First-time homebuyer savings accounts, part 2 (Virginia, Colorado, Minnesota, Iowa, Idaho)

I recently wrote in detail about the first-time homebuyer savings account tax deduction offered by the state of Oregon, and promised a followup with an assessment of similar accounts offered by other states. If you haven't read that post, then you should probably start there, since the concepts I describe there will be helpful as I skim through the remaining state offerings.

Virginia: 529 plans for housing

Virginia's first-time homebuyer deduction is in most ways more generous than Oregon's, with a few important catches to be aware of.

Advantages

First, and most importantly, Virginia allows you to designate (almost) any account as a first-time homebuyer account simply by filing a statement alongside your state income tax return, and allows you to designate as many as you please, as long as the accounts only include "cash and marketable securities." This is an incredibly expansive definition — in principle you could designate a Robinhood account and make all of your earnings exempt from Virginia state income taxes.

Second, there are no time or income limits. Oregon requires funds to be used for eligible purposes within 10 years of account opening or all your previous deductions are immediately reversed, while Virginia has no such requirement, and the Oregon tax deduction is phased out at high incomes, while Virginia's is uncapped.

Finally, Virginia allows you to designate someone else as the beneficiary of your account, which is why I think of these as 529 college savings plans for houses. The account owner (whether or not they are an eligible first-time home buyer) is able to claim the state income tax deduction as long as the designated beneficiary is eligible.

Drawbacks

There are two important drawbacks to Virginia accounts, although I don't think they outweigh the advantages.

First, only interest, dividends, and capital gains are deductible, unlike in Oregon where contributions up to a certain limit are also deductible. This is, again, a feature they have in common with 529 college savings plans.

Second, you cannot claim any deduction for earnings that occur "while the principal in the account was in excess of $50,000" or "while the aggregate principal and interest in the account was in excess of $150,000." But this limit is calculated separately for each account, you can designate as many accounts as you wish, and you can move cash and marketable securities freely between them. As long as you make sure to keep your balances in each account below $150,000, there's no limit to the state income tax deduction you can claim.

This is, unfortunately for the people of Virginia, spelled out crystal clear in the Code of Virginia: "there shall be an aggregate limit of $50,000 per account" is about as clear as a tax code can get.

How to maximize

Since there are no time limits or aggregate contribution limits, but strict per-account limits, their value is maximized when you have the highest earnings-to-principal ratio in each account. In other words, if you make a $50,000 deposit to an account, then you only have $100,000 of earnings "runway" before the account needs to be chopped up into smaller accounts, while if you make a $5,000 deposit, you have $145,000 in earnings before the $150,000 cap is breached.

Finally, note that the account beneficiary does need to be a Virginia resident buying a home in Virginia in order to make tax-and-penalty-free withdrawals from the accounts (and the account owner needs to have Virginia income to pay Virginia income taxes, obviously), which makes these accounts ideal for stashing money away as long as possible to pay for a child's house years or decades in the future.

The maximum state income tax rate in Virginia is 5.75%.

Colorado: strict contribution limits make for boring accounts

Colorado's legislators put a little more thought into their tax deduction, so the possibilities for really hammering the accounts are much more limited. Contributions are not deductible, there's an annual contribution limit of $14,000 (presumably for federal estate tax avoidance purposes), a total contribution limit of $50,000, and earnings are no longer deductible once an account has a value of $150,000 or more. There are no time limits on the accounts, so as in the case of Virginia, you'd ideally like to maximize the earnings-to-contribution ratio: a $1 contribution that generates $149,999 in earnings is 50% more valuable than a $50,000 contribution that earns $100,000.

The one relief Colorado gives is that you do not, in fact, have to be a first-time homebuyer in order to claim the deduction. Instead, you simply need to not be claiming a mortgage interest deduction. That might mean you don't own a home, but it also might mean you own your home outright, or that the mortgage interest you pay isn't enough to put your total itemized deductions over the threshold of the standard deduction.

The state income tax rate in Colorado is 4.63%.

Minnesota: restrictive, but lucrative

Minnesota has a range of additional requirements which limit the utility of these accounts. They have the same 10-year time limit as Oregon, with the additional restriction that the account's designated beneficiary must be "a Minnesota resident who has not had ownership interest in a principal residence in the last three years." Since you can change account beneficiaries at any time, this is a meaningless requirement, but it's still important to keep details like that in mind, especially when filing your deduction for the first time. Earnings are deductible, contributions are not.

You can designate multiple accounts but Minnesota's Department of Revenue offers astonishingly little additional information, so it's unclear to me whether the $14,000 contribution limit is on a per-account basis or shared across all accounts; if you're a Minnesota taxpayer, consult a tax professional before hammering these too hard.

The top state income tax rate in Minnesota is an astonishing 9.85%, which makes these the most valuable accounts I've reviewed so far, although they also have the toughest penalty on early withdrawals, a full 10% of the amount previously deducted (twice as high as Oregon's 5% penalty).

Iowa: deductible contributions, limited options

Iowa has the same pesky 10-year time limit, but deductible contributions and a relatively high maximum state income tax rate nevertheless put these accounts in the middle of the pack. They appear to have an inflation-adjusted deduction limit (in 2020 it was $2,137 for single filers and $4,274 for joint filers). Frustratingly, they have a geographic restriction similar to Oregon's, which is not on the account holder, but on the bank's location: "A first-time homebuyer savings account must be an interest-bearing savings account opened at a state or federally chartered bank, savings and loan association, credit union, or trust company located in Iowa."

I was unable to find any examples of accounts meeting that description with interest rates worth pursuing on their own, but Iowa's top marginal income tax rate of 8.53% means the income tax deduction alone has a maximum value of $3646 over 10 years (on $43,740 in contributions). Oddly, earnings themselves seem to remain taxable, but since these accounts earn negligible interest that's probably irrelevant to most Iowans.

Idaho: deductible contributions and interest, high annual limits

Idaho has a relatively modest maximum state income tax rate of just 6.5%, but their annual first-time homebuyer tax deduction is an incredible $15,000 for single filers and $30,000 for joint filers, with a total of $100,000 in contributions eligible for deduction for all taxpayers. The instructions for forms 40 and 39R are fairly inscrutable, as they refer in the "subtractions" section to interest being "tax deferred" while in the "additions" section there's no reference to adding back in "deferred" interest, so my hunch is that both contributions and interest are deductible up to the $100,000 lifetime limit.

Despite the poor drafting of Idaho's laws and regulations, the potential to hammer out $6,500 in tax savings in just three-and-change years seems like a no-brainer for those eligible.

Oregon first-time home buyer savings accounts: is the juice worth the squeeze?

One of the most interesting things about the US banking system is just how decentralized it is. While most developed nations have just a handful of major banks, the United States pairs those nationwide behemoths with thousands of smaller banks and credit unions that may serve an area as small as a single city or county.

Of course, in the 21st century these small banks are hardly a "secret," since any bank with a website has long ago been sucked into the search engine maw, but I still find the best way to learn about them is by keeping my eyes open while I'm traveling. That's precisely how I first found out about the Willamette Valley Bank's "First Time Home Buyer Savings Account."

What fresh hell, I asked myself, was this?

While not exactly common, there are a handful of states that offer these accounts, and the details vary enormously, which makes it a good opportunity to think through how to approach these gimmicks periodically spun up by legislators trying to encourage one supposedly virtuous behavior or another.

Federal or state tax benefits?

This is the most important question to ask, since state income tax rates are dramatically lower than federal income tax rates. For example, contributions to traditional IRA's and 401(k)'s are untaxed at the federal level, and since most states use your federal income (plus and minus any state adjustments) to calculate your state income tax liability, federal income tax deductions — when available — are several times more valuable than state-only income tax deductions.

Income limitations

Since the American people are a hateful people, eligibility for tax-advantaged accounts frequently hinges on your current-year or prior-year income. Since your income tax rate also depends on your income, tax-advantaged accounts are often unavailable to the people who would benefit most from them, and are of little value to the people eligible for them. This keeps their budgetary cost low, their benefits negligible, and the tax code unnecessarily complex.

Contribution limits

I sometimes come across what seems like an unbelievable opportunity and only upon further research discover that the maximum annual contribution is just one or two hundred dollars. When one of those accounts comes across your desk there's no need to dismiss it out of hand, just acknowledge that it will always be ornamental, not foundational, to your personal finances.

Deductible contributions or earnings

Deductible contributions are most valuable in the year the contribution is made, and allow you to time your contributions for years where your marginal tax rate is especially high. Deductible earnings (like the tax-free withdrawal of earnings from Roth retirement accounts) are more valuable if you expect either your income or income tax rates in general to rise in the future.

Investment options and interest rates

In employer-based plans like 401(k)'s and 403(b)'s your investment options are almost always determined by your employer with little or no say from employees (until they sue). State-based 529 plans hire their own administrators that may offer more or less discretion to investors. And IRA's offer the maximum choice in investment options since you can open as many as you want and move between them relatively freely.

Meanwhile, the gimmick accounts administered by banks offer interest rates on a "take it or leave it" basis. In today's interest rate environment I usually prefer to leave it than take it, but opportunities occasionally come up for out-sized earnings on deposit accounts, even if they're (horror of horrors!) taxable.

Deadlines and penalties on withdrawals

I've written before about the weird interest rate structure of Series EE bonds, which offer 3.53% APY exempt from state income taxes, but only if the proceeds are used in the year of redemption on eligible higher education expenses. Almost all gimmick accounts have restrictions like this: HSA accounts for health care expenditures, retirement accounts for old age, 529 accounts for almost anything education related these days, and first-time home buyer savings accounts for the purchase of homes by first-time buyers. If you don't meet the requirements of any given gimmick account, you usually have to pay back some or all of the tax benefits you claimed along the way, and often a penalty on any earnings in the account.

How do first-time home buyer savings accounts stack up?

With these basic metrics in mind, how do Oregon first-time home buyer savings accounts stack up?

• State tax benefits. For single filers, up to $5,000 in contributions and earnings can be deducted (note that Oregon calls them "subtractions" instead of deductions) from your Oregon taxable income for up to 10 years. Married filing jointly filers can deduct up to $10,000. Regardless of your filing status, the maximum total deduction is $50,000 over 10 years, so joint filers can maximize the tax benefits over just 5 years instead of 10.

• Income limitations. The deduction begins to phase out when your federal adjusted gross income reaches $104,000 for single and head of household filers and $149,000 for married filing jointly filers (see page 69 of this publication). At those income levels your marginal Oregon income tax rate is 8.75%, giving a maximum annual benefit of $437.50 or $875 on contributions and earnings of $5,000 or $10,000 per year (if your marginal tax rate is lower your maximum benefit is correspondingly lower).

• Contribution limits. While the state income tax deduction is limited to $5,000 or $10,000 in contributions and earnings per year, there's no limit on the total contributions you can make. Since these accounts are designed to be held for several years without withdrawals, banks and credit unions may offer more competitive interest rates on them. Rates are currently low everywhere, but the 2% APY offered by Willamette Valley Bank works out to an after-tax equivalent of about 2.2% APY: nothing to write home about, but almost double the rate available today on 10-year Treasury notes.

• Deductible contributions and earnings. When used for their intended purposes, neither your contributions nor your earnings are ever taxed at the state level (up to the $5,000/$10,000/$50,000 limits).

• Interest rates. The interest rates earned on these accounts are set by the banks and credit unions offering them, and are variable, so you shouldn't count on keeping the interest rate on offer when you opened your account. On the flip side, they can't go much lower, so if interest rates do rise in the future that might eventually be reflected in bank rates as well. While you can only have one of these accounts open in Oregon at a time, you can move the money between banks relatively easily if you want to chase higher rates as they fluctuate.

• Deadlines. There are two numbers to keep in mind: 3 years and 10 years. To open an account, you have to be "planning" to purchase a home in Oregon within the next 10 years, and you cannot have owned or purchased a home in the 3 years prior to your planned purchase. If you look at these statements closely, you can see that you may be eligible to open a first-time home buyer savings account even if you already own a home, as long as you "plan" to no longer own one at least 3 years prior to your "planned" home purchase.

• Penalties. If you make any withdrawals from the account for anything but qualifying home buying expenses within the first 10 years of opening the account, you'll owe a penalty of 5% of the withdrawn amount, and add the amount of the withdrawal to your Oregon state tax return in the year of the withdrawal. After 10 years, the 5% penalty is not imposed, but the entire amount of your deductions over the lifespan of the account is added back to your Oregon taxable income. I was unable to easily find any information about how to calculate the amount to add back in the event of non-deductible contributions and earnings (those above the $5,000/$10,000/$50,000 limits), but I assume it would be on a proportional basis (I'm not an accountant, and I'm definitely not your accountant, so ask him or her instead).

An interest-free loan from the good people of Oregon

The absolute most essential thing to understanding all types of gimmick accounts is that they are never designed to achieve their supposed purpose. IRA's aren't for retirement security, 529 plans aren't for college affordability, and first-time home buyer savings accounts aren't for housing access. Each and every one is designed to help rich people shield their income and assets from taxation, and in this, they are phenomenally successful.

The scam, in this case, is especially obvious, and works well for a married couple with variable income. That's because they have 10 years to reach the maximum $50,000 deduction (worth up to $4,375 in tax savings). In years where their marginal income tax rate is lower, they can skip contributions altogether and deduct only the earnings on the account, and in high-income years they can make the contribution that will maximize the deduction (after accounting for earnings). After 10 years, the $50,000 they previously subtracted is added to their Oregon state taxable income. If for the sake of simplicity you assume that $50,000 is the entirety of their Oregon state income that year, then they'll owe just $4,122 in taxes on it; they've literally borrowed money from the state at a negative interest rate! Of course, even if they pay the entire $4,375 back in taxes, they'll be repaying the 0% loan with less valuable future-dollars, and will have enjoyed the use of the money for 1-10 years.

Conclusion

It's not good that these accounts exist, and I would greatly prefer they did not. But if the people of Oregon want to make 0% loans to wealthy people in order to help them manage their income taxes, as long as you qualify you'd be crazy not to take advantage.

Now that I've provided this detailed framework, in a future post I'll be able to provide a (much briefer!) overview of the similar accounts offered by other states.

Understanding the latest two rounds of EIDL Advances

Last May I shared my successful Economic Injury Disaster Loan experience, which included a $1,000 "EIDL Advance" that doesn't have to be repaid and a $3,000 30-year low-interest loan. It took about a month and a half for the money to show up in my checking account, but other than that the process was fairly seamless, and the Small Business Administration (the agency administering the program) is the most well-staffed bureaucracy in the federal government so it was easy to contact them whenever I had any questions about the program.

Congress allocated an enormous amount of money to EIDL and its sister program, the Paycheck Protection Program, but since the programs were completely new, the first round of grants and loans were designed very conservatively to ensure that all eligible business were able to participate. In practice, that meant EIDL Advance and loan amounts were based on the number of employees: businesses were eligible for grants of $1,000 per employee (up to $10,000), and loans of $3,000 per employee (an arbitrary number designed to ensure all eligible businesses were funded).

It turned out, this deliberately conservative design left the SBA with an enormous amount of appropriated money they have to get out the door before the program expires. Enter the Targeted EIDL Advance and the Supplemental Targeted EIDL Advance.

Targeted EIDL Advance

On April 2, 2021, I was invited to apply for a "Targeted EIDL Advance." Remember that EIDL Advances were capped at $10,000, but Congress didn't give any guidance about who would receive how much. For whatever reason, the SBA decided to use number of employees (rather than size of payroll, cost of living, or astrological sign) as the basis for determining Advance and loan amounts. But that didn't change the maximum amount businesses were eligible for, which remained $10,000.

Enter the TEIDLA: an opportunity for businesses that received less than $10,000 in the first round of EIDL Advances to be "topped up" to the maximum $10,000 amount, as long as they met three criteria:

• located in a low-income census tract;

• 30% drop in revenue year-over-year during any 8-week period beginning March 2, 2020;

• fewer than 300 employees.

The last two are self-explanatory and easy to manipulate so let's focus on the first requirement, which will do the most to exclude businesses from eligibility. SBA chooses to express this requirement as being located "in a low-income community," but this is incorrect. It does not matter in the slightest whether your "community" is low-income or not. Eligibility hinges on whether you're located in a low-income census tract.

This is easy enough to look up using the tool they provide, although one thing to be aware of is that you can't just plug in your ZIP code to determine eligibility — that's far too crude a measure. You have to plug in your exact address, since even buildings on opposite sides of the same street may fall into different census tracts.

To use my own case as an example, last summer I moved about three quarters of a mile, remaining within the same ZIP code, let alone the same "community." But my old address fell within a non-low-income census tract, and my new census tract is classified as low-income, making me eligible for a Targeted EIDL Advance.

