Tales & Trails of a Traveling Wiseguy

As I wrote about the contribution limits for 401(k)s rising in 2023 a few weeks ago I was reminded that a lot of people don't understand the benefit of 401(k)s. I mean, I think most American adults understand it at a high level: "Investing money in a 401(k) saves on taxes, so you have more money at the end." But understanding the details of how that works— and how much it benefits them— is squishy. I get it; the math¹ can seem intimidating. Even for many people well educated in math or engineering it's too much to figure out. That leads to a lot of people not participating in 401(k) programs when they should. For example, many of my colleagues. 😳

I'll walk you through the math with a simple illustration. This will show you how much you can gain by investing through a 401(k) instead of an ordinary account. I call it the Tax-Deferred Advantage.

Here are five basic assumptions for my example:

1. Let's suppose you invest your money in company XYZ, which enjoys stock price appreciation averaging 7% a year over the course of many years. To keep this example simple let's assume XYZ does not pay a dividend or distribution. This is a little unusual as most companies, over 80% of the names in the S&P 500 index, pay dividends; and virtually all mutual funds pay distributions. This assumption keeps the tax calculations simple.


2. Let's suppose your overall marginal tax bracket is 28%. This includes both federal and state/local taxes, so think of it as 22% federal plus 6% state/local, or 24% federal plus 4% state/local, etc.


3. You start with $10,000, pre-tax, to invest.


4. You "buy and hold" XYZ — no trading until you're ready to withdraw. (This also keeps the example simpler.)


5. We'll look at the totals after 20 years.

Case A: You invest via traditional investment account. You start by paying taxes on that $10k. Your investment in XYZ is thus $7,200 ($10k less 28% combined tax). Twenty years later your account value is $27,862. (This is $7.2k x 1.07^20.) When you withdraw the money you pay tax... but only on the gain of $20,662. Your net after taxes is $22,076.

Case B: You invest via a 401(k). You pay no taxes on the $10k up front because it's tax-deferred. All $10 goes into buying shares of XYZ company. Twenty years later it's worth $38,697. When you withdraw the money you pay taxes on the whole amount. After taxes you net $27,862.

So, how did we do? The 401(k) gave us 26% more money ($27,862 vs. $22,076) after 20 years. That's the Tax-Deferred Advantage!

And BTW, the advantage gets even bigger when you change some of the model's assumptions. For example, if your investment pays dividends or distributions, the advantage is even bigger. If your tax bracket is lower in retirement than your working years, the advantage is bigger, too. I'll show examples of these in a later blog as the math gets more complicated.

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1: Insert curmudgeonly math joke: "That's not even math, it's arithmetic. If it were math it'd have letters!"

Earlier today I began sharing my opinions about the statewide propositions on the ballot in California. See Ballot Propositions - Nov 2022 - part 1. Here in part 2 I address the latter four props on this November's ballot.

Prop 28: Lock in Funding for K-12 Arts and Music: Gentle No.

A few days ago I wrote blog entry The Problems with Propositions. Prop 28 is exactly the sort of measure I had in mind when I explained the trouble with props that lock in spending requirements. The bill would ensure a certain baseline amount of funding for K-12 arts and music education. To be sure, supporting such education programs is a worthy goal. And because of that it may well pass. I mean, who could be against teaching art and music to kids? But here's the thing: a vote against this initiative is not a vote against art. It's a vote against tying the hands of state legislators in the budgeting process.

This year California's budget spends nearly $100,000,000 on K-12 education, an average of $17,000 per student. For context: yes, that's a lot. And it's a lot partly because the state has enjoyed strong tax revenues for several years. But strong revenues are not a given. During an economic slowdown— of the sort that most economists, business leaders, and even ordinary citizens are predicting will happen next year if not sooner— California's tax revenues fall. Legislators then face tough choices in where to allocate funds. Each voter-passed initiative that locks in funding for one item or another makes the decisions about where to spend the remaining money more dire. Lock-ins for art and music may mean that school programs for language suffer... or perhaps that programs for supporting the elderly or combating climate change get short shrift.

Again, I recognize that supporting art and music education is a sympathetic choice. The only problem I have with this bill is that it's a funding lock-in. That's why I'm calling my position a Gentle No on 28.

Prop 29: Dialysis Clinic Regulation: No.

Patients who need kidney dialysis face dire straits. Shouldn't the industry that keeps them alive be better regulated? Don't be fooled; that's not what this is about.

This initiative matches at least 2 of the 5 proposition problems I described the other day. First, regulation in an industry that is a matter of life-or-death for certain individuals is a deeply detailed bit of policy that  shouldn't be left to ordinary citizens to enact on strict up-or-down votes.

Second— and more importantly— this is a special-interest, self-dealing initiative in disguise. Follow the money to see who is bankrolling this and understand why. Funding comes almost entirely from the Service Employees International Union-United Healthcare Workers West union, which has been fighting with the two major providers of kidney dialysis over workers' contracts for years. This is now the second time in recent years the SEIU has gone to the ballot box in an attempt to gain extra leverage in negotiations. I support unions fighting for fair pay, benefits, and working conditions. I do not support them misleading voters at the ballot box to win what they cannot win in equal party negotiations. Vote No on 29.

Prop 30: Tax the Rich to Fight Wildfires and Climate Change: No.

Ah, Prop 30, another measure with a worthy-seeming set of goals. Wildfires are already a very destructive phenomenon in California, costing billions annually, destroying homes and habitat, and often causing deaths. Who could be opposed to reducing the risk of wildfires? Especially since as bad as they are now they're expected to get worse as a result of climate change.... Which this measure nominally also fights. Who but climate deniers doesn't want to fight climate change? And who better to soak with the bill for all of this than California's highest income citizens, those making over $2 million per year?

