house doesn’t care who does what. The owner is the one with the right to call the cops if a non-owner comes in unwanted. This instantly becomes an appeal to violence and the government.
This is even more true in the modern sense of the free market, financial markets exchange very little actual physical goods, the thing being traded is rights to contracts, rights which are guaranteed by the government regulator.
The only place this isn’t quite true is with blockchain based assets.
(That said, I'm guessing the intent of the provision is more about fairness/eliminating a loophole for the wealthy than strictly generating revenue).
[1] https://www.propublica.org/article/lord-of-the-roths-how-tec...
Roth IRA's are post-tax, that's the whole point of them. You put money in after paying tax and then you're done, when you withdraw for retirement it's tax free.
If this bill passes as written he would actually be forced to divest assets out of his Roth IRA and then pay taxes on them now. It's a really substantive change, hence the discussion.
He would be forced to sell his current assets in the IRA, yes—but what prevents him from rolling over the proceeds into another asset? As long as all the funds remain in a Roth IRA until retirement age there shouldn't be any taxes due to the reinvestment, now or later.
Or are you implying that he would choose to take the tax hit of losing the Roth status rather than sell the assets?
If this passes, it wouldn't go back and make him pay taxes on those, but it would stop other people from replicating that trick and it would greatly reduce the amount of future untaxed capital gains he will get.
Having these basic guardrails in place may be a good first step, and in the future the thresholds could be dropped below $10MM and 400K.
> 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.
This makes it sound like backdoor will be stopped for everyone, since after-tax contributions to a (Traditional) IRA are a necessary step.
Just a nit-pick of your analysis. The proposed legislation closes both the megabackdoor Roth (employee after-tax contributions) and backdoor Roth (prohibition on IRA contributions from being converted) regardless of income level:
"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"
...which, depending on what you consider a tax increase, appears to run contrary to President Biden's promise to not increase taxes for anyone making less than $400K. This gutting of IRA conversions seems like the only piece of the pie that hurts the middle class, although arguably the upper end of the middle class who have the means to set aside more than the $19K 401(k) max per year.
Probably not a ton of people. But there might well be a ton of money in these accounts.
https://www.theatlantic.com/politics/archive/2012/09/whats-r...
I'm not saying it's a good bill (no opinion, not enough info), but it isn't prima-facie crazy for congress to revisit retirement plans if they have evidence they are often being used for other purposes, or ineffectively.
Investing in the company which also pays your wages is a Texas hedge, and as such a terrible way to save for retirement, so this sounds like a good change.
No, its saying if you do well on certain types of investments you need to pay tax. If you do poorly on your investments and lose money, you'd actually want them in a taxable account (because you can count the losses against other gains).
Nearing retirement, earning low income now and have a significant amount of savings in non-retirement accounts = Closing the megaBD Roth screws me.
What should really happen is that anyone with net worth < a reasonable threshold should be able to simply roth what ever the fuck they want without having to figure out these annoyingly complex tax rules.
Talk about rich senators punching down vs encouraging company formation!
PSA: If you are starting a US company and haven't heard of QSBS.. look into it at the federal + state levels, as that's a good chunk of your potential net worth.
I would agree that QSBS support for the already-rich can be less effective -- your case of angels. I'd rather see improvements on the capping structure, vs pushing incentives even more (15-30%!) to working for FAANGs.
I kind of wish they'd go with just capping the gains, but would I still say that if I wasn't planning to use mine to "fund" high-return cryptocurrency arbitrages?
1) https://www.forbes.com/sites/sarahhansen/2021/06/24/peter-th...
https://www.theatlantic.com/politics/archive/2012/09/whats-r...
https://www.propublica.org/article/lord-of-the-roths-how-tec...
Then used the proceeds from that to invest in variety of things, including an early (angel?) investment in Facebook.
It's all detailed in the Propublica story where they described his Paypal investment as a "sweetheart deal".
Thiel bought his shares at $0.001/share in the same round where the company was valued at $0.20/share. At very least, he should've been capped at 10,000 shares in the IRA but instead he contributed 1.7 million ($2k/year IRA contribution limit at the time).