This actually caused a small issue on my application. After submitting my TEIDLA application on April 2, I finally heard back from SBA on June 30, and was told that I was ineligible since I wasn't located in a low-income census tract. The reason is that when you create an EIDL account, your business is permanently associated with the address you give. I had updated my contact information to my new address (one of the only things you can do online), but that didn't update the address associated with my business.

Fortunately, as I mentioned, SBA is the most well-staffed bureaucracy I've ever encountered and I was able to resolve the discrepancy in a matter of minutes by e-mailing a PDF of the first page of a credit card statement showing my new address, and the funds were disbursed within a few days (it might have been even quicker if not for the Independence Day holiday).

Supplemental Targeted EIDL Advance

To clear out the last of the money rattling around their coffers, SBA introduced a third EIDL Advance program with even narrower eligibility requirements:

• located in a low-income census tract;

• 50% "economic loss" year-over-year during any 8-week period beginning March 2, 2020;

• fewer than 10 employees.

I'm not sure why they express the financial eligibility in terms of "economic" loss instead of revenue loss as they do with the TEIDLA, but I assume they're measuring the same thing in both cases.

As you can see, logically STEIDLA-eligible businesses are a subset of TEIDLA-eligible businesses: all business with fewer than 10 employees also have fewer than 300 employees, and all business that suffered a 50% drop in revenue also suffered a 30% drop in revenue.

How this works in practice is that all EIDL Advances are cumulative, up to a maximum of $15,000:

1. EIDL Advance: all small businesses are eligible for $1,000 per employee, up to $10,000.

2. Targeted EIDL Advance: subset of businesses are eligible for the remaining difference between $10,000 and the amount received in #1.

3. Supplemental Targeted EIDL Advance: subset of TEIDLA-eligible businesses are eligible for a flat $5,000 on top of the $10,000 received in #1 and #2.

I received my invitation to apply for STEIDLA within minutes of my TEIDLA application being approved, and applying was even simpler than submitting my EIDL and TEIDLA applications. Literally all that was required was clicking the link in the e-mail, entering my IRS Employer Identification Number, and checking a box. I just submitted the application this morning (I wanted to make sure my TEIDLA was deposited first) and unfortunately it already appears in my SBA account as "Declined," presumably based on the income information I submitted with my TEIDLA application back in April.

Conclusion

Finally, I want to mention in passing that in addition to these new grants, SBA has also made additional money available to borrow. I have not explored that part of the program beyond my original $3,000 loan, but if you're an EIDL participant you should now see a button in your account saying "Request more funds."

Personal finance columnists love to rail against debt, but you won't hear that nonsense from me. As far as I'm concerned, EIDL loans check all the boxes for "good debt:" unsecured (as long as you borrow less than $25,000), long-term, and low-interest loans are a fantastic way to pay off higher-interest, revolving, or secured debt. For example, if you have high-interest private student loans, which are notoriously difficult to discharge in bankruptcy, and pay them off with an unsecured low-interest EIDL loan, that's an absolute improvement in your overall financial condition. People seem to find this concept easier to understand when it comes to, for example, refinancing mortgage debt at lower interest rates, but the exact same principle applies everywhere: if being debt-free is out of reach, then seizing every opportunity to swap good debt for bad debt is the next best thing.

Why is there a private market in long-term care insurance?

This is a question I've been thinking about lately while working on another project, and I want to walk through my thinking so far to see if any readers want to provide any additional insight.

Long-term care is very expensive, but not everybody needs it

Due to search-engine optimization and paid ad placement this information is actually annoyingly difficult to find (by which I mean I had to click to the second page of search results), but according to the federal Administration for Community Living, the average cost of a private room in a nursing home nationally in 2016 was $7,698 per month, and the average cost of care in an assisted-living facility is $3,628 per month. This is obviously a lot of money, between $43,536 and $92,376 per year depending on your state and the intensity of the care you need.

That is, if you need it, which not everybody does. This is the fundamental logic behind many kinds of insurance: when it is certain that an unknown future subset of a population will face a ruinous economic blow, the entire population can pool their assets in advance with the understanding that some of the population will "waste" their premia, some will "make it back," and some will receive a benefit far out of proportion to their payments. The entire population or subset of the population (coworkers, union members, age cohorts, etc.) pays the same amount for the same certainty of protection should they be the one to suffer.

It seems to me people often get confused on this point. For example, it makes no sense to sell "primary school insurance" to pregnant women or new parents, since virtually all newborns in the United States attend primary school. Buying insurance "just in case" your children attend primary school would be absurd, since almost all the insured would be receiving their own money back — there would be no pooling of risk, and the downside of a costly new level of administration. Parents who want to make sure they have money for school supplies just save money for school supplies, and everybody else takes their chances having to pay for pens and pencils out of their current earnings or from charity.

Long-term care insurance is expensive too

On the same federal site, I learned that in 2007 (yes, I'm also annoyed at the fact this datapoint is from a decade earlier than the one above, but it is what it is), the average long-term care insurance policy cost $2,207 per year and provided $160 in daily benefits for a maximum of 4.8 years. Note that once you have a qualifying event and begin to receive benefits, in most cases you are no longer required to pay a premium.

This makes it easy to calculate the maximum value of the average long-term care insurance policy in 2007: $280,320. Of course, since this is an insurance product, only a small number of customers will receive the maximum benefit. Some will allow their policies to lapse before they need care, some will die without needing long-term care (not necessarily by dying young — they might simply die a natural death in old age while still able to care for themselves), and some will end up needing long-term care, but for less than the maximum term, or at a lower cost than the maximum benefit.

Does long-term care insurance really "protect your savings?"

Long-term care insurance is often sold as a way for wealthy people to "shield" savings they may wish to leave to a spouse or heirs, out of fear that a few years of expensive care at the end of their lives will drain away their estate leaving their family or favorite charitable causes with nothing.

That's all well and good — after all, insurance isn't supposed to be an investment with a predictable rate of return, it's about buying piece of mind. Long-term care insurance, however, is such a novel product that it doesn't seem to me to have undergone the kind of scrutiny that older products like life insurance have. It's a cliche, for example, that it's better to buy term life insurance to protect your dependents, rather than the much more expensive whole life insurance, and invest the cost difference in assets that are likely to outperform the piddling interest rates the savings component of whole life insurance offers.

A similar principle seems to apply in the case of long-term care, for two reasons. First, people buy long-term care policies far too late in life, typically in their 50's or 60's, which means they pay very high premia. According to the American Association for Long-Term Care Insurance, the average time elapsed between policy purchase date and eligibility date is just 14 years. Think about it this way: people self-insure for long-term care for the first 50 or 60 years of life, despite having lower earnings and assets and longer possible time horizon of care, and then overpay for insurance when they have the most money and shortest life expectancy.

Second, framing the costs of long-term care as requiring you to "spend down" your savings ignores the fact that savings and investments also produce income which can be used to pay for the cost of care. If your care costs $67,956 per year (the average of an assisted living facility and a nursing home), and you receive the average Social Security old age benefit (in 2015) of $16,536, then you need to cover the difference of $51,420 per year. But that expenditure will not reduce your assets by that amount. Instead, it will reduce your assets only by the amount not covered by income generated by your assets. Assuming a permanent (extremely conservative) 3% rate of return over your working life, retirement, and period of care, you would need to accumulate $1.7 million in order to generate that difference purely out of income indefinitely, that is to say, without spending down your assets at all, with no long-term care policy. Moreover, since most long-term care policies have maximum benefit amounts, the more you spend on long-term care insurance, the more exposed you are to the risk of outliving the maximum benefit and having inadequate savings to cover ongoing care.

In other words, you need insurance during your working years while aggressively saving, in case your savings plan is interrupted before you're able to reach the point you can self-finance your care indefinitely.

The private insurance market is getting in the way

The problem, of course, is that while all of the above is true, it's also impossible. If you're young, getting the kind of long-term care policy I'm describing is in fact prohibitively expensive! That's for two reasons. First, so few young people do buy long-term care policies that insurance companies have too little data to price plans appropriately, and naturally err on the side of expensive. Second, insurance companies are acutely aware of the risk of adverse selection: why would a young person buy a long-term care policy if they didn't at least suspect they were likely to use it?

Group plans through an employer are an option for folks whose employers offer them, but obviously it's up to the employer whether to do so and what kind of plan to offer, so just because your employer offers a plan doesn't mean it's the best option for you. If you do buy a plan through your employer you should be able to keep both it and your original age and health rating after separating from the employer, although since you'll no longer be paying for the plan through payroll deductions be sure to keep an eagle's eye out for billing information to keep the plan from lapsing.

Conclusion

All of which brings me back to the point of this post: why is there a private long-term care insurance market in the first place? The obvious solution to long-term care costs is a robust public insurance program, paid for with a nominal tax on the entire working population. Young people with a small likelihood of needing long-term care could pay the same tiny percentage of their income as older people with the highest likelihood of needing care — but only if the entire population participates.

As long as the only way to buy long-term care insurance is from for-profit companies marketing to older people most likely to use it, then long-term care insurance will remain expensive, inadequate, and uncertain.

Two quirks to watch for when reporting 2020 unemployment compensation

There has been a fair amount of confusion and chaos around changes made to the taxation of unemployment compensation in the American Rescue Plan, so as I'm finishing up preparing my own 2020 taxes, I want to draw readers' attention to one very important and one very minor consideration when reporting unemployment insurance benefits received in 2020.

What's the deal with taxable unemployment insurance?

Since the 1987 tax year, payments received from a state unemployment insurance program have been included in taxable income at the federal level. Since most states use federal income as the basis for their own income tax systems, that's meant those benefits also flow through to state income tax returns.

There are "economic" arguments for and against taxing unemployment compensation, usually along the incoherent lines of whether untaxed unemployment benefits "discourage work" or whether taxed benefits "punish people who need the most help." My controversial view is that all income should be taxed at the same progressive rates, and poverty should be addressed by increasing incomes, not creating kaleidoscopingly complex tax brackets for each unique kind of income.

The most important point, however, is that the taxation of unemployment benefits has never really mattered. That's for three reasons:

1. almost no one receives unemployment compensation, due to strict qualification and work-search requirements;

2. unemployment benefits are very low (ranging from a maximum weekly benefit of $235 in Mississippi to $823 in Massachusetts);

3. and unemployment benefits are extremely time-limited.

Until March, 2020, in other words, the taxation of unemployment benefits was mechanically irrelevant: nobody received enough in benefits to pay much in taxes, so recipients didn't care, and the people who did receive benefits were so politically powerless they didn't have any way to make the government care about their well-being.

During the pandemic, each of these reasons was comprehensively obliterated. Millions of people were pulled onto the unemployment rolls for the first time through new programs like Pandemic Unemployment Assistance, benefit amounts were aggressively topped up with federal funds, and time limits were increased from 26 to as many as 79 weeks, depending on the specific set of programs you were eligible for.

That meant for the first time, middle class workers found themselves on the hook for thousands of dollars in state and federal taxes they hadn't budgeted for, and unlike traditional unemployment insurance beneficiaries, middle class workers vote.

Needless to say, a solution was quickly found.

The 2020 unemployment compensation tax exclusion

The solution was as crude as it was quick. In the American Rescue Plan Act, Congress simply excluded $10,200 in 2020 unemployment compensation per worker from taxable income. Unfortunately, the act was passed in March, long after forms and instructions were finalized and people had started filing their tax returns.

The IRS responded to this crisis in two distinct ways. First, it told people who had already filed their taxes not to file an amended return unless the exclusion would affect their eligibility for a different tax benefit (like the Earned Income Credit, Child Tax Credit, or Retirement Savings Contribution Credit). Instead, the IRS would itself calculate the exclusion and refund the difference in taxes owed.

It would be difficult to overstate how absurd this is. On a joint return, for instance, since unemployment compensation is reported jointly but the exclusion is per recipient, the IRS would have no way of determining whether one or both spouses had benefits exceeding $10,200 without manually consulting the 1099-G forms submitted by each state's unemployment insurance office for each beneficiary. The IRS seems to believe they will be able to handle this administrative burden; on the contrary, I suspect this will produce a huge windfall for early joint filers where only one spouse received unemployment compensation, since I don't think the IRS will ultimately have any choice but to exclude the full $20,400 from their reported benefits.

For those who had not yet filed their 2020 tax return, the solution was simpler, but does require some attention to detail. Unemployment compensation, like most non-W2 income, is now reported on Schedule 1 of Form 1040, on line 7. You might think that this is the number you need to adjust by up to $10,200 per unemployment compensation recipient. But that's wrong, and the updated IRS instructions are crystal clear: "You should receive a Form 1099-G showing in box 1 the total unemployment compensation paid to you in 2020. Report this amount on line 7."

The exclusion is instead reported on line 8, "Other income," as a negative amount. Then on "the dotted line next to Schedule 1, line 8, enter "UCE" and show the amount of unemployment compensation exclusion in parentheses on the dotted line," so Schedule 1 of your return might look like this, depending on your tax software:

The paid family leave exclusion

For most people receiving unemployment compensation, that's all you need to know. However, while reading the updated instructions I stumbled across a provision I'd never had any reason to be aware of: the paid family leave exclusion. The instructions for line 7 of Form 1040 Schedule 1 state:

"If you made contributions to a governmental unemployment compensation program or to a governmental paid family leave program and you aren't itemizing deductions, reduce the amount you report on line 7 by those contributions."

This is, to be clear, not a new provision of the American Rescue Plan; it was included in the original instructions for Form 1040 Schedule 1, and has been there for years (I'm still trying to figure out the precise origin of the provision, but it's already there in 2016). The provision is important to be aware of, however, if you live in a state or the District of Columbia that allows sole proprietors to opt into paid family and medical leave programs.

The important thing to note here is that your paid family leave premia are treated in an opposite manner from the unemployment compensation exclusion: they are deducted directly against your unemployment compensation on line 7, not added as a negative value on line 8.

I assume the logic of this provision is that the premia paid for family leave insurance form a kind of "cost basis" of your coverage, so it would "unfair" to tax the "same money" "twice," once when it "went into" the insurance program and a second time when it "came out." That's obviously bordering on the absurd, but it's the way tax accountants and lobbyists think so it's not terribly surprising they managed to smuggle it into law at some point.

Minimums, Anchors, and Thresholds

One of the most frustrating things that comes up almost immediately when you start talking to people about money is the way people treat certain purely regulatory or legislative figures as having some kind of moral or persuasive value.

The example that has driven me crazy for years is the advice to "contribute enough to your 401(k) to maximize your employer match." In most cases, that works out to something in the range of 3-6% of gross income. But what is so special about your employer's matching contribution policy? Even if you believed an employer was acting in completely good faith to set their matching policy purely for the benefit of employees, you'd still want to know what value they were optimizing for. An employer that matches 100% of the first 3% and one that matches 50% of the first 6% of gross income may both be acting purely for the benefit of their employees (i.e. they're not trying to minimize the cost of the program), while at the same time the 100% match might be optimized for lower-paid employees who can afford to contribute less, and are likely to otherwise rely on Social Security, while the 50% match is better for higher-paid employees who can afford to contribute more and whose Social Security old age benefit replaces a lower portion of their lifetime income.

In other words, "maximize your employer match" is only good advice if you fall in the group the program was optimized for! Otherwise you run the risk of contributing too much (and having to borrow money at high interest rates to meet living expenses) or too little (and seeing a sharp drop in income in retirement).

Once you know what to look for, you see these problems all over.

Required Minimum Distributions and the 5% Rule

There are two things it is absolutely essential to know about required minimum distributions from pre-tax retirement accounts, like traditional IRA's, 401(k)'s, and 403(b)'s. First, tax rates on retirees are laughably low. Second, this is the first time in their lives wealthy retirees have ever been forced to pay taxes, and they hate it.

A 59 1/2-year-old retiree beginning to make penalty-free withdrawals from a traditional IRA as their only source of income (for example to take advantage of the Social Security Magic Trick), can withdraw $53,075 (filing singly) or $106,150 (filing jointly) and pay an average federal income tax rate of 8.8% on contributions, interest, and capital gains that have never been taxed (this is the average of a 0% rate on the first $12,400 or $24,800, a 10% rate on the next $9,875 or $19,750, and a 12% rate on the remaining $30,800 or $61,600).

After age 70 the situation becomes slightly more complicated due to the taxability of Social Security benefits for very-high-income beneficiaries, but remember the maximum portion of your Social Security old age benefits that is ever taxed is 85%, so Social Security benefits are never taxed more heavily than pre-tax retirement distributions.

What makes required minimum distributions so painful is that it's the first time in their lives wealthy retirees don't get to choose whether or not to pay taxes. If you spent your whole life making pre-tax contributions and retired a millionaire, you might consider yourself lucky. But in reality, that's not how it works: folks who spend their whole lives avoiding taxes don't enter retirement relieved that they won the game of life. They enter retirement furious that there's nothing their accountants can do to keep them from paying taxes on their fortune.

