Financial Tip #7: Convert Traditional Retirement Assets to Roth Assets when Marginal Tax Rates are Low

Often people leaving the workforce raid their retirement plans to fund current consumption.  A departure from the workforce creates an opportunity for people to convert traditional retirement assets to Roth assets at low cost.  The low-cost conversion to Roth assets can substantially improve financial outcomes in retirement. Households are only able to make this low-cost conversion if they have a decent ratio of liquid assets to debts.


  • A previous post, Financial Tip #5, found that people leaving a firm with a high-cost 401(k) plan should roll over funds from the high-cost 401(K) to a low-cost IRA to increase wealth at retirement.   The rollover is often a prerequisite to converting traditional 401(k) assets to a Roth.
  • The tax code allows for the conversion of traditional IRAs to Roth IRAs. Distributions from a Roth account in retirement are not taxed and do not count towards the amount of Social Security subject to tax. The person converting previously untaxed funds in an IRA pays income tax on the converted funds in the year of a conversion.   The cost of converting traditional assets to Roth assets, the additional tax paid stemming from the conversion, is low when households have marginal tax rates.   
  • Marginal tax rates are lowest when a worker or a spouse leaves the workforce.  This can happen when a person returns to school, decides to care for a family member, becomes unemployed or retires.  
    • Conversion costs are $0 if AGI including the amount converted is less than the standard deduction ($12,950 for a single filer).
    • Conversion costs for single people filing an individual return are 10 percent of taxable income AGI minus the standard deduction for taxable income between $0s and $14,200.  Increases in taxable income up to $54,200 increase conversion costs by 12 percent, the marginal tax rate.
  • The potential gains from converting traditional retirement assets to Roth assets early in a career perhaps when returning to school are tremendous.   
  • A person leaving the workforce for school for a couple of years at around age 28 might convert $20,000 from a traditional IRA to a Roth at a cost of around $2,000.
  • The balance of the Roth account from this conversion after 30 years assuming a 6.0 percent return is $114,870. 
  • The direct tax savings from the conversion assuming a tax rate of 10 percent would be $11,487.  An indirect tax savings from the omission of tax on Social Security, assuming around $50,000 in Social Security payments spread over a couple of years, would be around another $5,000.  The conversion can be thought of as an investment of $2,000 leading to a return of around $16,000 in around 30 years.  The rate of return for an investment of $2,000 and a return of $16,000 in around 30 years is around 7.2%.
  • A person in a low tax bracket because she is young and single and returning to school and only working for the part of the year could be in a much higher tax bracket in retirement, especially if married and both spouses worked and claimed Social Security.  In many cases, the returns from converting a traditional IRA to a Roth will be much higher than the one reported by the simple example in the above bullet. A person living 100 percent on Roth distributions and Social Security could easily pay $0 in annual tax after accounting for the standard deduction.
  • A person returning to school full time with no reported earnings could convert an amount equal to the standard deduction to a Roth and pay no additional tax.  It would be irrational for a person with a 0 percent marginal tax rate to fail to make a conversion.
  • Workers leaving the workforce are often more concerned about meeting immediate needs than for planning for retirement.  However, conversion costs are small during a year a person leaves the workforce.
  • Workers leaving the workforce with debt or with 401(k) loans often distribute funds from their 401(k) plan, pay a penalty and tax, and are unable to rollover or convert funds to a Roth.
  • The five-year rule imposes tax and penalty on funds disbursed from a Roth IRA funded through a conversion from a traditional IRA within five years from January 1 of the year of the conversion.  A separate five-year waiting period is applied to each conversion.     The five-year rule applies for conversions after age 59 ½ even though all funds in Roth accounts funded by contributions can be withdrawn without penalty and tax at that age.  The purpose of the five-year rule for conversions and its implementation even after age 59 ½ is to prevent immediate access to funds in a traditional retirement account.  The five-year rule for conversions appears to apply to disbursements from both contributions and earnings for both pre-tax and after-tax IRAs. 

Concluding Remarks:   The cost of converting a traditional IRA to a Roth IRA, the additional tax paid on the amount of the conversion, is generally low in years where a person leaves the workforce.  The potential tax savings in retirement is considerable.

Several additional posts on IRA conversions are planned.  One post considers issues related to conversions of non-deductible IRAs in a procedure called a backdoor IRA.  A second post considers the advantages of converting pre-tax IRAs during retirement.

Financial Tip 6: Invest in Series I Savings Bonds Whenever Possible

Tip #6: Series I Savings Bonds should be included in every investor’s portfolio.  This asset purchased directly from the U.S. Treasury without fees is an effective hedge against inflation and higher interest rates.

Characteristics and rules governing Series I bonds:   The Series I bond, an accrual bond issued by the U.S. Treasury tied to inflation, is described here.  