It's like describing a software bug as a non problem since it only lead to two intrusions.. that you know of.. that cost your company a ton of money.
The strike price and the "fair market value" are often different so there's nothing exceptional or even unique there. Odds are, half the people reading this thread have had the same situation in their careers. The difference is that this company (Paypal) ended up working so those shares became valuable.
If you or I did it, we'd pay the strike price, it'd be reported to the IRS at the FMV, and we'd pay the tax on the difference. In this case, it would be some percent (22? 25?) of 1.7M*(0.20-0.001) or ~$338k.
Of course, from there you get into the "unrealized gains" battle that screws over people with illiquid shares.
Yes they are.
The whole purpose of IRAs is to encourage regular people to save for retirement. It was not meant to provide billionaires tax loopholes to avoid paying millions or even billions of dollars in taxes.
It's kind of like playing a game with someone. 99% of the people are following the rules and then some weisenheimer comes up with an idea that while technically not breaking a rule goes against the spirit of everything that the game stands for. What happens in that instance is the other players of the game will say, "Nice try, but no." This is what Congress is doing.
Because anyone can continue to invest in private companies. You just can’t get tax free growth from them.
>anyone can continue to invest in private companies.
is a very bold claim.
https://www.advantaira.com/wp-content/uploads/2021/09/WM-Tax...
Huh. So under current law, you can take your IRA money and "invest" it in a single-member LLC? Wild. Does that let you circumvent the proscription against living in properties you own through your IRA? Since in that case, the "owner" would be the LLC, rather than yourself per se?
I think you can get non-recourse mortgages, but it's more like 50% down instead of 20% like most non-owner occupied mortgages.
Does it prohibit those same transactions between an investment within the plan (like an LLC) and a disqualified person?
I mean, if I own Apple stock, I can buy things in the Apple store.
Entrepreneurs can put up to 58k a year into a Solo 401k
The average person that's putting the max of $6k (or less) into their IRA is not impacted by this and it's business as usual for them.
I believe this is in response to people like Peter Thiel
https://www.propublica.org/article/lord-of-the-roths-how-tec...
I also got by reasonably well with college student loan debt.
I'm relatively privileged in the above ways. If I wasn't quite so lucky and set up for success I'd struggle a lot to afford to put money into retirement accounts.
I think the rich should pay their fair fucking share of taxes. It helps society. This loophole they're trying to get rid of actually means that those who are far better off than the rest of us, who are using these loopholes to avoid taxes will have to pay more taxes. Seems like a real win for the low and middle class people here.
How exactly do you hope to create better opportunities for the low and middle income class? Here’s one idea: open up opportunities for them to invest in qualified accounts, like IRAs, silly.
https://www.propublica.org/article/lord-of-the-roths-how-tec...
This type of opportunity is NOT available for low to middle class families, never will be. It's simply being exploited by the rich. These families live paycheck to paycheck more often than not, they're not going to have the ability to invest shares of a company or real estate into their IRA. THey're more worried about paying their bills and the next paycheck. They don't have the extra income to make these kinds of investments.
No, seriously, go read the fucking article and I think you'd understand instead of very clearly advocating for the rich like you are.
What if - instead of the government keeping us to the lowest common denominator (social security) they encourage, educate, and allow everyone to be their highest common denominator?
If more people were off SS, then the entire governments budget would go down - which requires less taxation. We've taken the opposite approach.. support consumerism and spending, thus the government taxation and expanding budgets grow higher as our population ages to support a wider group.
The wealth gap is freaking massive and growing. How are low and middle class people supposed to support themselves when they can't even get fair wages to support themselves and plan for retirement?
Problem with the low/middle income is that where to begin? Rich people hire lawyers to do the work. Low/middle income like myself knows this is available but can't utilize it as we don't know where to start, how to do it, who to contact and can't afford to hire a lawyer.
I know tons of people don't know how our income tax rate bracket works.
I just learned yesterday that you can invest in bitcoin using self directed IRA. I am trying to figure out how to do it, but kind of lost.
If you read up on what Thiel (and presumably some others did), yes, they successfully invested using their IRA, but yes, they also took advantage of the tax status of a Roth to avoid paying capital gains tax.