Of course, I'm exaggerating in one sense: accountants absolutely do have ways of avoiding taxes in retirement, most popularly through "qualified charitable distributions," which allow distributions from pre-tax accounts to "skip" the retiree's tax return and thus potentially avoid triggering Social Security benefit taxability.

My point is much simpler: if you have a high balance in a pre-tax retirement account, and are charitably inclined, why would you allow the IRS to determine how much you contribute from the account in any given year? This is a classic example of a regulatory minimum being transformed into an anchor: at age 72 the IRS says you're required to distribute at least 3.9% of your balance, so you distribute exactly 3.9% of your balance. But what does the IRS know about your financial situation or the needs of the charitable causes you care about?

A related problem manifests in the rule that most private foundations and endowments are required to distribute 5% of their assets each year. There are, again, lots of ways to game this rule, but regardless of your foundation's strategy or goals, the 5% rule is almost universally treated as an anchor: "the IRS says we have to distribute at least 5% of the fund each year, so we will distribute exactly 5% of the fund each year."

Phase-ins, phase-outs, and income anchors

What makes these policies particularly strange is when the threshold dollar values are assigned explicitly moral or ethical values. For example, line 10b of the year 2020 Form 1040 allows you to deduct "Charitable contributions if you take the standard deduction" up to $300. But what's so special about $300? Is that the right amount to contribute? Is it too high, or too low? How was the number arrived at?

Likewise, in the 2020 tax year, the earned income credit phases in over the first $7,000 in adjusted gross income for single childless filers, and phases out between $8,800 and $15,800 in adjusted gross income. The tax preference for capital gains over earned income is strange enough, but in the case of the EIC you have the genuinely bizarre situation where people who work pay almost twice the marginal tax rate on their income even than people who realize short-term capital gains or receive interest income: between $12,400 and $15,800 in AGI, $100 in increased earnings results in an additional $10 tax liability and an $8 reduction in EIC, for a marginal tax rate of 18%, while an additional $100 in unearned income is only taxed at 10%.

You might call this a statistical artifact, and you'd be right. After all, the amounts of money involved here are so low you're unlikely to find many people who stop working after earning $8,800 each year, simply because there are few parts of the country where $8,800 is enough to live on. The more realistic case is people stop reporting their income, or move from formal work to informal work, after reaching the EIC maximum.

If you think comparing unearned to earned income is unfair, then let's make a more straightforward comparison, between a married couple with and without children. When a childless married couple goes from earning $25,200 to $25,300, they owe an additional $10 in taxes (their EIC having long since phased out). When the married couple with a child earns the same additional $100, the $17 reduction in the EIC represents a 17% marginal tax rate (the non-refundable portion of the Child Tax Credit would eliminate the additional $10 in income tax liability). Between $30,800 and $30,900 in earned income, the marginal rate jumps to 26%, as they exhaust their non-refundable CTC and owe $10 in income tax while losing $16 in EIC, while the childless couple pays just 10% on their additional income.

This example has none of the "economic" nuances of the capital gains example. You may really deeply believe that capital income needs to be incentivized through the tax code to encourage savings, to encourage investment, to Finance The Industries Of The Future! We can have an honest disagreement about that (you're wrong). But what possible reason could there be to tax each additional dollar earned by parents more heavily than that of non-parents?

In the case of childless single adults, the EIC phase-out results in underreported income, and I don't think that's a good result but it's not exactly a crisis simply because the amounts involved are so low. In the case of the phase-out for parents, the under-reporting of income continues (one spouse may earn unreported income while the other works in the formal economy), and it also carries the real risk of serving as an anchor in precisely the same way the charitable contribution, required minimum distribution, and 5% rule do: when you tell people "you can claim the maximum credit when your income is up to $25,200," at least some of them are going to seek to earn $25,200.

This argument is sometimes made in the context of explicitly pro-natalist politics ("we should pay people to have children to preserve our civilization"), but I don't care about that. However much you think the EIC should be (double it! halve it! eliminate it!), however much you think the CTC should be, whatever you think the income tax brackets should be (flat tax! confiscatory tax!), everyone should be able to agree that parents shouldn't be paying higher marginal tax rates than non-parents who are, in every other way, identical.

For good anchors, against bad anchors

One thing I hope comes across from this post is that anchoring is a totally normal and inevitable part of policy-making. Anchors will arise every time you write a number into a law. If you provide free public education from age 4 to age 18, most people will enroll at age 4 and most people will finish at age 18. That's partly because people like free child care, partly because people like free education, but it's mainly because those are the numbers in the law. They're normal, and since most people are normal, they do the normal thing.

What we should strive to do is write good numbers into the laws, conscious of the effect they will have on society's anchors. Most of the anchors I described were written for arcane budgetary reasons or administrative reasons that make no sense today, and could be easily eliminated.

For example, the government doesn't actually care how much money people spend in retirement — RMD's are required in order to trigger the taxation of as-yet-untaxed balances. That may have made sense when IRA's were created in 1974, but there's no reason today the government should be in any hurry. If people don't want to spend their money in retirement, let them keep it, then levy a flat 40% or 50% tax on balances at death. What's the rush?

Likewise, eliminating the phase-out of the earned income and child tax credits would be expensive. Fortunately, both programs are already administered through the tax code, where everybody writes down their income and pays taxes on it. "Paying for" the elimination of phase-outs is as simple as adjusting the tax brackets so the amount of money raised equaled the additional expense. There are huge banks of computers in Washington dedicated to making precisely such calculations.

Finally, this is not a way of "de-politicizing" issues. In some cases, it will re-politicize issues: if non-parents aren't willing to see their marginal tax rates rise in order to pay for a uniform EIC and CTC, then they should say so and make the case so we can decide who's right, instead of hiding under the bureaucracy of the welfare state.

What's the real story behind the zillionaire widow defrauded by her grandsons?

Via TravelBloggerBuzz, last week I read a fascinating story about the resolution of a FINRA arbitration complaint against two JPMorgan financial advisors by their grandmother, whose money they had supposedly misallocated for the benefit of themselves and their employer. Unfortunately, for the usual reason (laziness) the business journalist was unable to actually describe the content and stakes of the dispute, which left me with many more questions than answers.

Beverley Schottenstein is unimaginably wealthy

What is absolutely essential to understand about the case is that Beverley Schottenstein, the widow of Alvin Schottenstein, possesses almost incalculable wealth. To be clear, by all indications, she appears to have come by it completely honestly: she married an executive at a successful privately-owned company, then he died and left her an enormous fortune. One reason that fortune is so enormous is that she doesn't seem to spend any money: in order to participate in her FINRA arbitration she "rented a computer and hired an IT specialist." Judging by the photos of her apartment she has a taste for vintage crystal fruit and candy bowls, but unless she has a warehouse full of the stuff it's highly unlikely to break the bank.

Real estate appears to be her only real weakness, if you can call it that. The same grandchildren who went on to rip her off are described as "setting up in Manhattan apartments their grandmother had bought years earlier." She owns a condo in Bal Harbour, Florida, a few floors up from her son, the father of the crooks. She also seems somewhat active in the Jewish community, which may attract some of her charitable giving.

But other than real estate she appears to own exclusively financial assets. Her family was bought out of the furniture business in the late 80's, and since then her fortune has grown, and grown, and grown.

What is an "aggressive" investment for a 93-year-old zillionaire?

Like most guilds, the finance industry sometimes uses ordinary terms in peculiar ways, and this comes up in the Bloomberg article: "Her paperwork with JPMorgan characterized her as an aggressive investor. That could explain trading in instruments the attorneys say were too complex and risky for someone of her age—like $72 million in so-called autocallable structured notes that were traded in her account in 2014 and 2015, leading to losses the lawyers put at $10 million."

To understand what's going on here, you have to understand the way financial advisors are required to think about asset allocation. In simplified form, there are two dimensions to asset allocation: the allocation that gives you the ability to meet your financial goals, and the one you have the tempermental willingness to tolerate. An individual investor's position on those two axes is supposed to resolve into a risk tolerance or investment strategy between "conservative" and "aggressive." For example, I think that to a first approximation everyone under the age of 50 should have 70-90% of their retirement accounts invested in the stock market, with only a small remainder in cash or bonds. But at age 20, a 70% allocation to stocks might be considered a "moderate" risk tolerance, while at age 50, a 70% stock allocation might be considered "aggressive."

How useful you find this framework is a matter of taste, the point here is simply that it has been institutionalized over time. In Schottenstein's case, as the above quote suggests, you have a problem at the intersection of finance industry jargon and the real world. Her grandsons wanted her to invest in some exotic speculative Cayman Islands investments, and in order to do so they had to classify her as an "aggressive" investor. But this classification mangled the two dimensions of risk tolerance: she had a high ability to sustain investment losses, but a low willingness to do so. When the investments lost money, she got upset, even though it didn't affect her lifestyle in any way (she remained a zillionaire even before her $15 million FINRA payday).

There's absolutely nothing surprising or unusual about this situation. In fact, the experience is practically universal: as your investment balances grow, you should expect to experience price volatility as increasingly painful. A 45% decline in a $10,000 portfolio reduces your wealth by $4,500, while the same decline in a $1,000,000 portfolio reduces it by $450,000. What possible comfort are you supposed to glean from the fact that you have $550,000 left?

What I suspect really happened

Reading between the lines, I suspect the real story is simple: Beverley's grandkids were broke, unemployable, and in her will. Rather than wait for another few decades, they thought they'd get a head start on their inheritance: sign on at JPMorgan as her investment advisors and get paid a percentage of the assets they managed. At this point, Beverley may even have been in on the scam. As the article points out, "Their arrangement wasn’t unusual. It’s common and legal for money managers to work for relatives. Family money, in fact, often provides the seed for advisers to break into the business."

If you're planning to leave your grandkids a few million dollars one way or the other ("If they needed something—anything, god forbid, that had to be done with money—I was right there," Beverley is quoted as saying at the end of the article), then why not also add a high-profile entry to their resumes, a few years of seniority at a global bank, and the kind of prestige and reputation money can't buy outright but has to be laundered for?

Then the grandkids got greedy, and then they lost their minds. I've now seen a few e-mails sent around by brokers to friends and family members saying something like, "you have $10,000 in JCPenney bonds in your account that Fidelity would like to buy from you." There's nothing unusual about it: somebody comes to Fidelity asking to buy some bonds, Fidelity checks the accounts of their clients and makes them an offer. It might be a good offer, it might be a bad offer, but Fidelity is doing it in order to make a market between customers who want to own JCPenney bonds and customers who don't particularly care what bonds they own. If you're the broker who happens to identify the bonds that get moved around, you get a taste of the action. Otherwise, why would you bother your clients in the first place?

Still, the grandkids don't strike me as particularly bright, and the first time it happened Evan and Avi might not even have realized what they were doing. Their supervisor may have called up and simply asked, "we're trying to locate $10 million in Big Lots shares, can you ask Beverley if she'll sell?" And that quarter, their paychecks had a little extra in them. Before long, they realized that they could earn kickbacks from both buying and selling the securities JPMorgan made markets in. When JPMorgan needed a buyer, they bought, and when JPMorgan needed a seller, they sold. The clue that this is what was going on is mentioned in passing in the Bloomberg piece: "In all, the brothers’ unauthorized buying and selling added up to about $400 million in transactions over the years." But they didn't manage $400 million for their grandmother: they were churning the same $100 million or so, over and over and over again!

Now think about this from the grandkids' perspective: their grandmother didn't need the money. She spent all day lounging by the pool in Bal Harbour doting on her extended family — very much including themselves. On the other hand, they were grown men: they didn't want to ask their grandmother for an allowance, or a loan in order to buy the first class tickets they were sure they deserved. They prided themselves on their independence. When they churned her accounts they surely thought of themselves as taking a small advance on the inheritance they were due any day now.

And they weren't even investing in Ponzi schemes or trading in bitcoin! Sure, some of the securities they bought and sold were a little illiquid, but they were making markets for one of the largest banks in the United States and the world. As the Bloomberg piece points out, a key part of their defense was that Beverley actually made money on many of their antics.

Unfortunately for Evan and Avi, absolutely everything about this was a violation of securities law, and they knew it. We know they knew it because of another sentence buried in the Bloomberg article: "They logged more than 500 transactions as direct requests from Beverley in 2015 through 2018 that she didn't know about." This may come across as a throwaway line but has enormous significance: if any investor, from the most conservative to the most aggressive, directs their advisor to buy some security, no matter how inappropriate it is for their investment strategy, the broker is naturally obliged to comply. But trades initiated by the advisor have to fall in line with the investor's strategy. Evan and Avi were treating trades they initiated as being directed by Beverley, in order to evade investor protection laws and enrich themselves. Case closed.

Conclusion

Ultimately, the Schottenstein drama is in some ways both more interesting and more banal than the Bloomberg Wealth article was able to convey. On the one hand, you have what is essentially an ipso facto violation of securities laws, due to both the mischaracterization of trades as unsolicited (initiated by Beverley) instead of solicited (initiated by her grandkids), and the apparently-constant churning of her account in order to generate commission revenue for the firm instead of meet her investment goals.

Buried beneath that layer is a much more interesting story about an extended family that is obviously struggling with money ("Members of Bobby’s [the father of the grifter grandchildren] family told relatives that he’d drained their share of the settlement by the time Evan hit high school. They blamed bad investments") and yet surrounded by incalculable wealth. The grandchildren themselves clearly blame their cousin, Cathy Schottenstein Pattap, for "turning their grandmother against them" in order to secure a larger share of her estate. And without knowing anything else about the family, they might be right! But their cousin didn't make them break the law. Once she found out they were ripping their grandmother off, what was she supposed to do?

MEUC: the unemployment insurance top-up no one is talking about

Since the original CARES act in March, I've been trying to provide practical, real-world guidance on the nuances of federal and state aid to unemployed and self-employed workers. For reference:

• In May I shared my successful EIDL loan application;

• In July I asked whether the PPP program was designed to fail;

• In August I broke down what programs were still available as the CARES act was allowed to lapse;

• And in December I shared some nuances on the interaction of the Pandemic Emergency Unemployment Compensation and Extended Benefits under the December 27 relief act.

One brand new program was created under the December 27 act that has received very little attention because, like all these programs, it has taken the states weeks or months to implement the necessary changes to their unemployment insurance systems: the Mixed Earners Unemployment Compensation program. Since applications are now finally opening up nationwide, it's time to talk about it.

The two pandemic unemployment tracks

An enormous amount of federal aid has been pushed out to unemployed workers through the unemployment insurance system since the end of March. That aid has been distributed along two "tracks:"

• Workers who are paid through a W-2 payroll system, and who met the income and duration eligibility requirements for unemployment insurance (typically based on the 4 full calendar quarters of employment preceding the previous full calendar quarter) were put on the "traditional" unemployment insurance track, and receive first UI, then PEUC, then Extended Benefits.

• Workers who are self-employed, who report their income on Schedule C, or whose earning and employment history did not make them eligible for unemployment insurance, were offered a brand new and temporary program called Pandemic Unemployment Assistance.

Both traditional UI and PUA participants were eligible for the $600 Federal Pandemic Unemployment Compensation top-up through July and the $300 top-up beginning in December and scheduled to run through March.

It's impossible to overstate the revolutionary potential of the PUA program. Small business owners, freelance workers, and mis-classified "gig economy" employees, who had been deliberately and explicitly excluded from the employment-based safety net, were for the first time eligible for income replacement similar to that received by workers paid through payroll. While the program was temporary, and had slightly shorter time limits than the traditional benefit track, the usefulness of such a program has become so blindingly obvious that it feels like it can only be a matter of time before something similar is passed into permanent law.

What is MEUC and why was it created?

The single most important thing to know about the two unemployment insurance tracks is that they were mutually exclusive and you weren't offered a choice between them: PUA was only available to those ineligible for traditional UI. That means someone working a minimum wage job 20 hours per week, perhaps to qualify for employer-provided health insurance, who also ran a prosperous wedding photography business, wasn't able to claim PUA benefits based on their lost photography income and instead was forced to file for traditional unemployment insurance based on their meager wage income.

This is, objectively, not a particularly common situation. For all that we hear about the "gig economy," the overwhelmingly majority of workers are correctly classified as W-2 employees in any given year, those who do have side income typically earn very little in a given year, and workers with spotty employment and earnings records were already made eligible for PUA. Of course you can come up with possible examples from your own profession: a software engineer who builds apps on the side, or a doctor who picks up occasional emergency department shifts in addition to their family practice. These people exist! There just aren't very many of them, and only a subset of them become unemployed in any given year, with or without a pandemic.

Nonetheless, through some combination of a late-breaking sense of fairness and a particularly vocal lobby, this seeming injustice was rectified in the December 27 act through the created of the Mixed Earners Unemployment Compensation program.

How does MEUC work?

