The Prohibition Era kicked off in January of 1919 with the ratification of the 18th amendment to the Constitution. The amendment banned the manufacture, sale, and transportation of “intoxicating liquors,” essentially making alcohol illegal (until 1933 when the 18th amendment was repealed by the 21st amendment).
There were two groups of people that were particularly supportive of the 18th amendment. And they weren’t groups that you’d expect to be on the same side of an issue—the Baptists and the bootleggers.
The Baptists, of course, wanted alcohol to be illegal because of the destruction that they believed it wrought on society.
The bootleggers, on the other hand, were already selling alcohol illegally, and knew that business would be booming for them if legal sales were outlawed.
And so, these two groups fought tooth and nail for the same political outcome, albeit for completely different reasons.
There’s a similar phenomenon at play when it comes to tax planning in 2023.
People often ask me, “Is there a chance that Roth IRAs will eventually go away and we won’t be able to contribute to them anymore?” On its face, the question is logical.
Consider the thought process that someone might go through in deciding whether to contribute to a traditional IRA or a Roth IRA. Suppose they’re currently in the 22% tax bracket. A contribution of $5000 to a traditional IRA would lower their tax bill by $1100 in the current year. And if that $5000 is invested in the market for the next 20 years, it’s likely to quintuple and become at least $25,000, all of which would be taxable income upon withdrawal.
On the other hand, contributing that same $5000 to a Roth IRA provides no tax break in the current year. However, that $5000 grows tax free, meaning that the $25,000 down the road can be withdrawn without paying any taxes.
So the trade-off is simple: would you rather save $1100 in taxes now, in exchange for $25,000 of taxable income later (at tax rates that we can’t predict), or would you rather pay the $1100 now and have $25,000 tax-free later.
Most people will assess those numbers and determine that they’re better off to pay the taxes now because they’ll pay much less in total taxes over the course of their lifetime.
And if the assumption is that politicians want the most tax revenue possible, it’s logical to ask, “Won’t they try to take away my ability to contribute to a Roth since that will actually cause me to pay less in taxes over the long haul?”
But politicians are much more short-sighted than that. Nobody currently in Congress really cares about tax revenue 20-30 years from now. They’re much more interested in maximizing tax revenue in the current year to help pay for all of the asinine spending that they propose. Tax revenue three decades from now is someone else’s problem.
So they’re more than happy for you to contribute to a Roth.
You can like the Roth because it saves you money in the long run. And your congressman can also like the Roth because it makes him more money now. It doesn’t matter that you and he like it for completely different reasons—it only matters that you both like it.
And while it’s certainly possible that something unforeseen could happen, it’s very difficult to imagine a scenario where Roth IRAs go away, thanks to this odd alliance of modern day Baptists and bootleggers.
Crackin', Packin' & Tax Deductin'
If you’re a state legislator who’s trying to draw some gerrymandered congressional districts along partisan lines, there’s generally two ways that you can accomplish it—crackin’ or packin’.
If you choose to participate in crackin’, your goal is to “crack” the opposition party by spreading their registered voters out into multiple congressional districts so that they make up the majority in as few districts as possible.
As an example, in the blue state of Maryland where Democrats control the state legislature, they’ve drawn the districts to dilute, or crack, the Republican vote as much as they can, resulting in a few hideously-shaped monstrosities like their 3rd congressional district, the single worst gerrymander in the nation. It’s been described by a federal judge as a “broken-winged pterodactyl lying prostrate across the state.” See for yourself:
This has allowed Maryland to consistently guarantee six Democrats in Congress, one Republican, and one swing district.
On the other hand, it’s possible that the opposition party’s voters might be geographically distributed in such a way that crackin’ is difficult…in which case you might have to do some packin’ instead. This is where, instead of diluting the opposition vote, you try to concentrate it by shoving as many opposing voters as possible into a district or two, understanding that your party is always going to lose those districts, but all of the remaining districts in the state will be much more easily carried by your party.
Take for example Republican-controlled Ohio, where the state legislature has successfully quarantined enough Democrats in their “snake by the lake” 9th District to all but ensure a congressional delegation of 10 Republicans, 3 Democrats, and 3 swing districts:
And as you might guess, there’s a financial lesson to be learned from all of this crackin’ and packin’. Because when it comes to maximizing the deductions on your tax return, most people crack when they should instead pack.
Consider a couple who has the following potential deductions on their taxes this year:
$6500 property tax bill
$9000 in charitable giving
$4500 in mortgage interest
$3500 in state income taxes
That’s a total of $23,500 in deductions. But for a couple filing a joint tax return, the standard deduction is $25,900, meaning that they wouldn’t itemize deductions, they’d just take the bigger standard deduction.
But that’s because they were crackin’ instead of packin’. In other words, they diluted their deductions by letting them be uniform every calendar year.
What if they plan ahead for some packin’ next year? Here’s how they’d do it:
- Don’t pay this year’s property tax bill until January, meaning it will count as a deduction for 2023. Then pay the property tax bill again in December of 2023, doubling their property tax deduction for the year.
- In December of 2023, pre-pay their charitable contributions for all of 2024, meaning they’ll double up their charitable giving for the year as well.
Now they can itemize deductions in 2023 with a total of $39,000. They’ll have very little to deduct the following year in 2024, but that’s ok because they’ll still get to claim the standard $25,900. If they “pack” like this every other year, they’ll get an extra $13,000 in deductions every two years, which could represent a reduced tax bill of several thousand dollars, depending on their tax bracket.
If you’re a state legislator, there are laws that prevent you from getting too extreme with your crackin’ and packin’. But there’s nothing stopping you from doing it with your taxes.
Chess, Roulette, or Poker?
Almost any financial decision that you have to make can be compared to playing chess, playing roulette, or playing poker.