They will not be retroactively penalized for this (the law doesn't work this way), but their doing this has now made at least some in Congress want to prevent this from being possible in the future, since it was not what the Roth IRA was intended to allow.
The backdoor Roth part of this... basically anybody making even an entry level Tech salary should be doing it. That's not just for the Peter Thiels of the world.
(By "should" I don't mean "I would prefer if policy were this"; I mean "this is what's smart to do right now, at an individual level, under current policy".)
Also the government should file your own taxes, right now tutbotax & friends currently only exist due to government lobbying.
But getting you angry enough to defend his wealth is much more difficult than obscuring the fact that you won’t be affected by them, so we instead get vague and scary warnings about the bill.
One example: https://www.choiceapp.io/
Of course, someone with lots of investments will have the luxury of just making the highest-payoff ones with their IRA funds.
Independently, in the rest of the bill [1] there are lots of reasonable things like a $10 million IRA cutoff limit.
1) https://www.advantaira.com/wp-content/uploads/2021/09/WM-Tax...
401k limits are ~20k/yr -- about 10% of your pre-tax if you are maxing out on a 200k SWE TC (or much less given an employer match). Easily, your 401k (and rolled over IRA) can reach 200k (20k x 10) in a decade with no growth, and much more with growth.
At that point, this bill is relevant -- do you really want all your holdings in public stock that gyrate wildly in value every 7yrs?
This is also a way of contributing to a Roth (IRA?) if you don't qualify for a regular Roth IRA (make too much money) or want to contribute more than the $6k limit per year.
1. Mandatory contributions: currently 10% of your income; and
2. Voluntary contributions: you can contribute more and get a lower tax rate for doing so. By comparison, 401k contributions are tax free. Voluntary super contributions are not.
This is intended to fund people's retirements to alleviate the upcoming strain on the Aged Pension just like the issues with Social Security. That is, in 10-20 years there'll be <3 working people per retired person.
Australia's super requirements are stricter (eg currently you cannot withdraw before 65; 401k is 59.5). There are other differences.
Anyway, super is generally in mutual funds and the like. But there is an option for Self-Managed Super Funds (SMSFs).
This is where you can basically run your own fund. You need to get audited, pay fees, have an investment strategy, etc. Generally these are used to invest in things you can't through mutual funds. And this is abused to invest in residential real estate (because, you know, it always goes up).
I generally think this system has been a disaster and shouldn't be allowed. It's to protect people from themselves, basically.
For example, super investments can't be leveraged but through SMSF shenanigans I've seen balances wiped out by effective leveraging.
Also, you'll see marriages where one spouse's super balance is used by another in a bad manner and then the marriage breaks down and this just adds to the financial disadvantage and stress of that spouse. I imagine this is particularly an issue in the case of psychologically abusive marriages.
So I'm for any reform that restricts IRAs and 401ks from these one man shops.
>The whole deal is a 'we are spending tons of cash, so we need to take it from someone' plan
Funny how spending tons of cash is a problem only if it benefits poor and middle class people. I never saw this outrage on trillions spent on endless wars, since that benefits rich people. But if something helps poor or middle class and hurts rich people a little, there is a big outrage.
But, of course, politicians want to let big businesses maintain their competitive advantage by making 401k have higher limits than IRAs.
> I never saw this outrage on trillions spent on endless wars, since that benefits rich people.
Tons of people have been outraged by the war, but it was politically unpopular across all income classes to be against the war in early 2000s.
I am not talking about the war itself. I am talking about the outrage over spending on wars. For example, there is barely any debate in the public sphere about 'where to get money to spend on wars', but if it helps poor or middle income people, like say increased welfare payments, or healthcare or college, suddenly there is a huge outcry over "how do we pay for it".
1 in 4 Americans have no retirement savings: https://news.yahoo.com/1-4-americans-no-retirement-191314425... (same study: 1 in 8 over 60 have $0.)
If you won the lottery on crypto then you aren't going to be destitute in retirement. Pay the capital gains and enjoy your wealth.
Similarly, if you are a high earner and can afford to take advantage of things like the megabackdoor then you aren't going to be destitute in retirement. Pay the capital gains and enjoy your wealth.