Now that applications are available in many states, the design of the program is fairly simple. To qualify for MEUC, you must:

• be enrolled on the "traditional" unemployment insurance track — PUA recipients are categorically ineligible;

• have earned $5,000 or more in self-employment income in the calendar year preceding the year your unemployment benefits began.

MEUC benefits are $100 per week, are added to your UI benefit, and are in addition to the current $300 FPUC top-up (for a total of $400 in addition to your base benefit).

The program is currently authorized to pay benefits for the 11 weeks ending January 2 through March 13 (or January 3 and March 14 if your state's unemployment insurance week ends on Sundays), for a total of $1,100 to those eligible the entire time. The program was slow to roll out, but once you apply and are approved, benefits are retroactive to your first week of eligibility.

While I'm sure it was hell to implement for our noble unemployment insurance software engineers, the design of the program itself is straightforward, with two big red flags:

• First, unless you became initially eligible for unemployment insurance in 2021 (not initially approved, but initially eligible), your MEUC will be based on your 2019 self-employment income. Your 2020 self-employment income is totally irrelevant unless you became initially eligible in 2021.

• Second, you'll be asked to prove the self-employment income that you are using to certify your eligibility for MEUC. If you correctly reported over $5,000 in net self-employment income on your 2019 tax return (the one you filed in 2020), then your 2019 1040 and Schedule C should be all you need. If you incorrectly or inaccurately reported your 2019 self-employment income, then you should expect your MEUC claim to take a long, long time to resolve. It probably will be, eventually, but if a claims examiner needs to go over dozens of check images for every job you did in 2019, you are not going to be at the front of the line for approval.

Conclusion

Now you know everything there is to know about the Mixed Earners Unemployment Compensation program. If you're impacted, go apply for it. If you're not impacted, you may know someone who is, so share this post with them. But even if neither you nor anyone you know is impacted, I still want to draw your attention to two points.

First, this is no way to run an income support system. Throughout the pandemic, Congress has passed temporary, small-bore expansions and extensions of the unemployment insurance system, placing an enormous burden on our fractured, understaffed, and underfunded employment agencies. If self-employed people need income insurance, they need it whether or not there's a pandemic. If unemployed people need cash benefits, they need them whether or not there's a pandemic.

There really are needs that have to be addressed on an ad hoc basis: when a pandemic emerges, people need vaccines. When a tornado strikes, people need temporary housing, not vaccines. When there's a drought, people need water, not temporary housing. When there's flooding, people need dikes, not water. But whenever people can't work, they need money, and we need an income support system that reflects that fact on a permanent, not an ad hoc, basis. If you're a wedding photographer it doesn't matter whether you can't work because of a pandemic, a tornado, a drought, or a flood, it matters that your rent is due and you don't have any money, and that's a problem that can only be solved with a steady, reliable income support system.

Second, and this hearkens back to a message I've been pounding since I started writing here, you should report all your self-employment income and pay taxes on it. Under-reporting of income inspires a kind of glee in people that has always been a bit bizarre to me. On the one hand, workers will say things like "I got paid in cash so I don't have to report it" or "thank God I didn't earn enough to trigger a 1099 this year." On the other hand, busybodies will sourly cluck, "you know he's paid in cash, he doesn't pay any taxes on that money" as if the worker was somehow taking something from them. But both are wrong! When people under-report their income the only person they're stealing from is themselves, in the form of decreased eligibility for SSDI, Social Security's old age benefit, Medicare, and hopefully going forward benefits like a permanent PUA and/or MEUC.

Look, if you have 3 months to live, you have my heartfelt permission to forget about paying your taxes and any other bill to go party in Cancun until the curtain drops. But if you're an ordinary person living an ordinary lifetime, you shouldn't pay your taxes as a favor to anybody else. You should pay them as a favor to yourself.

How to apply to, enroll in, and attend college

In my Wednesday review of Ron Lieber's college-cost book I promised my own streamlined take on how to think about higher education. One of the great shortcomings of Lieber's book is that it's focused on parents: the "You" in the title refers to you, the parent, rather than "You," the student. Unless you plan on taking your children's tests for them, "You" the parent are mostly irrelevant to the process, so this post is intended to be read and digested by "You" the student.

Where to apply

Lottery tickets

There are a handful of schools that it's worth applying to if you stand even a chance of admission, but it's truly only a handful. If you have a GPA above 3.8, an SAT score above 1550, and an interesting life story, you should apply to Stanford, Harvard, Yale, and Princeton, removing any of the four you wouldn't attend for other reasons (if you grew up in New Jersey you might eliminate Princeton, for instance). You shouldn't plan on being admitted, but it's a cheap ticket with somewhat better odds than the lottery: even a 5% admission rate is thousands of times higher than your odds of hitting a Powerball jackpot.

Public flagships

Next, apply to the top one or two public in-state colleges and universities. You know these better than I do, but in California it's UC-Berkeley and UCLA, in Maryland it's College Park and Baltimore County, in Virginia it's UVA and the College of William and Mary, etc. If you come from a state without nationally-recognized public colleges and universities, then you may skip this step, unless you plan to remain in the state or go to graduate school (if you go to graduate school no one cares where you went to college).

Specialized areas of study

Finally, you need to decide if there's a specialized course of study you want to pursue. It may sound obvious, but colleges and universities are divided into departments: not every department exists at every school, and not every department offers courses in every specialized subfield.

For example, if you want to become a biomedical engineer and spend your career working on artificial vaccines to fight the next plague, you need to apply to schools with biomedical engineering programs. That means MIT, Cal Tech, Johns Hopkins for elite students, or Georgia Tech, Michigan, or Arizona State for residents of those states.

If you want to achieve language fluency, your options are likewise limited to Middlebury College or one of the schools in the federal Language Flagship program. That's not to say you can't or shouldn't take language classes at other schools, just that those classes will not get you anywhere close to fluency, which requires a specialized program built around it, in the same way that anybody can take a class in draftsmanship but architecture is the science of making sure the resulting building doesn't fall down.

I am deliberately avoiding the pernicious tendency to tell you to pick a "valuable" major that is going to speed you along your career path or accelerate financial success. I am simply telling you to be aware that if you have specific interests, you should apply to schools that serve those interests. I don't think the close study of Latin and Greek classics in the original is a particularly remunerative field, but if that's the field of study you want to pursue, you should apply to St. John's College in Annapolis, Maryland, or Santa Fe, New Mexico. If you don't, you won't have the opportunity to study what you want to study.

Finally, you can and should line up your applications with your qualifications so you're not wasting application fees.

Where to enroll and what to pay

There is (almost) no such thing as a "merit scholarship"

If you went to high school in the late 90's or early 00's, you may recall the groaning shelves in your counselor's office filled with 3,000-page tomes describing various "scholarships" you could apply for. You may even have shown up to scholarship night at the local Elk's Club to sing and dance for the Pachyderms. Rid yourself of these disgusting thoughts immediately: your starting point should be, there is no such thing as a "merit scholarship," in the sense of your academic achievement being translated through some kind of rigorous process into money that you can use to pay for college.

Now that our minds are clear, there are two exceptions: some individual universities have separate scholarship applications for specific pots of money. It's absolutely essential to differentiate these actual scholarships from "merit discounts," the grants off the sticker price that universities give students with good grades and test scores in order to attract them.

For example, like literally every university, the University of Montana has a pool of money it calls the "Academic Achievement Scholarship" in order to reduce the sticker price for high-achieving in-state students. But they're crystal clear, "Montana residents are automatically considered for this merit scholarship when they apply." This is a merit discount: they offer lower prices to high-achieving students than lower-achieving students because lower-achieving students are less likely to have alternatives.

On the other hand, the University of Montana also offers something called the Presidential Leadership Scholarship, which requires a separate application to the Davidson Honors College. Most colleges no longer have these separate scholarship applications (instead they "holistically" evaluate every applicant for merit aid), but if you're applying to a school that does, make sure you apply.

The second exception is National Merit Scholarships, but we need to be very clear in our terms here. National Merit Scholarships are at their core a weird branding tool, which essentially give schools an opportunity to target marketing material at promising students after they take the PSAT in their sophomore or junior year of high school. At the overwhelming majority of colleges and universities, there is no such thing as a National Merit Scholarship in the sense that matters: a National Merit Scholar who would otherwise receive $10,000 in grant aid instead receives $9,000 in grant aid and a $1,000 National Merit Scholarship.

There are a very small number of schools that, in order to boost their statistical rankings, really do offer scholarships to National Merit Scholars, and if those schools fit your other needs, you should certainly apply. Some of the links on this website are a little out-of-date but should give you a general sense of which schools this applies to.

Where to enroll

Fortunately, because of all the work we've done above, this is the easy part. Since you've only applied to schools you're willing to attend, attend the school with the lowest out-of-pocket cost. This is relatively easy to calculate, but there are a few traps here. Your out-of-pocket cost is correctly understood as your total cost of attendance minus grant aid.

School are pretty good about calculating your total cost of attendance, which typically consists of tuition, room and board (for on-campus students) or estimated food and housing costs (for off-campus students), books and equipment like computers, and mandatory fees.

Schools are pretty bad about calculating your aid. You can typically split an award letter into four buckets:

1. First are grants like federal Pell and SEOG awards, institutional need-based aid, and institutional "scholarships" like those discussed above.

2. If you qualify, you'll see a federal work-study award.

3. You should also see some combination of "direct" (i.e. federal) subsidized and unsubsidized loans.

4. And finally there may be a remainder called something like "family contribution" or "PLUS loan" amount.

Ignore the last three. Your out-of-pocket cost is your cost of attendance minus your grant aid. All else being equal, attend the school with the lowest out-of-pocket cost.

Of course, all else might not be equal. A lot might have changed since you put together your list of schools in November and you receive your financial aid award letters in May, and the school with the lowest out-of-pocket cost may not be on your list anymore. That's totally normal. But among the remaining schools, the ones you do still want to attend, pick the one that will cost you the least.

How to pay

Now let's look at #2-4 on the award letter.

Work-study awards are not financial aid. This should be obvious, but tuition is due at the beginning of each term while money is only received for work as it is performed (and usually several weeks after that). Mechanically, work-study income cannot be used to pay for higher education. Don't get me wrong — it can be used to pay for lots of things! It just can't be used to pay for higher education.

I have no serious objection to taking out direct subsidized student loans (at the school with the lowest out-of-pocket cost). These loans don't incur interest while you're enrolled, have a low fixed interest rate (currently 2.75%) and a low maximum of $19,000 over four years of higher education and $23,000 total.

Direct unsubsidized loans are a slightly worse deal, since interest accrues while you're enrolled, but have an even lower maximum of $8,000 in total borrowing, so if you exclusively take out direct loans, you'll graduate with "a bit" over $31,000 in student loan debt. Even better, these loans are eligible for income-based repayment (IBR), which limits the percentage of your income you're required to pay each year, and extinguishes the loans entirely after 20 years.

What happens if, after applying grant aid and direct federal loans, there is still a remainder? This is where schools expect parents and other relatives to chip in. The three ways to do so are by contributing current income, spending down savings (whether through specialized accounts like 529 plans, Series EE savings bonds, or withdrawals from brokerage or retirement accounts), or taking out additional, parental loans.

Fortunately, solving this exercise is simpler than it looks:

• 529 plans offer tax-exempt internal compounding of dividends and capital gains, but the tax benefits (if any) are only realized on withdrawal. If an account's value at any given moment is less than the total contributions to that account, the entire balance can be withdrawn tax- and penalty-free. If on the other hand an account has gained value, then all withdrawals are made proportionately from contributions and gains, whether or not they are used for eligible educational expenses.

• Current income can be used to pay for higher education expenses, but it can also be used to contribute to taxable or tax-advantaged investment accounts (or for current expenses).

• Direct PLUS loans have a fixed interest rate and repayment term between 10 and 25 years (30 years if the loan is consolidated and income-contingent repayment is chosen).

What this gives you is a huge amount of optionality across the three choices, because in any given year, you can use them in any combination. If in year 1 a 529 account is showing large gains, then it can be aggressively spent down tax-free. If in year 1 a 529 account is showing large losses, you can take out a direct PLUS loan to cover that year's educational expenses, and give the 529 balance time to recover. Likewise, if in year 4 the 529 account is still below water, it can be cashed out tax- and penalty-free to repay any PLUS loans taken out in the preceding years.

PLUS loans offer one additional form of insurance worth considering: they're extinguished on the death of the borrower (or the student). This gives a kind of asymmetrical information advantage to people who either become parents later in life or who become ill after their children enroll, since the borrowed money never has to be repaid by anyone.

How to attend college

This, ironically, is the part that Ron Lieber gets closest to right, despite not being the focus of his book. To get the most out of your higher education:

• spend as much time as possible;

• in the smallest classes possible;

• with as many tenure-track faculty as possible;

• while completing your degree requirements as quickly as possible.

Obviously on the one hand this is a "wisdom to know the difference" kind of situation. If you're a biology major, you're going to sit in some extremely large biology lectures because that's how introductory biology is taught. But even if your degree requires some large introductory lectures, I guarantee there are classes in your department and in other departments, that have small faculty-taught seminars with no prerequisites. The second you arrive on campus, find the interesting ones, take as many of them as possible, and make yourself obnoxious.

Conclusion

There are two competing forces in American culture regarding higher education. An enormous marketing machine is dedicated to convincing you that higher education is a "mood," what matters is how you "feel" and how good a "fit" you are. The other, equally absurd force wants you to believe higher education is "career training," where you learn "marketable skills" and "invest in your human capital."

The point of this post is to convince you that higher education is neither a mood nor an investment. It is much more like a trip to Disneyworld. Everyone pays a different amount and everyone has a different experience, based on the amount of work they're willing to put into planning, preparation, and execution. And just like planning a trip to Disney, your goal should be to pay as little as possible for the most rewarding experience you can possibly have.

Book Review: Ron Lieber just wants to ask questions about college costs (that have obvious answers)

Before I was a travel hacker, I was a higher education hacker. In fact, the first glimpse I had behind the rickety infrastructure of the modern economy was when I made a last minute decision to study abroad and my university's financial aid, which shouldn't have been applicable, appeared as a $40,000 credit in my account, which almost entirely paid for my last semester in college.

Over the years, I learned more and systematized those lessons, which you can now find all over this site. Of course, just like travel hacking, the higher education finance game is constantly changing, so even though I'm a few years out of graduate school, I still try to stay on top of new developments so I don't have to restart from scratch if I ever need to to coach my kids, nieces, or nephews through the process.

That made me intrigued, though not optimistic, to pick up the New York Times' personal finance columnist Ron Lieber's new book, "The Price You Pay For College," which you can find an excerpt from here. My pessimism was richly rewarded, since business and finance journalists are the laziest people alive, but the book touches on enough interesting topics that I thought it would be worth using as an anchor.

What Ron Lieber gets right: higher education is about expectations management

All the way back in 2017 I wrote a post about how to get a free education. The process is simple:

• find states that exclusively uses FAFSA to establish aid eligibility;

• find institutions that promise to meet full demonstrated financial need;

• establish residency;

• establish independence;

• only take out federal direct student loans.

You can read the whole post for more details, but anyone who follows these steps can attend college tuition-free.

But I also wrote in that post that you will not follow these steps, not because you don't believe they'll "work," but because it doesn't fit with the expectations you have for yourself or for your children.

And Lieber makes the same point throughout his book: what you expect out of the higher education application, enrollment, and attendance process is going to shape how satisfied you are with the experience. He encourages parents to begin discussing higher education with their children relatively early, and shaping a shared expectation that's more rather than less likely to conform with reality. In many ways this is a kind of "regret-minimization" strategy: you are trying to hit the spot in three-dimensional space that achieves a weighted maximum of intellectual satisfaction, personal life satisfaction, and lifetime income. Nobody hits the bullseye, but people who carefully interrogate their goals and expectations ahead of time probably have a slightly better chance than people who don't.

Flashes of insight that immediately vanish

There are a few genuinely novel observations that Lieber makes in passing, each of which could have been fleshed out much more fully than the short, breezy chapters he actually wrote. For example, he devotes Chapter 11 to the issue of campus mental health centers, and mentions in passing the potential difficulty of coordinating parental health insurance coverage with off-campus providers. This is, in all seriousness, an enormous issue that I know nothing about. Under the Affordable Care Act, offspring can stay on their parents' health insurance plans until age 26. But if a college student sees a mental health professional and pays with their parents' health insurance, what information does the parent see on the inevitable bill? Many universities offer discounts to students who decline student health insurance — what are the advantages and disadvantages of doing so?

Likewise, Lieber simply cannot make up his mind whether student "amenities" are driving tuition inflation or not. In Chapter 1 he convincingly argues that tuition increases are driven by the rising cost of instruction and falling state subsidies (a classic case of Baumol's cost disease). In Chaper 16, he describes colleges diverting "millions of dollars...from the academic spending pot." Well Ron, which is it?