Key Features of Series I Bonds:

  • Backed by the full faith of the U.S. Treasury
  • Cannot be redeemed until one year after issue.
  • Redemptions prior to five years from issue date forfeiture of one quarter of interest.
  • The composite interest rate changes every six months,
  • The interest rate is based on two components – a fixed rate and the inflation rate.   
  • The composite rate is guaranteed to not fall below zero.
  • The interest is taxed when the bond is redeemed.
  • Bond matures and stops paying interest after 30 years.
  • The Treasury limits annual purchases of the bonds to $15,000 per person with a limit of $10,000 on electronic purchases and $5,000 on paper purchases.  The paper Series I bonds can only be purchased through refunds from the IRS.

Reasons for Purchasing Series I Bonds:

  • Series I Bonds, unlike traditional bonds and bond ETFs, do not fall in value.
  • In the current low-interest rate high valuation environment, traditional bonds and stock prices are almost certain to decline in value.  
  • A retired person with I-Bonds outside of a 401(k) plan can respond to a market downturn by using proceeds from the redemption of I-bonds to fund current consumption rather than disburse funds from a 401(k) plan, which could be temporarily down in value.
  • The Series I Bond is a riskless asset.  Investors with this asset can reduce holdings of traditional bonds and cash and increase investments in equities.

Difference Between Series I Bonds and TIPS:

Treasury Inflation Protection Securities (TIPS also allow investors to protect returns when inflation and interest rates rise.

Key differences between TIPS and a Series I bond as explained here:

  • The TIPS value can fall in an era of deflation.  The Series I bond never falls in value.
  • The tax on interest from TIPS is paid annually and not deferred to redemption
  • TIPS bonds can be sold without forfeiture of any interest at any time.  The redemption of a Series I bond is not allowed until after a year from the purchase date and sales prior to five years from the purchase date involve a forfeiture of a 3 months of interest.  
  • All TIPS can be counted as a liquid asset.   Only Series I older than 5 years from issue should be considered liquid.
  • Up to $5.0 million in TIPS can be purchased in a single auction.  The annual limit on the purchase of Series I Bonds is $15,000.

Thoughts on Series I interest rates:

  • The current fixed interest rate on a Series I Bond is 0 percent.  The current composite fixed + inflation component on bonds purchased prior to May 2022 is 7.12%.  A delay in the purchase of a Series I bond until the second half of the year could result in a permanently higher fixed rate.  However, investors would lose an annualized return of 7.12% accruing in May. 
  • Bonds purchased years ago in a high interest rate environment have a higher current composite rate because the fixed component is higher.  People are currently aware of I-Bonds because of the elevated inflation rate.  The purchase of I-bonds also makes sense when inflation is low and interest rates are high because the investor will obtain both a higher fixed rate and increases in interest when inflation returns.

Concluding Thoughts:  Investors should purchase a Series I bond every year.  Investors who maximize receipt of the employer matching contributions to a 401(k) plan can then divert additional investments to a Roth IRA or a Series I Bond.  People without a 401(k) plan that allows matching contributions should contribute to a Roth, invest Roth contributions in equities, and divert some funds to the purchase of Series I bonds.

Financial Tip 5: Rollover 401(k) assets to IRAs.

Tip #5: An employee leaving a firm can substantially increase retirement wealth by moving401(k) funds to an IRA.   Be careful though!  Protections against creditors are stronger for 401(k) plans than for IRAs in many states.

Examples of potential gain from rolling over assets in a high-cost 401(K) to a low-cost IRA

Example One:  A worker leaving her firm at age 50 can keep $500,000 in 401(k) funds in the firm-sponsored retirement plan that charges an annual fee of 1.3% or can move the funds to a low-cost IRA that charges an annual fee of 0.3%.   The return on assets prior to fees in both the 401(k) plan and the IRA is 6.0 percent per year.  

What is the value of the account at age if assets remain in the high-cost 401(k) and if assets are rolled over into the low-cost IRA?

  • Account value of high-fee 401(k) plan is $995,796.
  • Account value of low-cost IRA is $1,148,404.
  • Gain from rollover is $152,609.

Example Two: A worker changing jobs at age 30 can keep $20,000 in the firm 401(k) or move the funds to a low-cost IRA.  The annual fee for the 401(k) is 1.3 %, the annual fee for the IRA is 0.3%. The underlying returns prior to fees for both assets in the 401(k) and assets in the IRA is 8.0%.  

What is the value of the account at age 60 if the person keeps assets in the high-cost 401(k) or moves funds to a low-cost IRA?

  • Account value of high-cost 401(k) plan is $139,947.
  • Account value of low-cost IRA is $185,140.
  • Gain from rollover is $45,194.

Note: The impact of financial fees on the future value of the account can be calculated with the FV function in Excel.  The arguments of the FV function are the rate of return after fees, holding period in years, and the initial balance in the 401(k) plan.   