The purpose of tax advantage retirement accounts when originally introduced by ERISA was to give employees of private companies a safety net in cases where their pension defaulted or when a pension wasn't offered in the first place. There's really no mention of it being specifically for people who are destitute or would not otherwise invest. Traditional IRAs are available for everyone, even high earners, no gatekeeping.
> Pay the capital gains and enjoy your wealth.
Traditional IRAs are taxed on withdrawal and function much like other investments.
Tax breaks exist to promote prosocial behavior. Getting people who are struggling to be able to afford to save for retirement is good for society. Giving people who made it big with a lucky gamble a benefit is just good for that individual.
The default is taxable accounts. Things like IRAs and 401ks are exceptions carved out to encourage the population to invest so that they don't end up eating cat food at age 80. People building huge fortunes in their IRAs isn't achieving this goal.
This is no skin off the back of the wealthy. They'll find another trick and life will go on. For those of them that actually care about "normal" Americans being able to do the same thing they did, it feels a little wrong that it requires an ever increasing amount moving parts and money to do what they did.
it is overly simplistic in USA - real people lose their "wealthy" status every day. You think a "wealthy" restaurant or bar owner is having a good day in 2021?
this class-baiting comes from the previous century, and IMO detracts from real problems right now
I don't entirely understand what you're construing as class baiting. You don't have to have any contempt for the incredibly wealthy to acknowledge that they're going to walk away from this with extremely minimal losses, while your average person with a Roth IRA account won't be able to use it for starting or supporting their own business.
This change is intended to prevent the abuse of Roth IRAs as a way to shield potentially enormous capital gains from taxation.
Just like why a person working for a company offering 401k is allowed to save $19k in a tax advantaged retirement account, but a person working at a small sandwich shop not offering a 401k is only allowed to save $6k in a tax advantaged retirement account.
They can't sell them to themselves because that's against the rules. If they distribute them then they have to pay a 10% tax penalty in addition to any income tax.
These are small thinly traded assets. What will very likely happen in practice is big wall street firms will come in and buy up thousands of American small businesses (retirees best assets) at a major discount similar to what Blackstone is currently doing with single family homes.
Almost all of the advantages of them accrue to the top decile of income earners. Why should we have exceptions in the tax code just to help richer people amass more money?
(see page 10, part 3 for Retirement Account provisions) https://waysandmeans.house.gov/sites/democrats.waysandmeans....
https://www.irafinancialgroup.com/learn-more/podcast/self-di...
How? You can only contribute a maximum of $7,000/year to all IRAs you own.
https://www.propublica.org/article/lord-of-the-roths-how-tec...
But it does (attempt to) say "you cannot avoid paying tax on gigantic capital gains by shielding it inside a Roth IRA". It is absolutely directed at ultra high net worth elites.
There is an argument that simply capping the gains inside a Roth IRA that can be tax-exempt would be a more efficient way to do this.
Instead - the name is big and bloated. Expanding budget deficits mean expanded spending, which can never go down.
War is peace. Freedom is slavery. Ignorance is strength.
This is not true - traditional IRA contributions are made pre-tax.
I'm sorry, but I made a factual statement. The money placed into a traditional IRA is a pre-tax contribution. The treatment of distributions is not relevant here; I am responding to a GP claim that money used in self-directed IRAs is strictly money that has been taxed.
Taxing tends to remove incentive to do something by increasing the cost. We want people to be productive (get paid an income)
Taxing wealth rather than capital gains and income seems far better, once you set aside the enforcement part of the conversation.
Once you bring that part in, you’re basically arguing we should o what’s easy, not what’s right.
Look at property tax, for example. It's a wealth tax and it requires a very complicated apparatus to generate ok-ish numbers every year. But that mostly works because houses are a moderately liquid market, so appraisers can mark to the existing market. And even then there's a lot of dubious stuff around the margins, like the way Trump was giving different valuation numbers depending on whether he wanted a loan or to brag (high valuation number) versus paying taxes (low valuation number).
What Thiel did was (and is) not illegal, but it is viewed as an abuse of the intent of a Roth IRA that (some in) Congress want to restrict in the future.