These are good questions that Ron Lieber does not even attempt to gesture at answering. He just didn't do the work, and reading his book will not provide any answers to these questions. There are many such instances in the book, where you start to think you're about to gain some essential guidance, and then the (extremely short) chapter abruptly ends.

Many of Ron Lieber's "questions" have definitive answers

The subtitle of Lieber's book is "An Entirely New Road Map for the Biggest Financial Decision Your Family Will Ever Make," but it would be much better subtitled "Questions Ron Lieber Was Too Lazy To Answer."

For example, he devotes one of the longer chapters (Chapter 30 weighs in at a whopping 14 pages!) to "All Your Questions About Saving for College and 529 Plans," and near the end poses the question: "What's the best 529 plan in all the land?"

His answer: "Again, it's hard to say."

It is not, in fact, hard to say. Ron Lieber just didn't put in the work. The answer is, maximize your tax-advantaged contribution to your in-state plan, then contribute to either Utah's my529 plan or Nevada's Vanguard 529 plan. You can find extensive information about prepaid 529 plans here as well.

Conclusion

If "The Price You Pay For College" has a lesson, it's a lesson about the importance of asking questions. But asking questions is the one thing Lieber almost ostentatiously refuses to do. The book is essentially a series of vignettes cobbled together from his columns over the years, with a few interspersed references to the pandemic, which apparently struck just before his book's deadline, compelling him to at least gesture at it lest the book lose relevance entirely.

If I sound annoyed, it's not because I didn't learn anything from the book. As I mentioned above, the question of mental health coverage and the resulting privacy concerns for students is a genuinely interesting question that I now know I want to learn more about. I'm annoyed because I and, presumably, a few people like me have actually done the work to learn about strategies for choosing and paying for higher education, and Ron Lieber didn't. He just turned a 1,200 word column into a 300-page book.

In my next post I'm going to leave Ron behind and share with you my version of the short essay Lieber's book should have been.

The right and wrong lessons from the Gamestop trading fiasco

Like everyone on the internet, for the last few days I've been following the fascinating and hilarious story of the little message board that made a small dent in the quarter-on-quarter performance of a few particularly poorly managed hedge funds. There are plenty of bad and a few good descriptions of the situation out there already, so I'll assume readers are familiar with the broad outlines: a hedge fund used a combination of short-selling Gamestop shares (where they actually borrowed the shares they intended to sell) and buying some put options. Some folks on Reddit got wind of the strategy and decided it would be funny and/or profitable to filet the hedge fund like a bluefin tuna by bidding up the share price by purchasing shares and call options on the same stock.

To be clear, I don't think there's anything particularly novel about these events. Short-selling has been around at least since the 17th century, and options contracts in one form or another for much longer. But that doesn't mean there's nothing to learn from these events, taking place as they are here and now, and not in Amsterdam 400 years ago. So here are my suggestions for this week's lesson plan.

Control is even more concentrated than ownership or wealth

Wealth inequality has been an increasingly popular topic since the Great Recession, but in many ways the common understanding of it understates the true consolidation of power in financial markets:

• Fidelity Investments is a privately held company, with the founding Johnson family controlling 49% of the shares, and Abigail Johnson, the daughter of the company's founder, serving as CEO.

• Charles Schwab is a publicly traded company, however 10% of the shares are owned by the firm's founder and chairman, Charles Schwab. It is currently in the process of acquiring TD Ameritrade.

• Blackrock has a slightly more diverse ownership structure (it's essentially owned by the mutual fund industry as a whole), but its founders in 1988, Bob Kapito and Larry Fink, are currently the company's President, and Chairman and CEO, respectively.

• Finally, Robinhood is privately held but has received venture capital investments from a small group of venture capital firms, who presumably are exercising some oversight of their investment in the firm.

You might think one exception to this pattern is Vanguard. After all, through a byzantine pyramid structure, the Vanguard parent company is owned by the investors in its funds (technically it's owned by the funds themselves, which are owned by investors). But there's a reason Vanguard holds its annual meetings at a satellite office in Arizona instead of at its headquarters in Pennsylvania, or a conference center in New York or Los Angeles: the last thing Vanguard wants is to give the impression that its owners exercise any actual control over the company.

The point of this is not that concentrated control is good or bad, but simply to distinguish it from the idea of wealth or ownership. Every investor has an interest in the performance of the assets they own, but that interest doesn't translate into control of the actual plumbing of the financial system. That's in the hands of 10-15 people who have interests of their own.

When you fail to prepare you prepare to fail

In the pandemonium of the last few days, people either wittingly or unwittingly tended to confuse three totally separate and (largely) independent events.

1. First, the exchanges (the New York Stock Exchange in this case, where Gamestop is listed) implemented so-called "circuit breakers" in the aftermath of the Great Recession. When those are triggered, all trading in a listed security is temporarily halted. As far as I can tell that occurred on Friday, Monday, and Wednesday, and left everyone temporarily unable to buy or sell shares.

2. Second, individual brokerages imposed heightened margin requirements on some stocks. Even for folks who don't have margin accounts, as a courtesy brokerages will often allow customers to trade with so-called "unsettled funds," either deposits from a bank account that haven't cleared yet, or receipts from stock, ETF, or mutual fund sales that haven't settled yet. This week some brokerages raised their margin requirements for the most volatile stocks to 100%, and required purchases to be made with settled funds.

3. Third, Robinhood and, to the best of my knowledge, only Robinhood halted purchase orders entirely for the stocks they identified as being subject to Reddit gamesmanship.

None of these have anything to do with each other, except that they all happened around the same set of stocks. Any stock can be frozen if its price action triggers an exchange's circuit breaker. Any brokerage can impose higher margin requirements on any stock it likes. Any trading platform can prohibit people from buying certain securities (although Robinhood got in trouble last year when its platform went down and people were unable to sell securities they already owned).

But all three felt to the Reddit day-traders exactly the same: last week they could easily get in and out of Gamestop, this week they can't. And to be clear, no one is at fault here: if everybody read the terms and conditions in full for every service they used, we wouldn't have time to do anything else. Ignorance is, in many cases, perfectly rational.

On the other hand, now that they know how this works, hopefully they'll be better prepared next time. It doesn't cost anything to open multiple brokerage accounts, and Robinhood isn't the only free brokerage account anymore: my Vanguard and TD Ameritrade accounts still haven't shut down trading in the affected stocks, although they have raised the margin requirement (#2 above) and were subject to the circuit breaker halts (#1), as everyone was.

Life-changing bets or make-life-interesting bets

Finally, let me extend an invitation to consider two ways to approach this kind of gambling.

A life-changing bet invariably requires putting up life-changing stakes, and this is mechanically true at all points on the income spectrum. Consider a family that scrimped and saved for years to put together a $50,000 down payment to purchase a new home. If they put those savings into Gamestop at $20 and got out at $467, they turned that down payment into $1.7 million and can buy their new home outright, plus maybe a nice summer place in Maine. That's a life-changing bet. But that's only possible because the stakes are so high: a family's life savings, their chance to own their own home, build up equity in it, take advantage of residential price inflation, etc.

I don't like life-changing bets. I like make-life-interesting bets. For example, in February 2018 I went in on $100 worth of Bitcoin. Bitcoin's gone up substantially in price since then, but today it's still only worth $243. If Bitcoin goes to $100,000 it'll be worth $737. If Bitcoin goes to $1,000,000 it'll be worth $7,400. That's real money, and I'd be glad to have it, but it's not life-changing money because I didn't put up life-changing stakes. If Bitcoin goes to $0, I'll still be fine.

Likewise, years ago after Fannie Mae and Freddie Mac went into federal receivership, I bought $400 worth of their shares, which are still publicly traded to this day, despite being obviously worthless (since the shares are not a legal claim on a stream of income). That bet is now worth just $200. If it goes to $2,000 I'll be happy, but if it goes to $0 there'll still be no skin off my back.

Finally, back during the MoviePass extravaganza, I bought a single share of the parent company, Helios and Matheson Analytics, for $3.45. It's now worth about an eighth of a cent.

The point of this exercise is not to say that my bets are right and anyone else's bets are wrong. My point is simply that you should figure out up front which kind of bet you want to make, so you don't accidentally make life-changing bets when all you really wanted was make-life-interesting bets — or vice versa. That's not an "economic," "rational," or "utilitarian" calculation, it's a calculation about who you are, what makes you happy, and how much you have to lose.

Conclusion

The main thing I want to push back against is the concept that the events of this week have any kind of practical relevance from the perspective of either "class" or "fairness." On the contrary, the markets seem to me to have functioned exactly as intended. Individual brokerages made decisions to reduce their exposure to unsettled trades and uncleared deposits, exactly as they should. A very few hedge fund investors saw a small dip in the net asset value of their holdings, and a very few hedge fund managers saw a small dip in their projected revenue for the year, which may lead them to shut down their funds in order to spend time with their families, mistresses, or art collections.

On the flip side, a very few Reddit members made small fortunes, and very many Reddit members made a few hundred or a few thousand bucks. At the end of the day, end of the week, or end of the year, all the money and all the shares will be accounted for and everyone will get exactly what they bargained for, whether they like it or not.

Good reasons to own bonds

For as long as I've been writing about money, I've been saying almost everybody owns too many bonds. My argument has nothing to do with "risk" or "volatility" or "rebalancing." It's much simpler than that: bonds don't pay enough in interest. If and when they start paying more in interest, I will like them more and start saying people should buy them.

But for every traditional use of bonds in an investment allocation, you're better off putting money into high-interest checking accounts or triggering new account sign-up bonuses. Federally insured deposits, guaranteed returns, and almost immediate access to your money are simply too valuable to give up without a good reason, and bonds haven't been a good reason for years.

As a rule, the more firmly I believe something, the harder I hunt for reasons I might be wrong, so today I thought I'd share the best reasons I could come up with to own bonds.

Seeking more risks

This may strike you as slightly counter-intuitive, since most people are trained to see bonds as the "safer" element of their portfolio and stocks as the "riskier" portion, but it's actually quite simple: it's relatively difficult to find genuinely different assets to invest in. Take for example Vanguard's US stock funds. You can buy the Total Stock Market Index Fund and get a market-capitalization-weighted exposure to the entire US stock market — a perfectly sensible thing to do, which is why I do it.

If you want to turn up the volatility on your portfolio you might instead buy the Vanguard 500, the Mid-Cap Index, and the Small-Cap Index and equally weight them. This would radically reduce your exposure to large-cap stocks (which make up the majority of the Total Stock Market Index) and turn up your exposure to medium and small companies. You might do this on the theory that small and medium companies are more volatile than large companies and therefore should offer higher returns over time.

The problem is, it barely makes the slightest difference. Since November, 2001, the total stock market returned 9.28% annualized and the equally-weighted portfolio (dividends reinvested, rebalanced annually) returned 9.94%. And nothing about that should surprise you! After all, both portfolios are investments in the success of the US publicly-traded corporate sector. Whether you look at an elephant through a magnifying glass or a telescope you're going to see the same thing: an elephant.

The first thing investors do when seeking more risks is to look abroad. Just as in the US case, you can slice up "abroad" differently: developed world versus emerging markets, Europe versus Asia, or even country by country until you've filled up your menagerie with an elephant, a giraffe, and a rhino. Genuinely different critters. But you're still looking at the success of the publicly-traded corporate sector. They're still all mammals!

I think that's fine. If you regularly invest in the global stock market for 30 years you'll end up rich, which is the point of the activity, right? Have a cardiologist standing by and all that. But once you've met that threshold, I find the impulse to try to goose your returns even more perfectly understandable. The only individual bond fund I own, in fact, is Vanguard's High-Yield Corporate fund. That's because I'm not using it to try to stabilize my investment returns, I'm using it in the hopes of increasing my investment returns! You might use the Emerging Markets Government Bond fund (or the ETF share class to avoid the pesky purchase fee) for the same purpose.

What I want to make clear is that I'm not talking about "diversification" or "risk tolerance" or anything like that. I'm talking about seeking assets with the potential to generate higher, not lower, returns over time. You might be wrong — the bonds you buy might default, might be called early, might suffer from changes in exchange rates — but there's nothing inherently irrational about trying.

Extreme Inflation Sensitivity

I personally don't take inflation very seriously, and think most people take it more seriously than they should. But there are reasons for that. I don't own a car, so fluctuations in the price of gas don't affect me directly at all (of course they trickle through the supply chain so I pay more or less for cabbage depending on how much it costs to deliver it). My biggest expenses are things like rent and utilities, prices which are "sticky" either by contract (my rent is written down on my lease) or by law (utilities are highly regulated). For those paying off fixed-interest loans like mortgages or car notes, inflation is a boon, since workers may see it reflected in paychecks without suffering increases in those large monthly expenses.

But of course there are people who really are directly impacted by price inflation. Truck drivers who pay for their own gas may not be able to immediately pass along price increases to customers if they have long-term contracts. Chefs who buy meat or produce wholesale may be reluctant or unable to immediately pass along price increases to diners (the origin of so-called "menu costs").

If that describes you, then you may well want to invest in assets that have built-in inflation insurance. High-interest checking accounts should (hopefully) eventually reflect inflation in higher interest rates, but assets like TIPS are guaranteed to.

Ease of Administration

One problem a lot of people run into is that their assets aren't in the right "buckets" at the right time. For example, consider a $100,000 portfolio that consists of $70,000 in stocks and $30,000 in high-interest checking account deposits. After a 50% drop in stock prices, the investor wants to restore their original asset allocation by buying $10,500 in stocks. No problem, that's what the cash is there for. But if the stocks are held entirely in an IRA, our investor has a problem: the 2021 IRA contribution limit is just $6,000, some of which may already have been used up through automatic contributions pre-crash (the 2020 stock market crash began in late February, for example). That means after a $6,000 IRA contribution, the additional $4,500 investment needs to be made in a separate taxable account, and can't be sold and moved over to the IRA until the next contribution year begins.

One way of looking at this is as a tax nuisance, since the sale of the rump shares will be a taxable event, but I think that's a pretty dumb perspective. US capital gains taxes just aren't high enough for ordinary people to worry about, although there are corner cases where reporting capital gains can cause serious problems, like Earned Income Credit qualification.

My perspective isn't that it's a tax headache, but that it's a headache-headache, and the more annoying it is to manage your finances, the less likely you are to do it properly. The advantage of target retirement date or target risk funds isn't that the funds themselves offer better returns than the underlying investments, but rather that the ease of managing them increases the likelihood that you'll manage them correctly. It obviously doesn't completely eliminate the risk of mismanagement — I once talked to someone who "simplified" their asset allocation by splitting their investments equally between the S&P 500 and a target retirement date fund, which of course also owned the S&P 500!

So if having some cash or bonds in your IRA or 401(k) is what it takes to fit your investment responsibilities within your mental investment bandwidth, then you have my blessing.

Conclusion

What I've been trying to stress throughout this post is that my aversion to bonds is totally unprincipled. When the interest paid on investment grade bonds is low, and the interest paid on high-interest checking accounts is high, I keep my cash in high-interest checking accounts. If the interest rate on investment grade bonds ever rises above the interest rate paid on high-interest checking accounts, I'll move the cash into bonds.

Let the economists argue about whether low interest rates are "structural" or "cyclical." I couldn't care less why they're low, I care that they're low.

Understanding one (positive) nuance of the latest federal relief

One of the most immediate consequences of the laziness of finance and economics reporters is that they're incapable of exerting themselves to understand any issue that doesn't affect them personally. Since journalists are also savers and investors, at least through their retirement plans, if a source says something about mutual funds or retirement accounts there's a chance a business journalist will bother to verify the information. But if a source says something about unemployment benefits, the reporter will simply write it down word-for-word. After all, what do they know about unemployment benefits?

Thus it has been with changes to unemployment insurance eligibility made in both the original CARES Act and the additional relief included in the appropriations bill that became law on Sunday.

Understanding PEUC

One of the most important features of the CARES Act was something called Pandemic Emergency Uninsurance Compensation, or PEUC. This was a totally new program that gave money to states to continue distributing unemployment insurance payments to former workers who had exhausted their 26 weeks of standard unemployment insurance benefits. There were two important limitations on benefits:

• eligible unemployed people could receive a maximum of 13 weeks of PEUC payments;

• and the last week eligible for PEUC payments was the week ending Saturday, December 26, at which point the program would end.

The CARES Act therefore mechanically created three buckets a person unemployed in 2020 could fall into:

• If you became unemployed the week ending March 21 or earlier, you exhausted your 26 weeks of standard benefits by the week ending September 19, and you exhausted your 13 weeks of PEUC by the week ending December 19. In one sense, that's good: you got the full 39 weeks in benefits. On the other hand, it means your benefits ended a week before Christmas, and either stopped entirely or you had to transition to a third program, known as Extended Benefits.