Alas, Prop 30 is another case of a moneyed special interest looking to do itself a favor at taxpayer expense while using a noble goal as a disguise. Follow the money and you'll see: a) the measure's main sponsor is ride-share company Lyft, and b) the measure's main expenditure is subsidizing purchase of electric cars and the construction and operation of recharging stations. How does (b) relate to (a)? California recently passed a law requiring all new cars sold be electric by 2035. Lyft depends on a huge fleet of vehicles... which it wants taxpayers to subsidize its contractor-employees buying & refueling.

Look, I'm all in favor of vehicle electrification. And I don't like wildfires or climate change. But this tax-the-rich-to-subsidize-a-huge-company measure is the wrong way to further either of those goals. It's a flawed and self-dealing initiative. Vote No on 30.

Prop 31: Uphold Law Banning Flavored Tobacco: Yes.

Prop 31 is a referendum... Instead of being an initiative proposing to create a new law, it is an initiative allowing citizens to veto an existing law. Many voters feel confused and irritated by so many props each year that they take a stance of "I'm just going to vote No on everything!" This is one of the cases where that mindset is misplaced. With a referendum a Yes vote upholds an existing law and a No vote removes it.

What's the law at stake here? 2020 the California legislature approved, and the governor signed into law, a bill banning the sale of certain flavored tobacco products. Cigarette smoking is a major public health hazard generally speaking, and flavored tobacco products have repeatedly been shown to appeal to underage smokers, hooking kids on a destructive, lifetime habit. It's important to attempt funded by the tobacco industry (again, follow the money) to veto our laws— and to do that voters must vote YES on 31.

I'm working on my taxes this weekend. It's my aim to finish them this weekend. If I don't they'll slip at least two weeks as I'll be out of town on a weekend trip in a week.

I'm using TurboTax again, for the 9th year in a row. I quipped last week that it's an abusive relationship partner. It's time to dust off and update this oldie-but-goodie I originally posted last year:



Like I explained last year I'm kind of stuck in a situation where TurboTax does what it does, which is not quite what I want, and no alternative is better. Use another tax prep tool? They're not as accurate. Hire an accountant? Way more expensive, and less transparent. I manage my own investments and manage sales for relative tax efficiency. Do taxes myself? I'm totally able to, but it'll take a lot more time without the automation done by software. So I stay in this bad relationship.

It's official, tax season starts today! Where "official" means the IRS is now accepting tax returns. Yay? 

I don't know anybody who really celebrates tax season. Even the accountants who make most of their annual income during tax season look at it with a degree of dread because it means a few months of working nights and weekends.

Likewise I don't know anybody who actually files taxes this early. Even the majority of the working and middle class who expect a refund— ergo, getting it earlier is better— mostly drag their feet on filing. I'm pretty much the only person I know who ever used to file taxes in late January or early February.

Last year I did my taxes on Valentine's Day and filed the return in early March. It's a bit later than I used to file, say, 20 years ago. The difference is that some of the financial statements I need nowadays take longer to be generated. We've actually got our W2s already, along with some other forms. Our 1099s are currently promised mid-February. Maybe they'll arrive a bit early so I can have another fun Valentine's Day!

Today I filed my taxes, both federal and state. It was... somewhat easy, using TurboTax for the 8th year.

You might recall I wrote about basically completing my taxes three weeks ago. I did. So why wait until now? Well, while I had all the tax forms (1099s, etc.) I needed I was allowing for the possibility that an updated tax form would be sent a few weeks later. Three weeks seemed like enough of a wait. Of course, Murphy's Law says an updated form will arrive in the mail this week. 😜

Why not wait until the proverbial 11th hour before the deadline, on April 15, like much of America seems to do? Well, I'd like to beat the rush. I'm expecting a net refund, and refunds are paid faster when the tax authorities aren't being crushed with filings.

Today is Valentine's Day. Hawk and I both disdain the commercial traditions surrounding the day. We're glad that means neither of us feels pressure to do any of the stuff Corporate America wants us to spend lots of money doing. Instead of writing further about all the dumb things we don't do on Valentine's Day, I'll write about what we did do this Valentine's Day. For me, at least, that's taxes. As in, I got most of my tax filings done today.

"But don't you just hate taxes?" a lot of people whine.

No, I don't. And I'll tell you why. 1) Paying taxes is our responsibility as citizens. Sure, I'd love to skip paying taxes and get everything for free, but that's just not adult. 2) Even though the process is way more complex in the US than in many other Western countries I don't find it that appalling.

Part of the common loathing of taxes is the trope of putting them off until the 11th hour and then panicking. Tax Day in the US is Thursday, April 15. The trope of people rushing to the post office late night on the 14th abounds. (Sophisticated procrastinators routinely file 6 month extensions... which only delays their panic to mid-October.) But why wait?

I worked on my tax filing done today because almost all the documents I need for it are ready already. W-2s were available weeks ago, as were the simplest 1099s. More of our 1099s came out two weeks ago, and the last I needed was released yesterday. Again: why wait?

It helps also that I've given myself even more of a head start than beginning 2 months before Tax Day. I actually started fourteen months ago. Every year I keep careful records starting on Jan 1. Another common trope about why taxes suck is sorting through a shoebox full of crumpled receipts. None of that here! My crumpled receipts are already presorted into folders by topic. 😏