Nobody cares about Thiel spending a few post-tax dollars on some wierdly cheap stock. The issue is that this stock grew to be worth US$5B within the Roth.
Traditional IRA: contributions are pre-tax, tax paid upon withdrawal. Theory is you will contribute more to avoid taxes while earning, compound growth works to your benefit, but now pay taxes on the full amount in the IRA as you withdraw it.
Roth IRA: contributions are post-tax, no tax paid on withdrawal. Conventional theory for typical earnings level is that you will be in a higher tax bracket when you start withdrawing then when contributing, so pay the taxes up front, let compound growth do its thing, then take out the entire amount with no taxes.
Ergo, if you can get contributions into a Roth that you know will show enormous amounts of gain, you're going to be able to pull that out entirely tax free. That would not be true for a traditional IRA or 401k, where you will pay taxes as you withdraw.
If Thiel had been unable to place that stock into a Roth IRA (i.e. buy it with funds already in the Roth), then the gains on it would end up being subject to taxation. Instead, he will be able to withdraw the $5B or whatever it is without paying any taxes on those gains.
For example, had he done this with a traditional IRA, then as he eventually withdrew the money, he would pay tax on the full amount in the IRA.
Put pseudo-graphically:
Roth: 1: invest $1 of post-tax income in the IRA 2: direct the IRA to purchase $1 of some stock 3: wait N years 4: IRA now worth $5B 5: withdraw $5B tax-free
Traditional/401k: 1: invest $1 of pre-tax income in the IRA/401k 2: direct the IRA/401k to purchase $1 of some stock 3: wait N years 4: IRA/401k now worth $5B 5: withdraw $5B and pay income tax rate on $5B - $1
Difference in total benefit: whatever the tax is on $5B - $1
Uhh... have you heard of capital gains tax? (And capital loss deductions).
> This will result in significant tax consequences for many people, including low and middle-income investors.
BS! In order to legally invest in private placements, you must be a "accredited investor" which means you earn over $200k individually or $300k jointly. If you're making over $200k, you're not middle class AT ALL. You're solidly in the top 10% of the country and likely much higher. This provision will have almost zero impact on middle class America
So I’ll say that then saying this impacts the middle class is disingenuous at best. On top of that, private placements usually require bare minimum investments of $50k and realistically $100k min investment is not uncommon. If you have that sort of cash to put into higher risk deals, middle class you are not.
https://www.irs.gov/newsroom/new-income-ranges-for-ira-eligi...
Also, you can “use” an IRA after you contributed to it, so you could be high income now but contributed to an IRA when you weren’t.
https://www.propublica.org/article/lord-of-the-roths-how-tec...
This is direct action against rich people abusing a middle-class retirement account. What percentage of actual middle-class people are investing in "private placements and single-member LLCs"? I'd guess it's close to zero. And it probably should be. The whole reason governments create retirement accounts with special advantages is to make sure people are self-supporting in old age and don't need additional state support. That means they should be investing in a broad spectrum of low-risk stuff, not exotic, hard-to-value instruments.
>The backdoor Roth IRA conversion is a technique where investors who earn too much to contribute directly to a Roth IRA make after-tax contributions to a traditional IRA and then convert the contributed amount, and perhaps other money in the account, to a Roth IRA.
https://www.thinkadvisor.com/2021/09/22/what-to-do-if-congre...
IANAL, IANA tax lawyer, TINALA
https://www.irs.gov/retirement-plans/plan-participant-employ...
https://www.nerdwallet.com/article/investing/backdoor-roth-i...
https://www.forbes.com/advisor/retirement/mega-backdoor-roth...
It’s been nice to want to help people but now, obviously, too many people know of some and their representatives are changing the laws.
It’s back to the way it’s always been: if you can afford good lawyers then you get to know of obscure tax codes. Lets leave it that way.
I'd rather be building something than dealing with tax, but I'm very much incentivized to do the latter (though your situation may differ).
People don't want to hear this because 401ks are silver bullets, and we are all inclined to desire silver bullets over applying rigor. Most people have no idea what part of their paycheck is invested in. Why do we let them lecture us on where to hold and grow our wealth?