• If you became unemployed the week ending March 28, then you perfectly maximized the benefits of the CARES Act, matching the expiration of PEUC with the expiration of your 13 weeks of benefits (this is the situation I happen to fall into).

• But if you became unemployed anytime after March 28, then you were "short-changed" by PEUC, since the program expired while you still had weeks of eligibility remaining.

This is, obviously, a bit screwy from an ethical point of view, but it's how the law was written, and it's how the law would have been implemented if not for Sunday's appropriations bill.

What is a PEUC "extension?"

If you followed the progress of the latest relief bill at all closely, you saw journalists repeat over and over again that it would extend PEUC by 11 weeks, or until March 14, 2021.

But now that you know how the program works, you know you should be asking, "extended which part(s) of PEUC?"

You could imagine Congress trying to save money by writing a stingy, narrowly-targeted bill exclusively for the third category of "unfairly-treated" people: PEUC would remain at 13 weeks of benefits but the deadline to receive them would be extended so people who became unemployed in the last 26 weeks of 2020 would have the opportunity to receive their full allotment.

Likewise, you could imagine an expansive, open-handed version that extends PEUC for all unemployment insurance recipients to March 14, regardless of whether or not they had already exhausted their benefits, or even paying them retroactively for weeks since their eligibility lapsed.

The only way to find out is to actually read the bill, which as far as I can tell none of our finest economics reporters have bothered to do.

Congress tilted towards generosity this time, except for the longest-term unemployed

The relevant part of the bill is Section 206, and it contains great news on three fronts and bad news on one. Let's start with the good news:

• First, it increases the number of weeks of eligibility, so folks in my second and third categories will receive up to 11 additional weeks in benefits on top of the 13 included in CARES.

• Second, it extends new enrollment in the program to March 14.

• Third, and this is another unreported aspect of the extension, it gives those with remaining eligibility after March 14 up to 4 more weeks to collect PEUC benefits.

Let's focus on that last part. As I explained above, a defect of the original program is that a lot of people were kicked out on December 26 even though they had not exhausted their 13 weeks of eligibility. In this law, Congress has reduced (although not eliminated!) that issue by allowing benefits to continue to be collected after the program stops enrollment:

"In the case of any individual who, as of the date specified in paragraph (1)(B), is receiving Pandemic Emergency Unemployment Compensation but has not yet exhausted all rights to such assistance under this section, Pandemic Emergency Unemployment Compensation shall continue to be payable to such individual for any week beginning on or after such date for which the individual is otherwise eligible for Pandemic Emergency Unemployment Compensation."

However, this comes with one big caveat: "Notwithstanding any other provision of this subsection, no Pandemic Emergency Unemployment Compensation shall be payable for any week beginning after April 5, 2021." Pay attention here: the text does not say "on or after April 5," but only "after April 5," meaning weeks beginning on or before April 5 are eligible, i.e. the four weeks beginning March 15, 22, 29, and April 5. That means if you have 4 or fewer weeks of eligibility remaining, you'll be able to exhaust your PEUC benefits. Any additional weeks of eligibility will vanish, unless the law is updated again.

Now the bad news: I mentioned in passing above that after exhausting PEUC benefits, unemployment insurance recipients had the ability to switch to Extended Benefits, which offers another 13 weeks or more in benefits in states with elevated unemployment rates. That's an essential lifeline, and it's good that it was there for workers who exhausted PEUC earlier in 2020. But with the extension of PEUC, a lot of people would benefit from switching back to PEUC from EB in order to preserve their Extended Benefits eligibility.

Unfortunately, Congress did not give people that option. Instead, they'll be forced to exhaust their EB and only then be able to receive PEUC benefits, if the program has not expired by then. This will provide at most a few weeks of additional benefits, to those who became unemployed at the very beginning of 2020, who will exhaust their Extended Benefits early in 2020 (after already exhausting their 26 weeks of base benefits and 13 weeks of PEUC), while folks who had the good fortune to be fired after the end of March will be able to tack their Extended Benefits onto the end of their extended PEUC benefits. I understand state unemployment systems are unwieldy dinosaurs, both for administrators and beneficiaries, but there's no possible rationale for giving people who kept their jobs deeper into the pandemic a longer total period of support than those who were fired earlier in the crisis.

Conclusion

Congress had a lot of opportunities to screw up this aspect of the relief bill, and fortunately they mostly avoided them. The shabby treatment of the longest-term unemployed does not cover America's institutions with glory, but for folks who would otherwise have exhausted PEUC on or after December 26, the bill contains almost undiluted good news.

How big a deal is reinvestment risk?

When financial professionals talk about investing, the conversation invariably turns to the question of "risks." This is a term of art only vaguely related to its everyday meaning. Ordinary people don't talk about "upside risk," for example. That's the possibility that your investment will perform better than anticipated — not a problem for an ordinary person, but a source of deep anxiety for an investment professional.

When it comes to bond (or "fixed income") investing, risks are meticulously separated into "credit" or "default" risk (the possibility that the issuer will default on its obligations), "interest rate" risk (the possibility that changes in interest rates will increase or decrease the price of the bond), "inflation" risk (the possibility that unexpectedly rising prices will erode the value of the interest and principle before maturity), and "reinvestment" risk. As I mentioned, each of these risks can have either sign: if you expect 10% of your bonds to default but only 5% ultimately do, you experienced upside default risk. More importantly, if everyone else expects 10% of issuers to default, but you are able to somehow predict in advance that only 5% will, you have an opportunity to underpay for unexpectedly (to everyone else) good bonds.

Lately I've been thinking about reinvestment risk, and wanted to figure out just how seriously it should be taken.

What is reinvestment risk?

Consider a 10-year, $10,000 bond that pays an annual coupon of $1,000: you deposit $10,000, and over the course of ten years you'll get back $10,000 in interest plus your $10,000 deposit. This bond has an interest rate of 10%, but it doesn't necessarily have a yield of 10%. To calculate the yield, you need to know what interest rate, if any, your annual coupon is reinvested at. If interest rates rise over the 10-year period, you'll be able to take advantage of rising interest rate by spending each $1,000 coupon on bonds with higher and higher interest rates. If interest rates fall over the 10-year period, then each reinvested coupon will earn less and less interest than the one before it.

Thanks to the magic of financial engineering, there are ways to avoid taking this risk. So-called "zero coupon" bonds, for example, don't pay interest, but are instead sold at a discount when issued, thereby "locking in" the yield (although still leaving you exposed to credit and inflation risks). Likewise, bank and credit union certificates of deposit are typically issued with a guaranteed yield over the life of the deposit, so your reinvestment risk is reduced to the single point of maturity (to manage this risk some people create CD "ladders" of varying maturities).

Of course, unless you're a gazillionaire, or being ripped off, you probably don't own individual bonds. Hopefully your "bond" portfolio is some combination of low-cost, well-diversified mutual funds or ETF's. But even so, the concept of reinvestment risk still applies: instead of the interest rate of an individual bond issuer, you're exposed to changes in the interest rate offered by an entire asset class, whether that's investment grade, high-yield, international, or emerging market bonds. Every month or quarter when your dividend arrives, it will be reinvested at either a higher or lower interest rate than it was in the previous period, and those changes will have some effect on your overall return.

But how big an effect?

How worried should you be about reinvestment risk?

To find out, I ran a simple test: if reinvestment risk has an important impact on returns, then the total return of a bond mutual fund with dividends reinvested should differ from the yield at the beginning of a given period. For example, the SEC yield of Vanguard's Total Bond Market Index Fund Admiral Shares (VBTLX) on December 1, 2010, was 2.6%. With dividends reinvested, the total annualized return through November 30, 2020, was 3.74%. Since these are nominal returns and investment-grade bonds let's set aside the inflation and credit risks and focus on the two components of this return: the interest rate and reinvestment risks.

Interest rate risk applies price action: the price of the investment is higher at the end of the period than at the beginning of the period because interest rates fell between 2010 and 2020: a share of the mutual fund cost $10.72 in 2010 and $11.64 in 2020. That's a 8.6% appreciation over the decade even if the fund didn't pay any dividends at all.

But of course it did pay dividends, which by assumption we've reinvested in the same fund. The SEC yield on the fund varied over the period from a high of 3.38% on November 27, 2018, to a low of 1.11% on August 21, 2020.

Subtracting the price action of 0.86% per year (8.6% over the decade), we can arrive at a crude retrospective calculation of this fund's reinvestment risk over the 10-year period: the upside reinvestment return was about 11% — a total interest return of 2.88% instead of the 2.6% SEC yield on the day the investment began.

With this methodology in hand, let's do it with a bunch of funds over a bunch of different time periods!

Keep in mind that we're trying to separate out reinvestment risk: over short periods, interest rate (price) action is going to swamp the effects of reinvestment: in the three years between December 1, 2017 and November 30, 2020, shares in VBTLX appreciated 8.2% — but the fund's yield was just 2.52% at the beginning of the period! If you want to gamble on interest rate action there are lots of opportunities to do so. Instead, I want to focus on what kind of expectations are reasonable.

I looked at four Vanguard mutual funds: the Total Bond Market Index Fund, the High-Yield Corporate Fund (VWEHX), the Total International Bond Index Fund (VTABX), and the Emerging Markets Government Bond Index Fund (VGAVX). You can see the calculations and results here, and make a copy to run your own calculations (and fix any of my errors).

There are three interesting numbers for each fund and date range: the beginning SEC yield, the total return, and the amount of the total return that isn't accounted for by price action, which I am calling "reinvestment risk." When that value is positive, then reinvesting dividends accounted for more of the appreciation than the mechanical application of share price changes. When it's negative, then reinvesting dividends would have made your investment underperform compared to the price action of the fund itself.

Let's take two extreme examples. If you invested in the Total Bond Market Index Fund on November 12, 2005, reinvested dividends, and sold on November 11, 2015, you'd have realized an annualized total return of 4.6%. But that return is actually lower than the return on the underlying funds, which you bought when they yielded 4.87%. If you had access to a different investment vehicle yielding 4.87%, you would have been better off not reinvesting the dividends and instead moving the funds to that alternative investment.

In contrast, if you bought the Total International Bond Index Fund on December 1, 2017, reinvested dividends, and sold on November 30, 2020, your reinvested dividends actually improved your returns. This shouldn't be surprising: shorter periods, and more volatile assets, should experience more interest rate/price volatility than more stable assets held over longer periods of time.

Conclusion

On the one hand, this is a totally superficial glance at the bond market. I picked four low-cost Vanguard mutual funds and 3 time periods for each fund, more from convenience than anything else: I had historical information available about them. Moreover, you'd be well within your rights to say that there was something "special" about the particular funds and particular periods I picked. War, financial crisis, plague, what relevance could these datapoints have to someone making investment decisions about the future, where war, financial crises, and plagues will all have been abolished?

I joke, of course. The only point of the exercise is to highlight the signs and the magnitudes: most of the time, over long enough time periods, you will get "roughly" the return on your bond investments as you'd predict from the starting SEC yield. Under some conditions you would be slightly better off not reinvesting dividends (as long as you have an alternate, higher-yielding investment vehicle in mind), and under other conditions you'll get an unexpected windfall from rising interest rates, but it's not unreasonable to anchor your return expectations, over long enough periods of time, to the starting SEC yield.

That yield might be too low! That's why I save in high-interest rewards checking accounts instead of bonds. But the possibility of future interest rate fluctuations shouldn't on its own discourage you from investing in bonds — assuming the available yields satisfy your return needs and expectations.

Is investment behavior "coaching" possible?

Ever since I took my first job in college as a sandwich artist, I've been suspicious of the American reluctance to talk about money. The franchisee scumbag who hired me told me how much I'd be making, and told me not to tell any of the other employees. The message was clear: he was going to be paying the white, male, inexperienced college student more than the black, brown, undocumented and experienced employees he already had.

That experience stuck with me, and so I try to talk about money as frankly and explicitly as possible. And it turns out, most people are eager to talk about money! Sometimes that's obviously a gentle form of humble bragging ("I've got a couple of small rental properties around town"), but more often it seems like people have a huge reservoir of topics they have been made to feel uncomfortable talking about, but are dying to ask about.

"What's going to happen?"

This is the question everyone asks, and fortunately it's the easiest to answer: nobody knows. The financial analysts have their models based on normal distributions and standard deviations, but the way I prefer to think about it doesn't require any math at all.

Over any given period, the likeliest thing to happen is what happened in the previous period, and this tendency is more pronounced over longer period than shorter periods. In other words, on an hourly or daily basis financial returns are completely random, but over 1-year, 5-year, and 10-year periods the mild tendency for each period to repeat the previous period's behavior becomes more pronounced.

The second likeliest thing to happen is for something to change. If yesterday the US stock market went up, it will probably go up again today, but it might not: it might go down instead.

The third most likely thing to happen is something crazy. In the last 20 years in the United States we've experienced a mismanaged terrorist attack, a mismanaged financial crisis, and a mismanaged pandemic. That's about one economically catastrophic event every 7 years. Such events may become slightly more or slightly less common over the next 20 years, and slightly better or slightly worse managed, but it's a reasonable place to anchor your expectations.

"How am I going to feel about it?"

This is the question no one asks, but the one that actually matters. Unfortunately, no amount of soul-searching is going to yield an answer. The only way to answer the question is to examine your real-time reaction to events when you have actual money invested in the outcome.

Each part of this equation is essential. Take the stock market crash between late February and late March of this year: from our perspective today, it looks like a sharp drop following by a slow, but steady, recovery. Before dividends:

• between February 19 and March 23 Vanguard's total stock market ETF (VTI) fell 35%;

• between March 23 and December 8 it rose almost 72%;

• and between February 19 and December 8 it rose 11.59%.

In hindsight, this was a pretty uneventful period. The year to date return in 2020 of 16.46% is on the high side of US stock market returns, but not unusually so: according to Yahoo! Finance, since 2002 VTI has performed better in 6 years, worse in 11 years, and had an almost identical performance in one year (16.41% in 2012).

But it sure didn't feel uneventful at the time! Stuck at home or forced to work in unsafe conditions, and seeing the stock market collapse alongside an ongoing mass casualty event felt like the end of the world.

So the question isn't how you feel about the drop in stock market prices today. Obviously today you feel fine about them. You might even be bragging about how smart you were to "buy the dip." The question is how you felt about them in March, and the only trustworthy way to know is verifiable contemporaneous accounts. I like using Twitter so it's easy to check how I felt at the time:

• Here I am saying the stock market is not where you should invest short-term savings.

• Here I am saying stock prices are driven by a combination of the supply and demand of liquidity, and speculation.

• Here I am saying stock ownership is properly treated as a claim on a stream of future revenue.

These are very boring views — I got bored just reading them — but that's not the point. The point is, they were boring views I know I held in real time during the stock market crash.

If you're not a heavy Twitter user, this exercise might be more difficult, but it's still worth doing. Do you have friends or family you talk to about investing? Go back and find the text messages, DM's, Facebook posts, or e-mails you sent during this period and take a close look. Your "memories" of how you felt are totally useless: find out how you really felt. I promise you're going to feel exactly the same way when the next crisis comes along.

"What should I do?"

This question is the synthesis of the two above. If you know what's going to happen (capitalism will undergo periodic crises), and you know how you're going to feel about it (ranging from ice-cold to full-blown panic), then you should be able to develop an investment philosophy that accommodates inescapable reality and human emotion.

For example, I hold a small position in Cambria's Tail Risk ETF (TAIL). I know that this fund has a negative expected value, and holding it will reduce the performance of my portfolio compared to fully investing in the stock funds I also hold. This is, from a finance point of view, completely irrational. But I do it because owning a fund that sharply rises during stock market crises is a way to make my investment philosophy (buy and hold forever) compatible with my emotional tendency to panic during global economic crises.

Checking my Vanguard transaction history, I bought TAIL at between $19.70 and $20.65 per share between September 20, 2018, and May 2, 2019, for an average of $20 per share. I sold it between March 2 and April 6, 2020, at an average price of $23.15 per share, for a total profit of roughly 15.75%.

That would sound impressive, except it was only $110.25 in total profit! That's because the point of the holding was never to turn a profit on the investment itself. It was to give me an investment I could be excited about selling during a global economic crisis, and it worked perfectly. Instead of selling my stock holdings which had collapsed in value, I sold a rapidly appreciating ETF and invested the funds in those newly-cheap stock funds. The stocks obviously recovered, with a helpful boost from the value of the TAIL shares I sold at the bottom.

The empty promise of behavioral coaching?

One of the things I've become more cynical about in the past 5 or 10 years is that we have the tools to manage people's investment expectations and behavior. I always try to foreground not the possibility, but the certainty of stock market losses. And during a decade of stock market gains, everyone pretends to understand. But despite all my efforts, the second the losses begin, the panic nevertheless starts.

