The Financial Riddler - 1/18/22
Financial Knowledge Is Financial Empowerment
And we’re back with another Financial Riddler, where losing is winning because, well, you’ll learn something. Just to be clear, the author of this quiz, moi, didn’t know the answers. He looked them up or calculated them using MaxiFi. So, no stress. And please share this game with your kids, grandparents, partners, financial planner, high school teacher, whomever.
To avoid peeking, scroll slowly and stop at “And the answer is.” Then check how you did. Also, play prior riddlers right here at larrykotlikoff.substack.com.
Last year’s global share of electric cars sold was
a) 1 percent
b) 2 percent
c) 5 percent
d) 10 percent
e) 15 percent
And the Answer Is …
The answer is 10 percent. The U.S. share was 6 percent. The EU share was 11 percent, and the Chinese share was 19 percent. Electric vehicle sales are soaring in Germany. Last month more than half the cars sold in Germany were electric! The transportation sector is a large source — 27 percent — of global carbon emissions and cars account for 41 percent of the sector’s emissions. Hence, if all cars were electric, we’d zap 11 percent of emissions. Well, not quite right. It takes energy, most of which is dirty, to produce the electricity that powers electric cars. Currently, only 20 percent of electricity is generated by clean energy. But this share is rising. For example, the UK’s dirty share of electricity generation is expected to fall by 70 percent by 2030. Battery production also uses lots of electricity. But, again, as electricity gets cleaner, batteries will get cleaner, and electric cars, trucks, boats, and planes (They’re coming!) will make a real contribution to cooling the planet.
GDP per capita in the U.S. in 2021 was $70,000. How much was GDP per capita in South Africa in 2021?
And the Answer Is …
The answer is d. $5,000 is remarkably low. But South Africa’s per capita GDP is far higher than that in most African countries. In Egypt, it’s $4,000. In Ghana, it’s $2,000. The U.S. needs to join hands with China and other developed nations and make massive investments in Africa. Its population will grow by 1.7 Chinas by the end of this century. That’s almost 2.5 billion people — all who will be hopping on boats to get to the EU, the UK, the U.S., and everywhere else that offers a decent living standard and has a climate that’s survivable. Listen to this podcast by a brilliant economist and humanitarian — Theo Kochen — who makes clear that smart ideas can go a very long way in substituting for money. China and the U.S. should make this their joint Las Palamos project and put together a team of top economists, educators, financiers, public policy experts, and others to shoot for this critical moon. The by-product will be lowering tensions between our countries, which are now almost beyond control.
Ruth, age 62, just retired in Minnesota with $1 million in an IRA and $250K in regular assets. She’s invested her regular assets in TIPS (Treasuries that are inflation-protected) yielding 1.5 percent real. The IRA is in stocks, which we’ll assume earn 3.5 percent real. Ruth just filed for Social Security, which will pay her $30,890 per year, in today’s dollars, through the end of her days. Ruth plans on taking her retirement benefits starting at age 75 but is going to convert $50K, in today’s dollars, of her IRA assets into Roth accounts each year through age 74. She’ll also withdraw her Roth money last. How much will this save Ruth in remaining lifetime taxes, measured in present value?
And the Answer Is …
The answer is d, which is nada. There are three interesting findings here. First, Roth conversions don’t matter much for Ruth. Second, the conversion reduces her federal income taxes as well as her Medicare Part B premiums (a tax in all but name). Third, the conversion raises Ruth’s state income taxes. Minnesota’s state income tax is progressive. It even taxes Social Security benefits on a progressive basis. (The effort to stop taxing Social Security benefits has not yet succeeded.)
If Ruth takes her Roth money first, the Roth conversion reduces her lifetime taxes by more — $8,341. Roth withdraws don’t count for determining the progressive IRMAA (Income Related Monthly Adjustment Amount) Medicare premium. And using that advantage by withdrawing from her Roth funds sooner than later helps.
What if Ruth believes federal and state income taxes will increase by 20 percent starting in 2030? This helps the conversion lower federal taxes. But there is an even larger rise in state income taxes.
Does taking Roth withdrawals first help? Not really. What helps is getting the … out of Minnesota to a state that doesn’t tax income. What if Ruth moves to Utqiaġvik, Alaska. That’s the Alaskan city closest to the Arctic Circle. It’s super cool and you’re in the dark for 24 hours half the year and in the light for 24 hours the other half. Plus, Alaska doesn’t tax income. With the projected tax hike and Ruth’s taking her Roth withdrawals first, the conversion drops her lifetime taxes by $32,322. Now we’re taking about three-quarters of a year’s spending!
Ask your friend the math genius if she can figure this out in her head? I sure as … can’t. Better yet, ask your financial planner to use his software to make these calcs. Unless he’s using MaxiFi, …, well, see what he comes up with. There aren’t two correct answers to these questions. And there is no other consumption-smoothing software on the planet that incorporates cash-flow constraints and is beyond anal in sweating the details.
What if Ruth is hanging out in Utqiaġvik, about to pull the trigger on the conversion and grab the free $32,322, but instead, she hits MaxiFi’s maximization button? This tells the program to optimize over when Ruth should take Social Security and when Ruth should start her retirement account withdrawals. It would also optimize over whether to take her Roth money first or second. But Ruth doesn’t have any Roth money as she hasn’t yet converted. So, what’s the gain in lifetime spending? Hint: It’s different from $32,322.
e) - $7,537
And the Answer Is …
The answer is a — $259,763! The maximized strategy has Ruth starting her retirement account withdrawals immediately and waiting till 70 to take her Social Security. This drops Ruth’s lifetime taxes by over $100K and raises her lifetime Social Security by almost $130K. Now that’s money magic.
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Does your software have the ability to factor in the effect of anticipated future tax rates (expiring TCJA rates) when looking at Roth conversions?
Does the software have the ability to to factor in the savings effect of Roth conversions depending on when a spouse dies. I rarely see the effect of moving to a single filer tax rate mentioned in discussions of Roth conversions.