That's not to say that 401ks in and of themselves are bad. Their existence doesn't mean that people shouldn't take their own risks and hold assets that keep their wealth liquid rather than locking it up. Personally, I prefer paying more in order to have liquidity. Many would disagree with that. But truth be told, no one knows any one answer that applies to all.
Everything else is a waste of time, plastic straw ban of lawmaking.
In many countries (like mine) organised labour has a wage negotiation-followed-by-industry-wide-strike season. Every year, come rain or shine.
Industry has long responded by: a) adjusting their 'final price' to accommodate the theatre b) automating whatever they can c) scheduling plant maintenance d) learning which jobs can be eliminated and doing so.
All without paying a cent in wages.
Since they seldom get all this done inside 6 weeks, its takes the labourers years to recover even a 5% increase.
Many (mining, paper, logging, hospitals) even budget for it.
Now that so many of us are participating in the stock market (in one way or another), we're more likely to support policies that Wall Street tells us will keep the market booming. Wall Street won by winning over Main Street.
Possibly. I can't complain personally, The shift from defined benefit to defined contribution retirement savings has probably been generally positive for those with the ability/discipline to take full advantage of 401(k)/IRA. The flipside is that relatively few people (mostly public sector) in the US now get a more or less automatic defined retirement payout from a pension.
Of course, the shift isn't just tax code changes. Traditional pensions also largely encoded long-term employment with a single organization.
Then during the 1980s as corporate accounting schemes became more sophisticated preference for 401(k)'s and other defined-contribution plans exploded because of how liabilities are calculated.
In every conceivable measure pensions are theoretically better for workers and society as a whole. I say theoretically because that's predicated on employers and pension funds (if employer managed) obeying good (translation: dead simple) accounting practices rather than spending all their time and effort figuring out how to subvert them in order to cook their balance sheets to increase their yearly bonuses. Many corporate merger waves since the 1980s have been driven by schemes to drain pension funds (cost "synergies"), and of course states are notorious for failing to fully fund pensions on a YtoY basis (states, unlike corporations, aren't actually required to fully fund pensions[1]).
All of these downsides to pensions can be easily remedied. But corporate interests have succeeded in selling the narrative that pensions are unreliable and inequitable, while 401(k)'s are more reliable and equitable. In fact pensions are categorically more equitable, and any less reliability (which is a dubious claim, notwithstanding the many high profile pension failures over the years--nobody reports on someone's 401(k) fund vanishing during a recession) is a consequence of lobbyists phenomenal success in killing legislation and enforcement efforts responsive to corporate financial accounting schemes. Overall reliability of private retirement systems has fallen over the past 40 years, but the decline for pensions was more precipitous simply because they were so damned good before CFO offices became profit centers.
Life insurance markets were once dens of fraud and outright thievery, the mortgage backed securities and CDOs of the late 19th and early 20th century. Relatively simple reforms restored the market to nearly unassailable reliability. Though, I suspect the necessary legislation only succeeded after life insurance stopped being the center of growth and profit for financial markets. Legislation regarding private retirement plans likely will only ever make substantial reform once corporations have finished exploiting all opportunities for subverting employee income disparity and asset protections, finally shifting their attention elsewhere.
[1] "Fully fund" does not mean paying in the entirety of a worker's expected retirement disbursements. Rather, it means ensuring that each and every year you pay the full fractional share of expected liabilities. Basically the same thing an individual is expected to do when managing their 401(k) contributions.
Switch jobs every few years? You probably weren't going to collect much in the way of a pension.
I'm not sure how much the switch has been about "corporate interests." As people became more mobile (for good reasons and bad), the idea of your retirement savings being tied up with a specific (usually large) company became less attractive to employees as well.
[1] Not per se a horrible thing, but that ability is better preserved for infrastructure and other discretionary investments rather than retirement.
Those lobbyists must be doing a terrible job, since the Pension Protection Act of 2006 strengthened the reliability of defined benefit pensions.
The problem is defined benefit pensions are extremely risky for beneficiaries since the existence of an employer decades into the future is a huge risk, as are changes in a world where things change quickly and many people do not stay at the same job for many years.
