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 and you should too.

Obamacare:

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.

I did this by putting all of our retirement savings into traditional 401K and IRA accounts, responding to this short term incentive.  Looking at life from a long term lense this was not the right move to make.  Roth’s are better because:

In retirement I will be filling my low tax brackets up with rental income, this is the 0% and 12% tax bracket.  Since I’m not shifting taxes from a high bracket now to a low bracket in retirement, the traditional accounts lose value.

Future tax rates are uncertain. With a Roth I can lock in 0% in the future, whereas with a govenrment that consistently prints money and spends more than it brings in, it is likely future tax rates will be higher.

It’s better to pay 25% taxes on a low amount now than 25%, 50%, or even 10% of a larger amount in the future.  Say I contribute $10,000 total this year.  It should double about every 7 years, so in 30 years it will have doubled 4 times.  $10,000 to $20,000, $20,000 to $40,000, $40,000 to $80,000 and $80,000 to $160,000.  Even being taxed at the same percentage I would pay $40,000 in taxes rather than $2,500 in taxes going with a traditional account over a Roth.

With recent congressional changes traditional accounts fare poorly when inherited.  The beneficiary must withdrawal all of the money over a 10 year period. If my heirs receive $2 million from me, that’s $200,000 per year (with no growth, so likely closer to $300,000 per year that needs taken out).  This will push them into a high tax bracket.  With a Roth account they still have to take the money out, but no taxes are owed.

So bottom line: Roth is better long term.

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 would be a stretch. however there is a clear path to 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.

Contributing the max to traditional accounts and reducing my income to save $6,000 on health insurance is a short term move if I ever saw one.

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. This is a short term incentive to benefit another short term incentive!

If they run their own business then they can only earn $400 before having to file a tax return.  I’ve been purposefully engineering their earnings so that they will not have to file a tax return.

What’s more important?  Me saving $500 a month on health insurance costs, or being able to have each kid put an additional $6000+ PER YEAR into Roth accounts? I think the math is fairly clear. We aren’t yet at a point where we can do this, but it will come.

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.

With unemployment you also have to apply for a certain number of jobs per week. For the state of CT, where I file, it’s 3 jobs per week.  This used to not be an issue. I would apply to high level jobs that I’m right on the bubble of being qualified for and if I got accepted, great, I would make a ton more money, if not, that’s OK too, I collect my unemployment benefits and go back to my contract jobs.  With our labor market the way it is now, and my primary focus being on reducing work hours, not increasing them, this doesn’t work.  I would likely be offered jobs that I don’t want to take, so I am no longer filing for unemployment.  Yeah, it was nice to make almost $700 a week to apply for 3 jobs, but long term it doesn’t make sense.

In addition to not being able to run a business and having to accept job offers that I may not want, there is also the threat of fines, fee, and administrative nightmare if they suspect you are in the wrong.  Several years ago this happened with me with Michigan unemployment. I had filed for a federal extension (back in maybe 2010 when that was a thing) and was getting around $200 a week for about 3 weeks then went back to work.  They determined I should have filed a claim in Virginia rather than the federal extension because I had worked for a Virginian employer for 2 weeks. It ended up being a massive paperwork nightmare over $600.  Not getting unemployment benefits reduces stress and risk.

Calories Per Dollar:

I always calculate food costs on calories per dollar, whether eating out or buying groceries.  This maximizes short term benefit, but creates a long term problem.  When we had little money early on this was fairly necessary, but now, not so much.  A focus on calories per dollar, that has become subconscious, has contributed to me gaining 25 pounds, having high cholesterol, and being borderline pre-diabetic.

In the short term, I “save” $2 when Whoppers are buy 1 get 1 free, but In the long run I gain weight and overall reduce my long term health. Fighting this instinct to see the healthier food with fewer calories for a dollar more as “a bad deal” is a change in incentives that I need to make.

A Salary:

W2 income is perhaps the greatest short term incentive in the world.  You trade over half your waking hours to a company in exchange for a small pile of cash on a weekly basis.  You can work there for 40 years and the day you stop working is the day you stop making money. W2 income is the highest taxed income, and the day you stop working you stop getting paid.  For 2021 W2 income was roughly 50% of our households total income.  I recently turned down a six figure job that would require 3 times the hours and 3 times the days of work that I have been doing.  The main reason to focus on my rental business and to minimize my total number of work days.

What short term incentives are you responding to? What action will you take to move towards long term incentives?