Q. The Federal Reserve has printed trillions of dollars to purchase Treasury bonds and mortgages. With so much excess money in circulation, isn't this going to result in high inflation? Also, there seems something disturbing about the Federal Reserve purchasing large amounts of Treasury bonds. The US government seems to be financing its own debt. Is this true? — N. A., Dallas, TX
A. In addition to existing, money has to move. While the Federal Reserve has expanded the supply of money greatly, transactions aren’t happening nearly as quickly as they have in the past. What economists call “the velocity of money’ has slowed substantially.
One reason this has happened is that people have been less willing (or less able) to engage in new consumption or investment since the financial crash. The economist who has written the most about this is Austin-based Lacy Hunt at Hoisington Management. Hunt does an economic review quarterly. If you want a well-written, historically grounded, graphically illustrated and data-dense discussion of why over-indebted economies can’t get out of their own way, just read the quarterly by clicking on “Economic Overview” at www.hoisingtonmgt.com.
Q. I contribute to 9 percent of my income to a pre-tax 401(k) and 9 percent to a Roth 401(k). When I retire, can I choose the one from which I want to withdraw funds? Is there an advantage to having this option when I retire? —K.B., Seattle, WA
A. When you retire you won’t have to withdraw from your regular 401(k), or the IRA Rollover account you may move it to, until you reach age 70 1/2. That's when Required Minimum Distributions begin. In your first distribution you will need to withdraw 3.65 percent of your regular 401(k) account balance at the end of the previous year.
In each year after that you will be required to withdraw larger percentages, but the increase is relatively slow. It only exceeds 5 percent, for example, at age 79. If you have a large account the increases may eventually have an impact on your tax rate as your distributions grow.
The increasing tax rate is why many people strive to do some amount of Roth IRA conversion early in retirement or in low-income years before retirement. Roth accounts have no required distributions. When you do make distributions it is not a “taxable event.” This can give you a lot of freedom to manage your tax bill.
Here’s an example. Suppose your 14-year-old car is about to die. You need $30,000 for a new car. How you get that $30,000 can influence your tax bill. If you take $30,000 from your Roth account, there will be no tax consequences. If you take the money from your regular IRA every dime of that $30,000 will be taxable.
Worse, the $30,000 could do something ugly to you, such as move you from the 15 percent tax bracket to the 25 percent tax bracket. So the $30,000 withdrawal could increase your tax bill. By $4,500 if it is all taxable. Or by $7,500 if the added money is taxed at 25 percent.
Actually, the tax situation could be worse— the $30,000 could also cause some of your Social Security benefits to be included in your taxable income, increasing your tax bill still more.
Another alternative would be to borrow the $30,000 and pay it off over 5 years, with an annual withdrawal of $6,154 to pay off the loan (assuming a 1 percent interest rate). That might keep you in the 15 percent tax bracket. Over the 5 years of the loan you’d pay $769 in interest— but it would be worth it if the smaller withdrawal kept you in the 15 percent tax bracket because the 25 percent tax bracket would add $3,000 to your tax bill as the IRS snorts “gotcha!”
As you can see, retirement may require lots of machinations if you are to avoid some big tax hits. Significantly, the biggest tax hits are the ones middle income tax payers face— the increase from the 10 percent tax rate to 15 percent tax rate and the increase from 15 percent to 25 percent.
Throw in the taxation of Social Security benefits and we’ve got a big set of tax booby traps for households with total incomes under about $100,000. We should all think about this as the growing zoo of presidential candidates announce their platforms and call their tax changes “reform.” Most will just be more empty talk about our wretched, indefensible tax system.