Help Decide 2017 Tax Strategy / SSDI Consideration Discussion

Finance
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I took some of the ideas from my Roth Conversion thread into account with a few other ideas. Starting a new thread since this isn’t Roth Conversion specific and I want other people to be able to discuss Roth Conversion strategies in the other thread. Also, this will be a discussion based around optimizing for another variable social security (SS) credits.

It appears I will have 5 reasonable options for my 2017 taxes. I don’t have much self employed income this year since I took time off to create some IP to leverage in future years. It’s relatively easy to legally decide whether to take up to a few thousand dollars in business expenses by Dec 31 or not so once I pick my desired path, I can make sure the end of year numbers line up, legally.

Please do not assume I can shift expenses into 2018 when I may be in a higher marginal tax rate. In most of my specific cases, I am simply choosing to forgo taking a tax deduction in some of these options. It may be beneficial to declare more income than I need to, in order to qualify for certain things. I am not a lawyer, but there’s many things a self-employed person deducts such as a laptop that could be a business expenses, or personal, and I don’t think the IRS will find me guilty of overpaying my taxes by failing to deduct a laptop I bought in 2017. Not even sure what the penalty for overpayment would be.

The image below is just the key numbers from my spreadsheet that matter in the analysis.

tax 2.png1478×316 35.2 KB

OPTION 1 - I declare no SE income. I can convert ~$14k of 401k money into Roth IRA, tax-free. I earn zero SS credits and contribute nothing into a Roth IRA (since I have no income and am not allowed to contribute).

OPTION 2 - I declare no SE income. I decide to covert more money into the IRA and pay some taxes, up to the 10% tier. I can convert ~$22k and pay ~$800 in taxes. Thus, I am paying $800 to convert an extra $8k versus option 1.

OPTION 3 - I declare $2k SE income. This allows me to contribute $2k into a Roth IRA for the year and earns me a single SS credit. I can convert ~$20k and pay ~$300 in taxes. This is because I now able to use the Savers Credit. Comparing this to Option 2, it’s costing me $500 more to perform Option 2 and convert $2k more in taxes, or 25%. So relative to this Option, Option 2 is crap, because the last $2k is at the 25% tax bracket.

OPTION 4 - I declare $2.6k of SE income. This allows a $2.6k Roth IRA contribution and earns 2 SS credits. Each SS credit in 2017 requires $1300 of earned income, and it might be worthwhile to declare an extra $600 in income to get one more credit. However, this comes at a cost of an extra $100 in taxes because 15.3% SE tax. So the question becomes - if I compare Option 3 and 4, is $100 worth buying 1 SS credit. I currently have 53 credits, which is more than the 40 needed for Disability coverage, but 20 of these credits have to be within the last 10 years.

I plan to early retire and I like the idea of SSDI (I am a libertarian, but I have been paying for it and wasn’t able to opt out, so yes, I plan to use if it I become legitimately disabled). Once I stop working, my SSDI coverage effectively can only extend a maximum of 5 years because SS Credits are capped at 4 per year. So in the best case scenario, once I stop working, I’ll have 20 credits in the most recent 5 years, which then extends Social Security Disability Insurance (SSDI) coverage another 5 years.

So effectively, each credit of SS is worth ~1/4 year SSDI coverage. Or 4 credits is a full year’s worth. Framing Option 4 in this way, is $400 worth one year premium of SSDI coverage. That seems pretty expensive, but only since I don’t plan on becoming disabled. If I do become disabled, I would currently qualify for $2k per month, for the rest of my life.

I have even considered continuing to do very part time work in retirement, just to qualify for the 4 SS credits each year, to keep my SSDI benefits in place. Perhaps every other year. Or perhaps I simply earn 2 per year, because the marginal cost of the second credit is much lower than the marginal cost of the 3rd and 4th, given the Savers Credit. I need a minimum of $2k of income to qualify for $1k savers credit annually, so I only need an extra $600 more for the second SS credit, versus $1300 more for each of the 3rd and 4th credits. SS credits will keep going up each year in cost, so the sooner I earn them the better, which brings us to the next option:

OPTION 5 - Declare $5,200 in income - earn the full 4 SS credits. Extend my SSDI coverage by a full year. Put $5200 into a Roth IRA. Convert $16.7k into the Roth. Pay $800 in taxes.

One final consideration - my SSDI benefits of $24k per year appear to be calculated based on my salaries of recent years. If I wind up shifting into early retirement and just declaring a few thousand dollars in income each year to keep my SSDI coverage active, it’s possible the annual benefit payout will be significantly reduced. I imagine there must be some bare minimum payout they give, but I have been unable to find exact numbers. I did reverse engineer the exact estimated SSDI payout I am currently eligible for, per my most recent SS statement online, and annual salaries do appear to be included in the calculation

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Would you buy a disability policy anyway? I have no idea if the $800 se tax you’d pay is a good deal or not. You do get the (much lower) SS disability payment no matter what, even if you don’t have the required quarters paid-in within the last 5 years. Weirdly, there is an exception for blindness, in which case you’d get the full amount based on work history. You’d essentially be buying a disability policy worth the delta between the plain and the enhanced SS amounts for the~$800 paid in SE tax.

