Stop Responding To Short Term Incentives

The Number 1 rule of economics is that people respond to incentives.  The problem is that short term incentives are MUCH clearer than long term incentives. I am challenging myself to stop responding to short term incentives to the degree that I have been.

Obamacare Incentives:

For several years I ensured that our total yearly Adjusted Gross income was 199% of the federal poverty level, qualifying us for the lowest cost ACA plans. This is because households under this percent receive a larger tax credit, deductible cost sharing, and other benefits.  At 200% they fall off a cliff and the deductible goes way up as do the monthly premium costs. Being under 200% of FPL also limits the amount you have to payback if you underestimate your income at the start of the year.

I got under 200% of FPL by putting all of our retirement savings into traditional 401K and IRA accounts. By maximizing these accounts I reduced our taxable income, which reduced out ACA costs substantially. However, I was responding to short term incentives.  Over the long term Roth accounts are better than traditional accounts.  Why?

  1. With Roth accounts you pay taxes now and don’t in the future.  While tax rates are at historic lows it makes more sense to pay taxes on the money now before tax rates increase AND before my assets appreciate.  $10K invested today should grow to $200,000.  I’m paying 12% federal tax now, in the future I wouldn’t doubt that tax rates could double.  Paying 12% on $10,000 is a much better move than paying 25% on $200,000 for tax efficiency.
  2. The SECURE act killed the stretch IRA.  The stretch IRA was a great generational wealth building tool.  Now it is dead.  The Roth IRA can be passed on to heirs with no taxes owed.
  3. Roth accounts are not subject to RMDs (required minimum distributions).
  4. Roth contributions can be withdrawn tax and penalty free at any time.

Getting my income to <200% of FPL also allowed politicians like Joe Biden to refer to me as poor and gives them fodder for their big spending plans. I am now putting all of my retirement money into Roth accounts.

For next year one of my goals on my income planning spreadsheet was to end up below 400% of AGI, so that I still qualify for ACA plan subsidies.  This would be <142K Getting above 142K will be a stretch since I’ve never earned over 100K, however there is a potential path to around 160K.  I was looking at how to reduce my income by about 20K, in order to save 6K on my health insurance.  How does that make sense? My oldest kid will also earn over $12,550, so all of his income will count towards this 400% of FPL threshold as well. It doesn’t make sense for me to respond to this short term incentive anymore.

Tax Returns:

If my children earn over $12,550 they have to file a tax return and doing so would trigger their income to count against total household income for ACA qualifications.  IE, if Kid 1 earns $12,551 all $12,551 counts as household income, if Kid 1 earns $12,549 NONE of it counts as household income. IF I am comfortably able to pay the full sticker price for our health insurance at 400%+ of FPL, then it doesn’t matter if my kid(s) have to file tax returns.

What’s more important?  Me saving a few hundred a month on health insurance costs, or being able to have each kid put more money into Roth accounts with over half a century to compound? I think the math is fairly clear. If I have the ability for them to earn over $12,551 in our business then we should absolutely do it.

Tax Brackets:

Tax brackets go hand in hand with the ACA issues. Our tax brackets follow a graduated rate, so the more you earn, the more the IRS takes.  For years I wanted to stay in the 15% or 12% tax bracket, however once again, why would I purposefully make less money to not pay taxes?  The next bracket is the 22% tax bracket.  Even with all payroll and state income taxes, I still keep 65% of each marginal dollar.  Furthermore at $147K Social Security taxes phase out. Limiting income due to taxes may make sense in higher brackets and higher income tax states, but not in my case.

Unemployment:

To qualify for unemployment benefits I can’t run a business, that would make me self employed.  The industry I am in has frequent layoffs and filing for unemployment benefits is part of the deal.  (Unemployment benefits, (excluding the $300 federal bonus) are typically paid 100% by the employer).  Anyways if I run a business I can’t qualify for unemployment.  Court cases have shown that owning investment real estate is not running a business, so I’m clear there.  The Amazon FBA selling is completely done under Mrs. C., who runs that business and I occasionally volunteer my time for research because I enjoy researching financial stuff, but I am not part of the business.  I feel like I am running a tight rope on this. I file through Connecticut for unemployment benefits (one of my employers is based in CT), and they require you to apply for 3 jobs per week, you also can not turn down work in most circumstances.  Given the current labor market I would be hard pressed to not be offered a job. I have decided to stop filing unemployment claims to give myself more personal freedom and less stress.

W2 Jobs:

W2 jobs are perhaps the highest degree of short term incentives. Think about it, the vast majority of people working W2 jobs are trading their time for money, and they spend 90%+ of the money they receive on a monthly basis.   W2 income is also the highest taxed income!  For rental real estate we aren’t taxed on capital gains unless we sell, we can borrow tax free against this increase in value, and rental income receives the 20% QBI deduction and doesn’t count as Self Employment Income.  Spending more time working on building our real estate empire vs. working W2 jobs is the ultimate shift from short term incentives to long term incentives.  For 2022 I have approximately 1,500 hours of work lined up, then I will drop to 600 hours for 2023 and 2024.  Thankfully Mrs. C. quit her job in 2019 and it was one of the best decisions we ever made.

Calories Per Dollar:

When making food decisions at restaurants and at the grocery store I am ALWAYS calculating calories per dollar.  I started doing this out of necessity early in our journey and the practice has become subconscious.  This was necessary when I was making $15,000 a year and had no net worth, but now my long term health needs to be a higher concern.  Calories per dollar thinking is a scarcity mindset and its about the immediate effects of the food.  It leads to consuming too many calories, and the wrong calories at that.   It’s now almost a joke in my house and Mrs. C. tells me I can’t calculate food in calories per dollar anymore.

I am now about 25 pounds heavier than I should be, with most of the gain being the last 18 months.  My cholesterol is high and I am borderline pre-diabetic.  I need to shift my thinking from calories per dollar to long term health on my food choices.  As difficult as it will be, I need to stop ordering the double burgers and large fries and go for the grilled chicken, even if it’s a couple bucks more for 500 less calories.

What short term incentives do you find yourself responding to and planning your life around vs long term incentives?  

John C. started Action Economics in 2013 as a way to gain more knowledge on personal financial planning and to share that knowledge with others. Action Economics focuses on paying off the house, reducing taxes, and building wealth. John is the author of the book For My Children's Children: A Practical Guide For Building Generational Wealth.

Leave a Reply

Your email address will not be published. Required fields are marked *