Chess is a game of pure skill. All possible information about the game is equally available to both opponents and neither player can hide anything from the other. Because the game is purely analytical, we’ve seen several occasions where a computer has beaten a world class chess master. But because there’s no such thing as luck in chess, it would be virtually impossible for a beginner to beat the master.
At the other end of the spectrum is roulette, a game of pure luck. Despite what you may try to tell yourself, you don’t have any information to work with. There’s no skill that you can bring to the table to improve your chances. A first-time player is on equal footing with a chain-smoking degenerate gambler who goes to the casino every day.
And somewhere in between we find poker. Poker combines both luck and skill because the game includes information that you know (like the cards in your hand) and information that you don’t know (like which cards your opponents hold). More often than not, a highly skilled poker player will beat a novice, but sometimes the novice will win if he stumbles across a lucky hand that’s so strong that it can’t be overcome by the skill of the experienced player.
All of your financial decisions fall into these same three categories—pure skill, pure luck, or some of both. A few examples…
Roth Conversions – You can convert money from a traditional IRA (money that’s yet to be taxed but will be taxed upon withdrawal) to a Roth IRA (where it will grow tax-free and can be withdrawn tax-free later). You’ll just have to pay the taxes at the time of the conversion.
This is chess. All information is available to you. If you do a Roth conversion in December, you know at that point what your income is going to be for the year, and you know exactly what the tax brackets look like. From there, it’s easy to see how much it’s going to cost you in taxes to do this conversion and you can decide whether or not it’s logical to pay those taxes now so that the money will be available tax-free for you later.
Timing the Market – Many people are convinced that they can time the market, meaning that they can “sell high” right before a crash happens, then “buy low” and put their money back in right before the market recovers. Unfortunately for them…
This is roulette. It’s true that there are people who have successfully timed the market before. Of course, there are also plenty of people who have had a really good day at the roulette wheel. Both of these people have benefitted from luck, not skill. To successfully time the market, you have to be right twice—you have to sell at exactly the right time, but then you have to buy back in at exactly the right time too. And no matter what chart you’re looking at or what data you think you’ve mastered, nobody knows where the market roller coaster is going to go next.
It’s also important to note that just because somebody successfully timed the market once before, that’s no indication of their ability to successfully do it again. Just like the guy who won at roulette on Friday night…he walks into the casino on Saturday with the same chance of winning as the guy who lost his shirt the night before.
Deciding on a Retirement Date – Occasionally, people will be forced into retirement, maybe by a health issue, or perhaps by a company or industry telling them that it’s time to move on. But most of the time, you have to decide whether or not it’s the right time for you to walk away from that paycheck.
This is poker. There’s a lot of information that you know…like how much money you’ve saved, how much you want to spend, and what guaranteed income streams (like Social Security or pensions) will be available to you. On the other hand, there’s plenty that you don’t know, like how long you’ll live, how your investments will perform in the future, and what kind of health problems you might face down the road.
So anytime you’re faced with a financial decision, determine if it’s a decision that requires you to play chess, roulette, or poker.
If it’s chess, you should seek guidance…because skill and experience always wins at chess.
If it’s roulette, you should determine if there’s another way to approach the situation so that you aren’t forced to play a game of pure luck.
If it’s poker, you should stack the deck. Find ways to reduce the areas of uncertainty and increase the things that you know. In other words, reduce the reliance on luck and increase the opportunity to employ skill.
And then all that’s left to do is enjoy the game…
A Plane on the Ground
In 1967, a Texas lawyer named Herb Kelleher used a cocktail napkin to sketch out his plan for a new company called Southwest Airlines that would provide cheap flights connecting Dallas, San Antonio, and Houston. At the bottom of the napkin, he wrote one simple sentence…
“A plane on the ground makes no money.”
So before the company even got off the ground (so to speak), he’d already recognized a very important concept: if your assets are just sitting around collecting dust, they’re worthless.
Southwest started out with three planes. The company lost money for two years (because they didn’t have enough demand to keep three planes in the air all the time), so Kelleher sold a plane to get them down to just two. By its third year, Southwest was turning a profit—an unheard of accomplishment in the aviation industry.
Another important component of Southwest becoming profitable was their mastery of baggage handling. The quicker you can get luggage on and off planes, the quicker you can get the plane back in the air. And if that allows you to squeeze in another flight or two each day, that extra flight or two can represent a lot of additional profit.
A lot of folks need to learn the same lesson with their personal assets. I see a lot of people who have their planes on the ground. A few examples…
- Money that’s just sitting in a bank account (and in many cases, growing by the month as you continue to spend less than you bring in) isn’t helping you. You need to have enough for an emergency fund (3-6 months’ expenses) and enough to cover any known major expenses that will be coming up in the next 12 months. Over and above that, any money sitting in cash without a purpose is losing money for you. And no, you don’t need $75,000 for an “emergency.” How many $75,000 emergencies have you ever heard of? By the way, this same concept can apply to business owners who keep way too much money in the business bank account.
- Overly conservative investments in retirement accounts (especially if you’re more than 10 years from retirement) aren’t doing you any favors. A lot of people end up being too conservative in their 401K, IRA or Roth, simply because they’re uneasy about the immediate future of the stock market. But if you’re not retiring anytime soon, the stock market’s immediate future is probably going to be largely irrelevant to you.
- For empty nesters whose kids have moved on, the house might be a plane on the ground. Suppose you raised the kids in a 5-bedroom house in a great school district, and it’s now worth $750,000. But you no longer need the great school district or the five bedrooms, which means you’re heating, cooling, maintaining and cleaning a lot of space that you don’t need and paying a lot in property taxes for that school district. Not to mention all of the equity that’s trapped in the house that could be working for you some other way if you sold and downsized to a house that you buy for $450,000.