More Than Chump Change

I prepared our taxes for the first time this week. Last year was a false start, after a red flag popped onto the page, halfway through the TurboTax application. Panicked, I called a new accountant. Send help, I penned, delivered with the expediency of Paul Revere flanking the ride of his life.

Before this, I had used an accountant for several years. But he filed my tax returns late, by extension, in the final two years, without discussing it until after the fact. I didn’t mind so much, until I was hit with a penalty for paying a capital gains tax late. I thought as my accountant, these details fell under his jurisdiction. It should have been noticed and dealt with in a timely manner. 

Fool me once, shame on you. Fool me twice, shame on me.

The following year, Russ and I were filing jointly for the first time. We made an appointment at HR Block in DC. It cost $350 for Melvin to prepare our Form 1040, and the process was fairly painless, considering the world was embroiled in a newly-hatched pandemic at that moment. After that, I decided last year I would compile our information myself, with the help of TurboTax. We both had W-2’s to submit, after all. No more wrangling 1099s, coming and going, like coupons ripped from the Sunday paper, and lost somewhere between the car and the grocery store. I was halfway through the application when the red flag appeared. TurboTax alerted me (“we” really, since filing jointly pools all streams of income into a single one), I had exceeded income limits for contributing to my Roth-IRA.

Huh?

No, I didn’t exceed IRA contribution limits. Brokerage houses tally that number with every addition to your account, all the way to the limit, that proverbial glass ceiling. Viewing additions to my IRA accounts is like staring at the glass ball hanging from the ceiling in Squid Game, when the cash shoots into it after each deadly round. Instead, my problem lied with Uncle Sam.

Shaking his finger, he admonished, “You make too much now, to save too much for later. You’re fired.”

Just kidding, he didn’t say that last part. And the statement, my accusation, is only a partial truth. I can contribute freely, up to the federal limit, to a trad-IRA, just not a Roth IRA. This is Uncle Sam’s strategy to ensure a steady flow of cash to grease operations later. The government collects income tax on funds in a traditional IRA when you remove it from the account, presumably at the age of retirement, after saving it for decades. In a Roth account, individuals pay taxes on contributions at the input. This makes the withdrawals later tax-free.

Paying taxes on contributions now, while you are still working, and not later when you have surpassed your highest earning years, is significant peace of mind. But I suppose that was exactly what Uncle Sam had in mind with this caveat (wrist slap). The future is uncertain. Laws were devised to ensure the bolstering of pockets for tomorrow. After all, this country was/is built on “buy now, pay later,” some of it born of necessity, the rest culturally rote consumerism. We pay taxes now on income earned, and we will pay taxes again, oftentimes on what you have already paid taxes on the first time around as income earned, then deposited into an individual retirement account, to pay taxes on again when removed from that particular financial vehicle, as we enter what is potentially our most vulnerable years—physically, financially, etc. 

TurboTax’s truth bomb was like swallowing a grenade whole. Mind blowing; an education earned using the empirical evidence of a costly mistake made. The accountant contacted on the fly, dug us out of the quagmire I had no idea I was mired in, chin deep. They walked us through the “recharacterization”process. This term sounds like a new fandangle therapy to improve one’s constitution, like a medically-induced LSD trip, but no, I learned “recharacterization” is the process of changing the “designation” of your IRA contribution from one to the other. For us, it was recharacterizing money from Roth status into traditional status. If done within the deadline (aka Tax Day), there is no penalty. This is a necessary step, not just because of the deadline, but because the money also never leaves the retirement account ecosystem, which would elicit a taxable event. 

Relieved, and grateful, we discussed a financial plan for the future, a plan to keep us out of trouble. He mentioned a retainer; a minuscule percentage of assets. We coughed nervously. The great irony of our situation was Russ and I made too much money to qualify for any tax “breaks,” but not enough to qualify for a financial advisor. We heard the same story twice, from two different advisors. “Our average client makes $500,000 a year, has a net worth of 2 to 3 million, and is ten to fifteen years from retirement.” 

Literally. Verbatim. Twice.

Umm, that’s not us. 

Russ and I discussed it at length, nevertheless. Did we pay the cost for someone to circumvent expensive mistakes, or did we just forge ahead, banking on (pun!) the probability of incurring costly mistakes in the future, learning from them, and moving on? It is the difference between paying upfront, or paying later, splitting the difference, not unlike overpaying your tax burden throughout the year, versus paying just enough, with the certainty you will write a check to Uncle Sam, before the deadline. I pay ahead, because not doing so feels like a dangling noose swinging in front of me, inviting my neck to dance. Plenty choose otherwise. Possession is nine tenths of the law, and that includes compounded interest. The argument of those braver than me is, “Why should I let Uncle Sam earn interest on my money that is essentially in escrow until April 15th?” Their strategy is to capitalise on interest earned, while in their own account, before handing over any balance owed to the USA.

Ultimately, Russ and I decided to go it alone. It was a decision made mostly due to default, not really qualifying as worthwhile candidates for a financial advisor, but also, we were confident that as we neared the finish line at the end of our careers, our cumulative mistakes would cost us significantly less, than management fees would have. Every penny counts. After all, there is a big difference between a 0.03% expense ratio of an exchange-traded fund (ETF) and the average expense ratio of 0.5% to 1.0% for most mutual funds when calculated over what is hopefully decades. If you owned $100,000-worth of an ETF, with an expense ratio of 0.03%, over twenty years you would have “paid” $2,500-plus to have the fund “managed.” If you invested that same dollar amount, for the same two decades, in a mutual fund with an expense ratio of 0.5%, you would pay over $41,000 out of your proceeds (interest earned) in management fees over that same twenty-year period. That’s more than chump change. 

How did I calculate those differences in cost? Anyone can discover anything they wish to better understand on Google. Love it or hate it, Google has decentralised the platform of information, lowering the barriers to entry for everyone. This is both good and bad. Much more information, and possibilities for education, are accessible to everyone, but conversely, significant value is whitewashed from a lot of it. Now I can do my taxes myself, and buy or sell my own ETF’s whenever I want, without incurring a transaction fee. I can bank online, find my rights as a tenant, or as a property owner, studying the real estate laws in my state as compared to others. Searching, I can find the best offer on a new pair of shoes, or a used car, and everything in between. In short, I can eliminate the middleman, of the middle class, marching towards modern capitalism.

It all seems a moot point on the precipice of this war. The future is uncertain, for all of us, a humanitarian crisis unfolding before our eyes. We always think, we must believe really, that war is what happens to other people, not us. I’m not so confident of this anymore. I am only certain that following death, Uncle Sam will still stand on my doorstep, a collection plate clutched in his bony hands.

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