And they are risky for employers in that expecting every employer to also function as an insurance company selling annuities and survive as long is expensive and ridiculous to execute. That is how you end up with so much corruption and money wasted because so many people have no idea what is going on (and the root cause for taxpayer funded DB pensions being a quagmire since voters have no idea what is going on).
There is zero reason an employer cannot just give the normal cost (the present value of the benefit accrued during the year) to an employee, and the employee put it in VOO rather than the employer doing the same and then having to pay actuaries and fund managers. I am happy I do not need to pay finance people who have been obviated by automation.
Pensions were already dead long before 2006, and inevitable future pension failures baked into the system years and decades earlier. And in any event the PPA heavily favored 401(k)'s, the price extracted by Republicans for creating the Pension Benefit Guaranty Corporation. And the PBGC itself also favored corporations. Nothing about the PPA directly addressed the underlying reasons pensions were failing; the PPA was about creating a soft landing.
> The problem is defined benefit pensions are extremely risky for beneficiaries since the existence of an employer decades into the future is a huge risk, as are changes in a world where things change quickly and many people do not stay at the same job for many years.
They're not risky at all. A pension is just an annuity, the corporate equivalent of employer-provided health insurance vs open market health insurance. Annuities, like life insurance, are considered some of the most reliable investments possible, precisely because of relatively strict, century-old reform legislation. See my response elsethread regarding fully funding requirements and the difference between employer vs independent management. Again, this notion that pensions are fundamentally risky is a false narrative. To the extent pensions are risky, it's only because the laws don't adequately address what in other insurance markets would be considered systemic accounting fraud.
Exactly, but DB pension funds are not regulated by insurance commissioners the way insurance companies that sell annuities are. I wonder why every taxpayer funded pension and private company pension before PPA 2006 would value an annuity at a lower price than an insurance company would…
Since they are the same as annuity, then the employer should just go out and buy people an annuity. Or better yet, give the employer cash and let the employee decide if they want to buy an annuity or not. Insurance companies make single digit profit margins, it is not like having every employer roll their own insurance company was saving anyone any money.
> the corporate equivalent of employer-provided health insurance vs open market health insurance.
It is not quite equivalent since the company is not the one deciding how to do the actuarial calculations, at least not in a way that can be tilted like having their own people on a pension board of trustees would. Most of the health insurance aspects are taken care of by managed care organizations (aka health insurance companies). It would be equivalent if employers offering DB pensions were hiring insurance companies to calculate the cost of their annuities.
But they never would, because annuities are simply very expensive. At the end of the day, compensation for most people in the US was falling or stagnant in real terms for the past few decades (and people were living longer), so offering them properly priced annuities would have made any business untenable, hence businesses jettisoning them in favor of DC plans.
Annuity return rates suck relative to pensions and especially stock market returns (ignoring potential long-term risk). But I have the impression that if you're rich or if you're part of a group effort, the returns get better, much like any other class of financial instrument. But I don't actually know if that's true; never looked into it.
Similarly, if your annuity terms are bargained by a sophisticated party on your behalf, you'll likely end up with a more optimal cash vs future benefit balance. Whereas if the decision is left up to you, you'll do what the vast majority of people do, which is favor cash. And favoring cash is something even a financially conservative, risk-averse person might do, because to laymen "conservative" means cash in hand. Just a few weeks ago my dad explained to me that he wanted to cash out his old union-provided annuity and stuff the money in a mattress because he was concerned about Biden/Pelosi policies driving higher inflation. I wanted to be like, "WTF!?"[1], but I long ago learned not to argue with cranky old men, though I'm well on my way to becoming one. (It was a tiny annuity, anyhow, started only a few years before he retired. Definitely not worth lecturing anyone over.)
[1] Because almost certainly the annuity was inflation adjusted.
Health insurance, like life insurance and annuities, is pretty efficient already with low single digit profit margins.
Average annual employer sponsored insurance is $7,675 for single PPO coverage in 2019:
https://www.kff.org/report-section/ehbs-2019-summary-of-find...
And average lowest cost monthly gold premium on healthcare.gov is $516 ($6k annual) in 2019:
https://www.kff.org/health-reform/state-indicator/average-ma...
