I firmly believe tax policy changes behavior. The higher your taxes go, the BETTER your life becomes! Why? Because at the margin, the less money you keep, the less motivated you’ll be to work. Since the love of money is the root of all evil, the less time you spend chasing money, the happier you will be.
One of my catalysts for leaving work in 2012 was because the finance industry was in a structural decline. We were working longer hours for less pay. At the same time, we faced a progressive tax system where we had to pay a 39.6% Federal tax rate plus a 3.8% Net Investment Income tax plus a 0.9% Medicare tax plus an Alternative Minimum tax plus a 13% State tax plus Social Security tax plus Sales tax plus retroactive State taxes to pay for government overspending. Instead of complaining about paying a 60%+ marginal tax rate, I just negotiated a severance to make no money as a writer.
My life since leaving work has never been better, all because I decided to focus on maximizing freedom instead of maximizing net worth. When you’re in the grind, it’s hard to fathom the benefits of giving up a steady paycheck. But the benefits truly are incredible.
For those of you who naturally like to work more when you can keep more of your money, here are three items from the new tax plan that will ruin your life or your family if you are not careful.
Surprise Items In The Tax Plan That May Ruin Your Life
1) Your 529 plan can now be used for private secondary education. Before, you could only use the proceeds of your 529 plan for tuition at an accredited four-year university. Under the new tax plan, you can now use $10,000 a year towards private grade school tuition.
I’m one of many parents who is still undecided about the wisdom of spending a fortune on private school instead of just having my son go the public school route. With the internet making education and meet-ups free, the value of a private school education has declined. Therefore, it makes little sense to spend record high levels on tuition just because you can afford to.
Once you start spending $10,000 – $60,000 a year on private grade school education, expectations for your kids go way up. When your expectations go way up, a pressure cooker environment may develop that suffocates the joy out of everyone. If your kid is especially sensitive to the plight of others, by going to such an expensive institution, he or she may feel tremendous guilt or pressure to perform. As a consequence, they might logically choose to work in a soul-sucking industry that’s focused on making as much money as possible to pay you back or provide the highest ROI, instead of choosing an industry that’s focused on helping those most in need.
The new usage rules for the 529 plan may tip the scale in favor of sending your child to a private grade school. It’s one of those 20% off coupons that can end up costing you a fortune. What the new tax plan should have done was provide a deduction if you send your child to public school instead. The more parents focus on the public school system, the stronger it will become given there will be more involvement and more funding.
Doesn’t having your child learn the same material at public school, while saving $300,000 – $500,000 in private grade school fees and avoiding the stress of high expectations, sound wonderful? Not if the new 529 plan rules can help it.
2) Miserable high income earners in expensive cities become even more miserable. I know I’ve done a poor job of highlighting the plight of HENRYs (high earners, not rich yet) living in expensive cities like San Francisco or New York, but that doesn’t change the fact that so many of these well-educated, 50+ hour a week, highly taxed, stressed out of their mind individuals are miserable. They see no end in sight to their grind because they don’t build passive income and don’t work on a side business to give them an eventual escape outlet.
By capping state income and propery tax deductions at $10,000, residents living in high state tax and high property price cities are getting an uppercut to the chin. The annual property tax bill for a $1.5M median priced home in San Francisco is ~$19,300 a year. Add on $16,000 a year in average state and local income taxes paid, and you’re at $35,300. Your tax bill could easily be $5,000 more as a result.
Meanwhile the capping of mortgage interest deduction on a new mortgage amount of $750,000 means about $10,000 less in mortgage interest deductions in the first year of amortization. You can now add on another $2,000 to your tax bill.
One of the reasons why I sold my rental house, which I’d owned since 2005, is because of its onerous $23,000 annual property tax liability. Yes, it can still be deducted as an expense for landlords, but the new deduction limit for new homes will have a negative knock on effect on property values. I anticipated some type of detrimental tax law to pass given San Francisco is a sanctuary city in a blue state. But I just expected some type of reduction in the mortgage interest tax deductibility. To add the $10,000 SALT cap is a huge negative surprise. Further, the $10,000 cap is for married couples, while two singles get $10,000 each.
This new tax law may be the tipping point that causes a consistent net migration out of expensive coastal cities and into no state tax states or states that have a much lower cost of living. Coastal cities have turned into one big grind. Traffic is horrendous. Home prices are unaffordable. The cities are turning economically homogeneous. Even moving to the western part of San Francisco has not allowed me to escape the tentacles of the tech industry. My only next step is to move to Hawaii and deploying my BURL real estate strategy of investing in the heartland.
Related: Scraping By On $500,000 A Year
3) Estate tax threshold rises to $11 million for individuals and $22 million for couples. The easiest lifetime net worth target to shoot for is the estate tax threshold because nobody in their right mind would keep anymore due to the 40% death tax. When it was $5.49M per individual, it provided a high enough goal for most people to shoot for without feeling too discouraged that it was an impossible dream. While most people never accumulate $5.49M, they do get to a level where they can comfortably leave all their assets to their heirs tax free.
Now imagine you are one of those people who believes they’ll reach that $5.49M threshold before the age of 100 thanks to inflation, investment returns, diligent savings, and good financial planning. You are on cruise control gliding towards your goal of leaving a significant tax free estate to your heirs. Now, suddenly, you’ve been incentivized to figure out a way to work longer, harder, and take more investment risk to save $2.2 million in estate taxes ($5.51M X 40%) and get to the $11M target.
Of course any reasonably motivated person can’t help but gravitate towards killing themselves for more money. Further, there’s a good chance the estate tax threshold might change again in the future, thereby wasting all your time trying to get to a $11M net worth!
What many of you will now logically do is input some figures in a compound interest calculator and see what it will take to get to $11 million. Below is a realistic assumption I’ve provided where your $100,000 grows to $11,467,826 in 50 years if you earn a 6.5% annual rate of return and save $25,000 a year. Time to get to work, forever!
BONUS: The higher AMT threshold makes you no longer satisfied with making top 5% money. $200,000 is the ideal amount for maximum happiness for an individual because it’s not subject to as many deduction phaseouts and the AMT. In 2015, more than 10.3 million households had to calculate their AMT liability. The effective tax rate on $200,000 is also reasonable at ~20%.
Now that the income phaseout threshold for the AMT has risen from $120,700 / $160,900 for singles / couples to $500,000 / $1,000,000 until December 31, 2025, it’s only natural to try and make up to these limits. And generally, to make $500,000 / $1,000,000, you’ll either have to move to a big, expensive, congested city or work 80+ hours a week for at least five years building a business to give yourself a chance.
The Only People Who Won’t Be Miserable
The only people who won’t be miserable under the new tax plan are those who are already rich. These are the people who are getting the most money back for just existing, even though they need the money the least.
As a result, the tax plan will make millions of regular income earners miserable due to the envy they have for those who already have the most. Even though the tax plan provides tax savings to the middle class and lower middle class, it doesn’t feel right when some others get so much more.
I feel sorry for those people who decide they are now going to ruin their lives to earn more money they don’t need due to lower taxes. I wish everybody does start earning $500K per year and accumulates $11M per person in assets just to see that money doesn’t improve happiness. Once you earn enough money to comfortably provide for your family (~$100K a year in non-coastal cities, ~$250K a year in coastal cities), happiness is dictated more by health, family, and friends.
Beware of the endless grind.
Readers, do you forecast your behavior changing under the new tax plan? Are you more motivated than ever to chance money that doesn’t do anything for your well-being? What are some other surprises in the new tax plan that may affect behavior? Subscribe to the FS iTunes channel to listen on your mobile device on your way to the grind!