I suspect there are, roughly, only three kinds of investors: the gullible, the astute, and the hopeless. I don't mean any of these terms pejoratively, just descriptively.

Gullible investors are those who know they need advice, either seek it out or are found by it, and take it. I suspect gullible investors end up with the best investment outcomes, not because the advice they receive is necessarily good or honest, but simply because they take it. To give a simple example, the Rydex S&P 500 C shares have a net expense ratio of 2.43%. This is utterly insane: Vanguard offers the same product for 0.03%. But nobody's paid to sell gullible people Vanguard ETF's. People are paid to sell Rydex C shares, and it turns out, they're fine. Assuming quarterly investments and reinvested dividends and capital gains since April 2006, the absurdly expensive Rydex shares returned 10.04% and the absurdly cheap Vanguard shares returned 12.57%. The difference is a lot of money, which goes to the con artist, her supervisors, and their employer who sell the Rydex shares, but if a con artist is what it takes to get you invested, you ended up doing fine invested in the scam. Who is going to sneeze at 10.04% annualized?

Astute investors illustrate the timeless maxim that "a little knowledge is a dangerous thing." The astute investor checks on her investments every day, because it's the "responsible thing to do." Just like a doctor does his hospital rounds or a dentist supervises her hygienists, the astute investor knows exactly what he owns and checks in regularly to make sure all is well. But of course, all is never well. When stocks are up, bonds are down. When emerging markets are down, developed markets are up. But unlike the doctor or dentist, there's nothing for the astute investor to do! This leads to a kind of psychic tension, where the astute investor knows they must act, but no action is capable of addressing the real problem: they pay way too much attention to their portfolio.

Finally, there's the hopeless investor, the one who needs help the most but is incapable of seeking it out, or if they do seek it out, incapable of internalizing it. The hopeless investor not only responds immediately and emotionally to every market movement, but also acts on it. He sells into crashes and buys into rebounds, locking in losses and excluding the possibility of gains. If you recognize yourself as a hopeless investor, then my boring opinion is that you shouldn't bother. Open high-interest checking and savings accounts, buy CD's and Treasuries with known, fixed interest rates, and save as much as possible. You'll miss out on all the highs and all the lows, but your money will be there if and when you need it. This isn't a case for despair: there are lots of high-interest checking and savings accounts out there! It's just a case against investing in products you are not capable of using responsibly.

Unreduced Social Security spousal and dependent benefits and the family maximum

Last week I wrote about the way age differences can play an important role in thinking about the timing of Social Security old age benefit claims. Specifically, spouses need to take into account two separate variables: the increase in the primary worker's old age benefit by delaying their old age benefit between ages 62 and 70, and the increase in the spouse's benefit by delaying claiming their spousal benefit between ages 62 and the spouse's full retirement age (67 for folks born after 1960). Logically, delaying a Social Security benefit claim should be based on the total benefit foregone and the corresponding total increase in future benefits across both claim types (if any).

There's one additional nuance that I want to explore in more depth here: unreduced dependent benefits and the family maximum.

The now-defunct "file and suspend" scam

Until 2015, one of the most popular ways to maximize Social Security benefits was known as "file and suspend." With this scam, one spouse would "file" for their old age benefit at exactly age 62, then immediately (this could be done in a single phone call) "suspend" their old age benefit, allowing it to increase at the legally specified rate until age 70 (or any time before then). The filer would never receive an old age benefit payment, but filing would entitle their spouse to claim their spousal benefit (appropriately reduced if claimed before full retirement age).

What tipped this over from scam to fraud, and finally drove Congress to close the loophole, was the fact that spouses could file what was called a "restricted application:" they would claim only their spousal benefit, while allowing their old age benefit to continue to accrue until the spouse turned age 70!

In 2015, Congress passed two fixes that elegantly ended this abuse, while leaving flexibility for those who want or need it in making Social Security benefit claims decisions:

• First, it is still possible to file for an old age benefit at any age after 62, and then suspend your claim as soon as you like. However, when a worker's old age benefit claim is suspended, all spousal and dependent benefits are also suspended.

• Second, Congress limited (but did not eliminate — more on that in a moment) the ability to file a restricted application for spousal benefits. Now, when a spouse files for benefits on another worker's record, they are "deemed" to file for their own old age benefit as well if they are at least age 62, which stops the clock on both the spousal and old age benefits' legally specified increases.

To summarize: under the previous regime, if two spouses each have enough Social Security credits to claim an old age benefit, it was frequently possible to maximize the total benefits received by the household by delaying the actual receipt of each spouse's old age benefit until each spouse turned 70, even while collecting spousal benefits. That opportunity is no longer available.

Late-in-life caretakers and the exception to deemed filing

Remember how Congress fixed the "restricted application" loophole: they said any spouse over the age of 62 claiming spousal benefits was "deemed" to also be filing for their old age benefit, stopping the clock on that benefit's appreciation.

But what about spouses below the age of 62? They can't be deemed to be filing for their old age benefit because they're not yet eligible for their old age benefit. However, they're also not eligible for their spousal benefit, so there's no harm and no foul, with one big exception everyone should be aware of: the dependent-in-care rule.

To put it as simply as possible, spouses of any age are eligible to claim a full spousal benefit (50% of the worker's primary insurance amount) while they are caring for a dependent under the age of 16 (or disabled dependents under certain conditions), and claiming that spousal benefit before the age of 62 is not deemed to be a simultaneous claim for old age benefits (at age 62 the deemed filing rule kicks back in).

If it helps you get your head around it, think of this as the "Donald-and-Melania" rule:

• Donald was eligible to claim his maximum old age benefit in June of 2016, at age 70;

• In June of 2016, Melania was just 46 — almost two decades away from eligibility for a spousal benefit;

• But in June of 2016, Barron, a dependent-in-care of Melania and Donald, was just 10.

Since Barron was under 16, Melania was able to file for her unreduced spousal benefit immediately without being deemed to file for her old age benefit, because she's not eligible for her old age benefit yet. She is also free to continue to work and earn additional Social Security credits, increasing her own primary insurance amount.

As an underage dependent of a retired worker, Barron is also eligible for his own child benefit, also calculated as 50% of his father's primary insurance amount (this amount is not augmented by delayed retirement credits or reduced by early retirement reduced benefits).

So far, so good, right? Donald gets 124% of his primary insurance amount for delaying his old age benefit until age 70, while Melania and Barron each collect another 50% of the PIA. When Barron turns 16, Melania's benefits end (since she'll be just 52), but Barron can collect his for another few years as long as he stays in school.

No so fast.

The family maximum

It's all fun and games playing around with Social Security benefit calculators, until you run into the family maximum: the most a worker, spouse, and dependents can receive on a worker's earnings record. You can look at the formula for yourself, but as it's pretty inscrutable, I'll just share the four easiest 2021 datapoints:

• a worker whose primary insurance amount falls under first Social Security "bend point" of $1,272 has a family maximum of 150% of their primary insurance amount;

• a worker whose primary insurance amount is exactly $1,837 has a family maximum of $3,449, 188% of their primary insurance amount;

• a worker whose primary insurance amount is exactly $2,395 has a family maximum of $4,193, 175% of their primary insurance amount;

• and the maximum primary insurance amount in 2021 is $3,115, producing a family maximum for that worker of $5,449, 175% of their primary insurance amount.

The family maximum starts steady at 150% of the worker's PIA, gradually rises to 188%, then gradually falls to 175%, where it remains until the maximum PIA is reached.

If you don't understand this mechanism, you cannot make appropriate old age benefit claiming decisions. There's no one right way to claim your Social Security benefits, but there is one wrong way: not knowing how they're calculated.

Conclusion

Alongside the changes Congress made in 2015, the family maximum imposes a hard cap on how much Social Security benefits can be gamed. While there aren't any hard and fast claiming rules, some obvious suggestions fall out of the design of the program:

• a worker over the age of 62 should "almost always" claim their old age benefit immediately if they have one or more dependents under the age of 18-19;

• a worker over the age of 62 should "always" claim their old age benefit immediately if they have one or more dependents under the age of 18-19 and a spouse under the age of 62;

• after a worker's spouse turns 62, if a worker is under age 70 they should "consider" suspending their old age benefit in order to allow both the worker's old age benefit and the spouse's spousal benefit to increase at the statutory rate, until the worker reaches age 70 and the spouse reaches their full retirement age or age 70 (depending on their respective earnings histories).

A final note I want to make as clear as possible, these age differences and family structures have virtually nothing to do with the sybaritic impulses of our tiny ruling class; the overwhelmingly more common experience is grandparents or other relatives caring for children whose parents have died or disappeared. Especially now that the glaring file and suspend loophole has been closed, we should be encouraging retired care providers to maximize the benefits they are receiving, both for their own well-being and for every generation of Americans to come.

The spooky effects of age differences on Social Security benefits

I was skimming one of the interminable posts over at Michael Kitces's Nerd's Eye View blog by Jeff Levine and was struck by his description of a very strange feature of the Social Security spousal benefit calculation. To spare you from trudging through the post, there are three curious features of Social Security benefits to consider:

• A worker's old age benefit is reduced if claimed before the worker's full retirement age (67 for people born after 1960) and increased if claimed after the worker's full retirement age, until age 70 when the benefit is no longer augmented (although it's still subject to inflation-based cost-of-living adjustments).

• A worker's spouse's spousal benefit (50% of the worker's primary insurance amount) is reduced if claimed before the spouse's full retirement age, but not increased if delayed past the spouse's full retirement age (there's one added nuance I'll return to later).

• A worker's spouse cannot claim their spousal benefit until the worker claims their old age benefit.

This creates a few interesting situations to consider.

Differentials in earnings and age

I find it useful to illustrate scenarios using extreme examples, so let's take a look at two such extremes.

Consider a 62-year-old worker with a 67-year-old spouse, and assume the worker has earned consistently more during their lifetime than their spouse. By filing for their old age benefit at age 62, the worker sees a permanent 30% reduction in their old age benefit ("36 months times 5/9 of 1 percent plus 24 months times 5/12 of 1 percent"). However, since their spouse has already reached the spouse's full retirement age, their spousal benefit will be a full 50% of the worker's primary insurance amount — unreduced by the worker's early old age benefit claim. Thus, the total household benefit will be 120% of the worker's primary insurance amount. By the the worker turns 67, the household will have received 6 times their primary insurance amount.

After that, the household will continue to receive 20% lower benefits than if the worker had waited to claim their old age benefit (and the spouse their spousal benefit) at 67: instead of receiving 150% of the worker's primary insurance amount, the household will continue to receive just 120% of it. 20 years later (when the worker is 87 and the spouse 92) the lower lifetime benefit will finally offset the early windfall and the couple will have permanently lower income each additional year they both live (depending on the rate of return they received on their earlier cash flow).

Now consider a more complicated question: if a worker has a younger spouse, when, if ever, should they delay filing for their old age benefit after their spouse has turned 67? After their spouse reaches age 67 the spousal benefit will no longer increase, but the worker's old age benefit continues to rise by 8% of their primary insurance amount per year (until age 70).

Take a couple with the same birthday one year apart, with the higher-earning spouse also the older of the two:

• If the worker files at age 67, the household will receive a benefit of 145.84% of the worker's primary insurance amount (100% in old age benefits, plus a spousal benefit reduced by filing 12 months early);

• At age 68, the household will receive a benefit of 158% of the worker's primary insurance amount (108% in old age benefits and 50% in spousal benefits);

• At age 69, the household will receive a benefit of 166% of the worker's primary insurance amount;

• At age 70, the household will receive a benefit of 174% of the worker's primary insurance amount.

This calculation gives a mechanical breakeven point of 15.5 years: if both spouses survive until the worker is 85.5, the higher benefits after age 70 offset and then overwhelm the 3 years of foregone spousal benefits. Larger age differences give different breakeven points: a 5 year age difference (i.e. the spouse claiming benefits at age 62 versus age 65) gives a breakeven period of 12 years (the proof of this is left as an exercise for the reader). This is logical, since for spouses below the full retirement age, delaying the worker's retirement increases both the worker's old age benefit and the spousal benefit, meaning fewer years are required after delayed filing to make up for the earlier, foregone payments.

Two corner cases

So far I've been talking about situations where both the higher-earning worker and spouse are eligible to file for benefits at all. But there are two unique cases to consider: a spouse too young to collect spousal benefits, and a household with a minor or disabled child.

In the case of a spouse below the age of 62, the worker's old age benefit filing decision should be made without regard for the spousal benefit, which typically means delaying filing as long as possible until age 70 (unless you have other pressing financial needs or known health issues that make it unlikely you'll benefit from delaying old age benefits). That's simply because the spouse isn't eligible for a spousal benefit, so nothing the worker does can increase or reduce it. The spousal benefit claiming decision should be made on its own.

The second situation to be aware of is when a spouse is caring for a minor or disabled child. Regardless of the spouse's age, they're entitled to the full, unreduced spousal benefit. That means a worker filing for old age benefits at age 62 (accepting a 30% reduction in benefits) can entitle their spouse of any age to a full 50% of their primary insurance amount as long as they're caring for a minor or disabled child. Additionally, the minor children of retirees are entitled to their own benefits (subject to certain household maxima that are a topic for their own post). High-earners who have children late in life thus have considerable incentive to claim their old age benefits at or before full retirement age, to increase the number of years their spouses and children are entitled to the full spousal and child-in-care benefits.

I actually have personal experience with this aspect of the program, since I was born late in my father's life and received several years of dependent child benefits while I was in high school. I can't say that they did me much good, but it's something for older parents of young children to be aware of when making an old age benefit filing decision.

Modern economic growth (and personal finance)

I've recently started listening to a podcast about economic history called, fittingly, The Economic History Podcast, and the last episode on the "Great Divergence" was so interesting it ended up rattling around my head for a few days, and I thought I'd share a few thoughts.

What makes modern economic growth "modern?"

In the (excellent) public schools I attended in the US, we received a kind of potted history of the industrial revolution. You probably remember the broad strokes: Eli Whitney's cotton gin, replaceable rifle parts, Fulton's steamship, Ford's assembly line, Taylorism, the Green Revolution, and all the rest. In this telling, technological advances (industrial, political, and sociological) led to increased productivity and freedom from the "Malthusian trap."

In the interview I linked to, Professor Stephen Broadberry poses the interesting question: how do you know when you've entered a period of modern economic growth? After all, the cotton gin only needs to be invented once (and only where cotton is cultivated), so you can't say a country starts experiencing modern economic growth when it invents the cotton gin. Instead, he suggests a very interesting definition: modern economic growth is a condition of 1) rising output (e.g. GDP) per capita and 2) a growing population.

One way of thinking about this is to imagine an entirely agricultural society with three types of soil: rich, moderate, and poor. On rich land, farmers are able to produce more food than they need to survive. On moderate land, they can produce just enough to feed themselves. And poor land is capable of producing less food than is required to feed its farmers. When you have a small population, they should try to cultivate the rich land first, and since the land produces more food than its farmers require, the population has plenty of room to grow and fill up the rich land. Of course, eventually the rich land will end up full, so the population will spill over to the moderate land. This is no great trouble however, since the moderate land is still capable of producing enough food to feed all those who work it. But note what happens in economic statistics: GDP per capita mechanically falls as population rises, since the lower-producing moderate land is now being tilled by those farmers unable to access the rich land. Finally, as the moderate land becomes fully occupied, the next generation is forced to turn to the poor land, subsisting on the starvation rations they're able to grow for themselves and the excess they're able to extract by politics, custom, or violence from the farmers of the rich and moderate lands. At each stage of this process population increases but GDP per capita falls, since each additional farmer is tilling less and less arable land, adding quite literally more to the denominator than the numerator.

Now consider the process in reverse: a plague blows through the rich land, killing a large portion of the population, and the farmers of the moderate and poor land claim it. Here, a fall in population is matched by a sudden rise in per capita GDP, as the poor land is abandoned and the produce of the rich and moderate land is divided over a shrunken population.

Economists have a bad habit of writing a clever mathematical model and then claiming that it is actually how events played out in human history, so to be clear, this little vignette does not describe any human society that has ever or will ever exist. It's just an illustration of one way GDP per capita and population size can be linked: a variation on the so-called "Malthusian trap."

The professor's definition of modern economic growth handles this by saying that modern economic growth begins when you experience a period of both rising GDP per capita and rising population. In this definition you can't "juke" the stats by killing off your population: you can only achieve it with an economy that supports both increasing living standards and a rising population.

Shrinkage, stocks, flows, and stocks

In the final part of the interview the professor made an otherwise bland point that got me thinking specifically about the consequences of his logic for individual investors. Societies, according to his research, have historically become rich not by maximizing their growth during periods of growth but by minimizing their shrinkage during periods of shrinkage. This jumped out at me because it's the exact opposite of what passes these days for individual financial advice: an individual investor maximizes their returns by tolerating periods of uncertain losses of uncertain length.