> Annuity return rates suck relative to pensions and especially stock market returns (ignoring potential long-term risk).
Ignoring the main risk of an investment certainly makes it cheaper. That is what we have been discussing these past few comments. Once those risks are taken into account, by legislation like PPA 2006, the time shifting of costs into the future becomes more difficult and is one big reason why DB pensions are not tenable.
Although, at this point, I would argue an even bigger reason is that they simply have been obviated (same for annuities by insurance companies). Why pay an insurance company a cut of your investment returns when you can get rock bottom expense ratios on target date funds from Vanguard or buy VOO? That is what all these DB pension fund managers and insurance companies are doing anyway. Same reason why whole life insurance is a scam. All of these products have been automated and their middlemen bypassed.
What are the DIY alternatives to whole life?
For me (and I think many others), an annuity that ends at death is not my primary goal when considering how to arrange my investments.
To my mind, Social Security, pensions, 401(k)s, and the like can all play a part. My larger point about pensions specifically is that there's nothing inherently less risky in pensions from a purely accounting perspective. Actuarial tables were astonishingly precise 100 years ago, and our ability to diversify and insure risk through private markets has only grown while at the same time U.S. monetary stability has achieved undreamed of heights, even considering asset inflation. The basic dilemmas and moral hazards, meanwhile, have largely stayed the same, albeit sometimes obscured by increasing technical complexity.
The biggest part of the puzzle concerns public policy. For some reason we keep returning to tired debates about socialist vs private markets or personal freedom vs authoritarianism, like we're still picking sides in an insurgent communist revolution at the turn of the previous century. (The current debates are astonishingly similar to the ones we've had prior, such as over hourly limits, employment disability insurance, and especially Social Security.) It's ridiculous. We have a decent grasp on which basic tools work better in which contexts and why, partly because the science of economics has improved, and partly because the past century saw a large number of social experiments play out at large scales both domestically and especially globally. The immediate question isn't which singular option to chose, it's about how to mix-and-match instruments and incentives. Interactions and second-order effects are still fuzzy, and political cultures do matter, but there are so many tremendous improvements we could make before we hit that next wall.
For the recipient of an earned pension, there is substantially less volatility in future payout (as compared to defined contribution plans). There is some value in that for the individual. For people who are capable to save more than the minimum required in a personal account, an annuity is on-average worse than their own diversified portfolio of mostly equities. But for people saving/earning the minimum pension, capping downside risk has a pretty large benefit and, at least in that sense, I would say pensions are "inherently less risky".
Is the pension fund making sound investments? Will the city, state, or corporation be sound decades from now or will they be bankrupt or struggle to pay obligations made by their priors that were maybe inflated?
Private investment vehicles are independent of your employer. If they go bust your balance is sound if it wasn't in their securities, which is again ultimately the investor's choice. If I make bad investment decisions I can live with it. I can't live with promises others couldn't keep, I'm at their mercy.
I would prefer eliminating 401ks entirely and expanding IRAs. IRAs allow choice of broker and much wider investment options. If I know what I'm doing I can take more risk. Otherwise I can play it safe with mostly index funds and sensible asset allocation. If I don't know where to start I can hire an advisor or multiple of my choosing to handle it for me. It also would eliminate vesting periods which keep people in jobs they're unhappy with.
> nobody reports on someone's 401(k) fund vanishing during a recession
Recession dips are temporary. If you're well diversified and don't panic sell the balance should recover. Whatever balance you're relying on near term should not be in something volatile like the stock market.
That's exhibit A of what I'm talking about!
This is an article about IRAs being heavily restricted, 401k's are in the same 400-section of the tax code. IRAs are subsection 408, 401k's are subsection 401(k).
Literally just stop talking about it, stop trying to get a personal finance blog going, stop trying to get youtube views funnelled over to a personal finance discord server, just let unaware people run around like chickens with their heads cut off because when you tell them whatsup they try to get the laws changed when they fail to take advantage of it adequately
Ignorance is bliss and convenient, this is where we are. Just get the tax breaks you have because of your superior reading comprehension skills and eventually your ability to outsource and augment those skills to experienced lawyers and accountants with the same skills.