I have also thought about some kind of part-time job just to have the optimal amount of earned income for the reasons you mention, but it seems expensive if I’m just trying to manufacture earned income via a schedule C and paying the full 15% SE tax, and I haven had any earned income in well over 5 years. So I’d have to work 5 years before it would kick in again :frowning: Y’all correct me if my understanding of all this is incorrect.

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You might check the cost of a individual disability policy for comparison.

If your goal is to just get disability coverage and you’re considering paying $400 for it, I’d think simply buying an insurance policy would be easier.

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I think the benefit of SSDI is that you don’t have to be employed to get it, that is, it pays based on your work history rather than your current earned income, hence the five year credit restrictions to keep older retired people from claiming it.

Can you really buy a private disability policy while unemployed that gives a similar benefit for $800/year? I thought they were all keyed to earned income.

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It seems to be a ten year look back for half the needed credits. 40 credits required, 20 of which need to be earned in the previous 10 years, unless you qualify for exceptions allowing fewer credits based on being younger. So you could stop earning credits altogether and still be eligible for another 5 years. SSDI is the higher one based on work history. SSI is the lower one, based on need and has income/asset tests.

https://www.ssa.gov/planners/disability/dqualify2.html

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We could also add into the discussion, what is the value of being able to contribute into a Roth IRA?

Certainly, there’s some tangible financial value to being able to contribute into a Roth IRA. If I have zero earned income, I can make zero Roth IRA contribution. If I have $5200 earned income and pay $800 in SE taxes, then I can contribute $5200 into a Roth IRA.

Using a simple online compound interest calculator, $5200 compounded at 10% annually for 30 years will yield $90k which is about an $85k profit.

Assuming it was invested in a stock index fund and will be taxed only at the long term capital gains rate of 15%, you will owe about $13k in taxes. So the question is whether paying $800 to get 30 years of tax free growth is worth saving $13k in taxes.

If I use the same compound interest calculator and put that $800 (that I would have paid the SE taxes with) and instead invested it into the same 10% /year stock fund, we’d have $14k at the end of the 30 years. We’d have to pay $2k in taxes on it (at 15% and be left with $12k.

So in this example, it doesn’t make much of a difference whether I put the money in the Roth or not for those 30 years. It’s about the same if I just kept the $5200 and the extra $800 that would have paid SE tax, for a total of $6k, in a taxable account.

There’s some added creditor protection for keeping it in the Roth IRA, as well as not having to pay annual taxes on dividends. Also a hedge against future tax rate increases, assuming such increases don’t also touch the Roth through some future backdoor tax.

So, I’m not really sure. Also, if I decide to take that $5200 out of the Roth before 30 years, let’s say take it out after 3 years (via principal withdrawal), then I paid those taxes for virtually no tax-free gain. And since my tentative plan is to withdraw around $10k a year from the Roth IRA each year in early retirement, maybe it doesn’t make sense to pay the SE taxes for the purpose of Roth IRA contribution - unless other factors make sense, such as SSDI credit or savers credit deduction.

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How are you getting around the ACA penalty? The ability to get ACA subsidy and/or avoid Medicaid also may factor into one’s decision. On FW I wrote the seminal maximizing ACA thread. Even if you think ACA insurance is garbage it still provides coverage in catastrophic situations.

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Not sure what you mean by the ACA penalty - do you mean that having too high of an AGI precludes me from getting ACA subsidized insurance? If so:

I currently an grandfathered in to a catastrophic pre-ACA healthcare plan that I pay $150 a month for. I think the absolute cheapest ACA plan is $300 and the government would cover 80% of it, I believe so I’d be out $60 a month.

But once I left my grandfathered plan, I can’t go back to it, ever, and I’d be stuck paying $300 a month forever, even once my income goes up and I no longer qualify for a subsidy.

There’s always the possibility of my income skyrocketing due to getting a special contract, being self-employed, and so far I haven’t wanted to take that risk. My old pre-ACA plan doesn’t cover pediatric dentistry or substance abuse counseling so they can sell it to me cheaper.

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I assume you’re paying your current bills through spending of taxable savings?

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Currently, yes. However, depending on things go over the next few years, I may need to draw down the Roth IRA - which makes the value of a contribution much less.

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Referring to ACA penalty, there are two - the penalty of not having insurance and the effective income tax caused by having higher income within a subsidy tier.