An individual investor should pray for depressed stock prices the entire duration of their earning life: if each year well-diversified mutual funds trade at a lower and lower multiple of their earnings, then the same annual IRA or 401(k) contribution, and reinvested dividends and capital gains, will buy more and more shares each year. This is doubly true thanks to what economists call the "wealth effect:" when the stock market is up, your net worth looks better, so you are inclined to spend more and save less, while when the stock market collapses you tend to spend less and save more — magnifying the benefits of investing during stock market lows!

But national economies work on a different principle: GDP is a measure of annual productive activity, not a built-up stock of all previous or estimated future productive activity. And one important input into that process is the way people are, unfortunately, forced to move through the productive economy over time. While Amazon shares can drop 50% this year and then rise 100% next year, with no harm done to the individual investor, a lost year's harvest can't be "made up" in a future year because the farmer herself will be a year older, with one fewer year to produce anything at all.

The resulting question is simple: should the government go to extreme lengths to get an additional percentage point of growth during periods of growth, or should the government go to extreme lengths to combat shrinkage during periods of shrinkage? During the post-war economic boom, growth seemed like the "default" state of the economy, and policies like the Great Society were implemented to combat shrinkage. In the 80's and 90's, growth was seen at risk and increasingly intensive efforts were made to preserve it, despite the human costs in the form of austerity. And in the 2000's, shrinkage has had equal time with growth, and western economies are struggling to settle on a solution.

What is post-modern economic growth?

If pre-modern or "Malthusian" economies faced a trade-off between GDP per capita and population, with the former rising alongside mass death events and falling during times of peace and tranquility, and modern economies embraced rising GDP per capita alongside rising population, it's worth asking what post-modern economic growth could look like.

Countries could return to a neo-Malthusian order, where falling populations are accompanied by rising GDP per capita. Note that, as in the case of a plague in a highly-productive agricultural area given above, the falling population doesn't have to occur in the lower-productivity part of the workforce: all that is required is that the economy be dynamic enough to shift workers from low-productivity sectors to high-productivity sectors. A common example of this model is Japan, which has accommodated a declining workforce by shifting the remaining workers into the remaining high-productivity jobs.

An alternative model is to embrace a rising population, but disregard growth in GDP per capita. This would also violate the professor's definition of modern economic growth, since it would accommodate rising population without insisting on rising GDP per capita. If the US GDP per capita is around $60,000, we could invest in economic growth that would replicate that per capita GDP without attempting to accelerate it, alongside a growing population of Americans. Note that individuals could still experience a rising standard of living under this regime if income were redistributed over time from the highest earners to the lowest-earners, without per capita GDP either rising or falling.

Conclusion

I don't have any strong feelings one way or t'other about the professor's conclusions or his data, but I found the interview fascinating, so if you've got 37 minutes to spare I highly recommend the episode, and if you do end up interested, the podcast's back catalog has some tremendous content, virtually all of which is delivered in an adorable Irish brogue.

Cheap lessons

One of my favorite concepts to tell people about is "affordable luxuries," the things that barely make a dent in your bank account but immediately spark joy: cheap candles, nice towels, or a new filter in your refrigerator. There are times when spending a lot of money will make you a lot happier, and there are times when spending just a buck or two will make you even happier, and I love sharing all the latter situations I run into.

There's a parallel situation, which I call "cheap lessons." In a cheap lesson, you don't come out feeling good on the other side; you come out knowing something you didn't know beforehand. It may hurt, but what makes it cheap is that you don't suffer more than absolutely necessary to learn it.

Trading individual stocks

My first cheap lesson was all the way back in high school, when I started looking at the wall of stock quotes listed in the local paper (local papers had stock quotes back in those days). My mom's stockbroker was a friend of the family so I was at least vaguely familiar with the concept of a stock market, and I asked if I could pick a stock. I dutifully studied the list of quotes, thoroughly researched a few companies (meaning I looked at the America OnLine stock market forums), and then picked one at random. For the life of me I can't remember the name of the company, but I do remember the ticker, "G," and that the company had something to do with service station gas pump technology. I don't think they made the gas pumps themselves, but they might have written software for them or something.

Every day I would open the paper and check my stock's price. The first few days were a whirlwind, with the stock doubling or tripling in price! Then the stock collapsed and never recovered. A week or two later it wasn't listed in the newspaper at all, and a little more time on the AOL forums revealed the company had filed for bankruptcy to protect it from a tsunami of lawsuits. To this day I have no idea if it was a pump-and-dump scam or just another victim of the first internet bubble.

What makes this a cheap lesson? First, I was playing with someone else's money and second, I picked a cheap stock, so the maximum loss was limited by the purchase price — you can't lose more than you pay. In hindsight, my mom also got to deduct the capital loss from her ordinary income during her peak earning years, so it ended up being a cheap lesson for her to teach as well.

There's an unfortunately common idea that tax deductions and various other scams mean that it's often better to lose money than to make money. And it's true that there are a few corner cases I've written about in the past where that's true: in 2019, a single filer with only earned income who maxed out their traditional IRA and 401(k) contributions and then earned the single additional dollar that tipped their adjusted gross income from $19,250 to $19,251 would see the value of their Retirement Savings Contributions Credit slashed from $703 (eliminating their federal income tax liability) to $400 (owing $308).

Likewise, it's true that it's sometimes necessary to spend money in order to make money: if you need a car to get to work, the cost of the car doesn't exist in a vacuum, rather it's a necessary input into your income stream, the same as a carpenter's hammer or a surveyor's tripod. But the fact you might claim a tax deduction for your expenses almost never makes them free: you're almost always better off financially spending less rather than more.

Take-home pay

Another lesson I was fortunate to learn young was the yawning chasm between the wage your employer offers you and the amount of money you see in your paycheck. This is a lesson experienced workers take for granted, but the only way to really learn it is to see your first paycheck. In high school I took a job for maybe 10 hours a week at the local Boys and Girls Club doing a few menial chores like signing video games and pool balls in and out. I didn't work very hard and they didn't pay me very much, so it seemed like a pretty good deal. But when my first paycheck came, imagine my surprise that I wasn't earning $51.50 a week (the federal minimum at the time was $5.15 per hour), but just $47.56. I stormed into my boss's office to demand an explanation, and to her credit she walked me through the paystub and explained each deduction to me.

Of course, the problem with the US income tax system isn't that our rates are too high — our rates are far too low, especially on high incomes and capital gains. The problem is that it's too complicated. Take a look at the possible trajectory of a young person's take-home pay over time:

• In high school, they take a part-time job that pays the full 7.65% FICA tax on all earnings, but are exempt from filing income taxes because their earned income is below $12,000 — unless they had state or federal income taxes withheld, in which case they must file in order to claim their refund.

• Their freshman year of college, their financial aid package includes an undergraduate work-study job that is exempt from FICA taxes during the school year, but is still subject to federal and state income taxes.

• The summer after freshman year, they keep the exact same part-time job at the university, but see their take-home pay drop 7.65% since it's subject to FICA taxes whenever they are not actively enrolled in classes.

• Sophomore year, they lose their work-study grant and can't find a non-work-study job on campus (many campus make-work jobs are restricted to work-study grantees), so they work 20 hours a week at an off-campus restaurant. Their income during the school year continues to be subject to FICA and state and local income taxes.

And we wonder why people have a hard time budgeting. As this "simple" example illustrates, the difference between salary and take-home pay is one of the most important lessons you can learn, and it's best to learn it as cheaply as possible. Most of the benefits documents I've reviewed over the years were pretty good about spelling out the costs and benefits of various programs (health, life, and disability insurance, for instance), but made no attempt to translate a salary offer into a realistic take-home pay amount.

Let's skip forward to our young scholar's graduation, when they take a new job in the big city at the generous salary of $45,000 per year, with a start date of September 1 (we'll say they took the summer off to hike the Appalachian Trail). Conscientious of the federal guideline for "housing burden" to spend no more than 30% of their income on housing, they rent an apartment for $1,125 per month. Unfortunately, after their FICA taxes are deducted, this already leaves them paying 32.5% of their take-home pay in rent. Fortunately, they only worked 4 months at the new job, so their federal and state income taxes are minimal. The next year, things get worse. Now their paycheck is reduced by the same FICA taxes of $287 per month, but also federal income taxes of $312, leaving them just $3151 per month in take-home pay. Now they're paying almost 36% of their take-home pay in rent.

Conclusion

In my experience, most problems have an easy solution and a right solution, and more or less everybody knows what the right solution is. They just don't want to do it, because it's hard. The easy solution to the take-home pay problem is to lean on parents to "educate" their children about the nuances of federal tax law (about which they themselves know nothing), and blame it on them when they get it wrong. It doesn't solve anything, but it also doesn't cost anything, which is what makes it so easy.

The right solution is to simplify the law. Make all income subject to FICA. Treat all income identically. Abolish workplace retirement savings accounts. End phased-in means-testing. End phased-out means-testing. Stop creating targeted tax breaks for con artists.

Hard things are hard because they're hard, and not everyone has it in them to do what's right. But if you can't be part of the right solution, you should get out of the way, not promote "personal finance education" as an alternative.

Personal finance during the plague: the lean months

Become a Patron!A stylized fact about the course of the current pandemic is that while the economic impact was swift and severe, the effect on personal finances was muted by the rapid federal deployment of direct cash aid, in the form of "stimulus checks," expanded and extended unemployment insurance payments, and Paycheck Protection Program and Economic Injury Disaster Loans.In other words, the production and sale of goods and services was dramatically interrupted, but much of the income people received for that economic activity was replaced by federal cash assistance. On a national basis, this led personal income to actually rise, while consumption dramatically fell and the household savings rate consequently rose to 33%.Those were the fat months. You were able to continue paying your housing and utility bills, and might have paid off credit card debt or built up a savings buffer for the first time in your life. You might have had enough to help out friends or relatives whose unemployment insurance claims were delayed or denied, or who were ineligible for assistance because they're undocumented or don't have a sufficient earnings history.The fat months are over. As recently as July I thought the logic of expanded unemployment insurance benefits was irresistible, even to Republican senators, and the fight would be over whether to extend them just through the election, or through the end of the year. It turned out the logic was resistible, Republicans resisted, and unemployment benefits crashed in the first week of August. Now, bills are piling up, courts have begun processing evictions, and we're entering the longer, darker phase of the crisis: a collapse in economic activity paired with a collapse in personal incomes. The lean months, if not years, have arrived.

File for unemployment insurance

Sure, it sounds obvious, but as shocking as the unemployment insurance claims data have been for the last 5 months, many eligible people still haven't filed claims, for a multitude of reasons. Traditionally, there has been a waiting period before the newly-unemployed are even eligible to claim benefits, on the grounds that many of them are almost-immediately rehired (McDonald's fires you so you walk across the street to Wendy's). That waiting period was waived during the current crisis, but low-information workers with prior experience with the system may not know that.Others may have waited to claim the benefits they're entitled to from a confused sense of pride. I say "confused" because this is a bit like paying homeowners insurance premia your whole life then declining to file a claim where your house burns down out of "pride." The benefits are yours, you paid premia out of every paycheck, claiming them doesn't decrease anyone else's benefits, and declining them doesn't benefit anybody else. This is just masochism masquerading as pride, something anyone who has pledged a fraternity is familiar with.And of course, some people may have delayed filing because of the incredible technological barriers the states allowed to fester over the years to discourage people from receiving the benefits they're entitled to. However much you like money, seeing lines of cars miles long at claims centers is daunting enough that some number of people ultimately ended up daunted. Alongside the routine duties of daily life, the burden of an unfamiliar, archaic government bureaucracy can easily become too much to handle.Fortunately, unemployment insurance benefits are retroactive to the date of your separation, including the $600 weekly federal expansion that ran from April 4 to July 25. Even if your weekly state benefit is low (all state benefits are low), that retroactive $600 in weekly federal benefits is an absolutely essential entry point to the lean months.

401(k) "loans" and distributions

Let me say up front, the terminology around 401(k) "loans" has always baffled me. The first time I heard someone say you could "borrow" money from your 401(k), I assumed they meant you could use your 401(k) balance as collateral for a loan. But it turns out, a 401(k) "loan" is just a tax- and penalty-free withdrawal that has to be returned to the account within a specified timeframe. If the funds aren't returned to the account, you have to pay taxes and penalties on the pre-age-59 1/2 withdrawal. But the funds were yours to begin with, and they remain yours the entire time. In other words, it's a withdrawal, not a loan, simply moving funds from one account to another, then back again.Having said that, if you need additional cash to get through the lean months, and you didn't panic during the early stages of the pandemic, your 401(k) may well be your largest liquid asset right now, and a withdrawal might make perfect sense. There are three things to keep in mind:

• Pre-pandemic, your employer may have, but was not required to, allow you to withdraw up to 50% of your 401(k) balance, up to $50,000 as a "loan."
• Under the CARES Act, your employer may have, but was not required to, allow you to withdraw up to 100% of your 401(k) balance, up to $100,000 as a "loan."
• Under the CARES Act, you can make a penalty-free distribution of up to $100,000 from your 401(k). The withdrawal is taxable as ordinary income, by your choice either in the year of withdrawal or split equally over the year of withdrawal and the following two years. You can also return the funds to your 401(k) and file (an) amended return(s) for the year(s) you paid taxes on the distributions. Repayments must be completed within 3 years of the date of the distribution.

There are two key issues here: your employer's elections before and after the passage of the CARES Act, and your decision whether to take a "loan" or a distribution. If your employer restricts or forbids the size of 401(k) loans, your only option might be a distribution. But even if a loan is available, you might still prefer to make a distribution instead, for the simple reason that the CARES Act did not ease the regulations on the repayment of outstanding "loans" at employee separation. If you elect to take a "loan" instead of a withdrawal, then lose your job, you'll usually have to repay the loan by the next year's tax deadline or pay taxes and early withdrawal penalties.In other words, a distribution gives you the option, but not the duty, to redeposit the withdrawn funds and file amended tax returns to reduce your reported income, while a loan obliges you to return the tax-free withdrawal or face both taxes and penalties. In our particularly late stage of capitalist degeneration, my strong suspicion is that savvy tax preparers will ultimately find a way to "recharacterize" loans as hardship distributions for tax purposes after employee separation, but remember that savvy tax preparers aren't cheap either.

Penalty-free repayable IRA distributions

Here the situation is much the same as above, although simpler: you can make a taxable, penalty-free distribution of up to $100,000 from a traditional IRA (Roth IRA distributions are always tax-free, although the penalty on early withdrawal of earnings is also waived on those). The same 3-year repayment rule applies as well: you can file amended tax returns after repaying your withdrawal and receive a refund of any taxes you paid on your early distributions.The question of whether it's better to withdraw from your 401(k) or your IRA has to start with the question of how much money you need. If you need all the money in all your accounts, then you hardly have a choice. But if your investments are spread across 401(k) accounts and IRA accounts, and are more than enough to meet your needs during the lean months, the first place to look, as always, is at your investment options. Your 401(k) offers investments selected by your employer (or their delegate), and probably has higher fees and fewer options than your IRA. On the other hand, in rare cases your 401(k) might give you access to otherwise-closed investment vehicles you won't have access to elsewhere.

SNAP, LIHEAP, and Medicaid

Finally we can jog through the main assistance programs still available to ordinary people after the "welfare reform" of the 1990's:

• the Supplemental Nutritional Assistance Program offers a debit-card-style benefit that can be used for cold and packaged food at most grocery and convenience stores. During the crisis, benefits have been maximized for all recipients regardless of income (although they still depend on family size), and the program's onerous work requirements have been suspended. This is the last "cash-like" benefit still available in the United States, and you should apply for it as soon as you lose work, since benefits are retroactive only to your date of application, not your date of separation.
• the Low Income Heating Energy Assistance Program is a benefit administered in most states (at least most states where it gets cold enough to need heating) through a partnership with utilities. Beneficiaries receive an energy credit towards their bills, plus in some states a subsidized price for electricity, gas, or heating oil. Importantly, all SNAP recipients are "categorically" eligible for LIHEAP, so it's best to apply for LIHEAP after establishing eligibility for SNAP to minimize your paperwork requirements.
• Medicaid is the no-premium, no-deductible, no-copay health insurance program that paid for 43% of American births in 2018. It's the ideal model for American health insurance. You may have straggled through a few months of COBRA coverage, trying to figure out whether to pay your premiums or finagle retroactive coverage. Forget it. Enroll in Medicaid. You're gonna like the way you're covered.

Conclusion

It's not good, folks. The nation's energies and resources are being squandered while hundreds of thousands die and tens of millions suffer needlessly. Those responsible will never be held accountable, and their victims will never be made whole. If grieving were enough, the crisis would have been over months ago. But we also have to act. These are the lean months.Become a Patron!