 Additional Comments:

  • Most roll overs from 401(k) plans to IRAs occur when a worker leaves a firm for another employer.  Some firms allow for some in-service rollovers.  
  • Some workers, in need of cash routinely, disburse funds from their 401(k) plan.  The disbursement of funds from a traditional 401(k) plan prior to age 59 ½ can lead to penalties or tax.   A roll over of funds from a 401(k) plan does not lead to additional tax or any financial penalties.
  • One motive for moving funds from a 401(k) plan to an IRA is the desire to place funds in a Roth account when a firm only offers a traditional retirement plan.   The act of rolling over funds from a 401(k) to an IRA and the act of converting the new conventional IRA to a Roth IRA are separate and do not have to occur together.  Conversion costs are lowest when a worker has low marginal tax rate.  Several future posts will examine the costs and benefits on converting traditional retirement accounts to Roth accounts.
  • The federal bankruptcy code protects both 401(k) plans and IRAs. However, 401(k) plans offer stronger protection against creditors than IRAs outside of bankruptcy.  Whether IRAs are protected from creditors is determined by state law.  ERISA, a national law, provides protection against creditors for 401(k) plans.  This difference can persuade some people to keep funds in a 401(k) plan, rather than covert funds to an IRA.  Go here for a state-by-state analysis of protections against creditors for owners of IRAs.
  • The calculations, presented above, of greater wealth from the rollover assumes identical pre-tax returns for the high-cost 401(k) plan and the low-cost IRA.  Most financial experts believe that low-cost passively managed funds tend to outperform high-cost funds.  Interestingly, Warren Buffet, probably the best active investor of all times suggests passive investing in low-cost funds is generally the better approach.
  • Factors other than transaction costs can impact the decision to rollover 401(k) funds or stay.   Some 401(k) plans allow investors to purchase an annuity at retirement.  The existence of automatic enrollment from a 401(k) plan to an annuity could induce some workers to keep funds in a 401(k) rather than roll over funds into an IRA.

Financial Tip #3: New Entrants to the Workforce Must Prioritize Debt Reduction over Saving for Retirement

Tip #3: New entrants to the workforce, facing unprecedented levels of student debt, should prioritize debt reduction over saving for retirement.

Most students with substantial student debt should reduce or forego retirement savings until their debt levels become manageable.  Students entering the workforce with substantial debt could reasonably forego saving for retirement for the first three years of their career. Potential advantages of pursuing a debt reduction strategy and the creation of an emergency fund over saving for retirement include:

  • Reduced lifetime student loan interest payments
  • Improved credit rating and reduced lifetime borrowing costs
  • Reduced likelihood of raiding retirement plan and incurring penalties and tax
  • Increased house equity and reduced stress associated with debt

Discussion of advantages of rapid student loan reduction at the expense of saving for retirement:

  • The decision to initially forego saving for retirement and earmark all available funds towards repayment of student debt leads to a substantial reduction in lifetime payments on student debt.  Two examples of the magnitude of the reduction in lifetime student loan payments are presented below.
  • A student borrower starting her career with $30,000 in undergraduate loans could take out a 20-year student loan leading to a monthly payment of $198.82 and lifetime loan payments of $47,716.   Alternatively, this student borrower could forego contributions to her 401(k) plan, increase student loan payments by $565.4 per month and pay off her student loan in 61 months.   The new total student loan repayments are $33,837, a total savings of $13,879. 
  • A second borrower with three student loans — a $35,000 undergraduate loan at 5.05%, a $40,000 graduate loan at 6.66% and a $25,000 private student loan at 10.00% — choosing the standard 20-year maturity on all loans has a monthly payment of $775 and realizes total lifetime payments of $200,633. The modification of the private loan to a five-year term initially increases the monthly student loan to $1,065.  The total lifetime student loan debt payments for the person who repaid her private student loan in 5 years instead of 20 years and earmarks the reduced loan payment to further loan reduction is $146,271.  This is a total lifetime savings of $54,362. 
  • The student borrower who rapidly reduces or eliminates all student debt can increase savings for retirement once the monthly student debt payment falls or is eliminated. Furthermore, the rapid elimination of the high-interest-rate private student loan could facilitate refinancing of the remaining student debt at favorable terms.
  • The failure to maintain a good credit rating will lead to higher borrowing costs on all consumer loans and on mortgages in addition to higher lifetime student loan payments.  
  • Assumptions on the impact of credit quality on interest rates were obtained for credit cards from WalletHub, for car loans from  Nerd Wallet, for private student loans from Investopedia, and for mortgages from CNBC.  The differential between interest rates on people with good and bad were 9.8 points for credit card debt, 7.0 points car loans, 10.0 points for private student loans, and 1.6 points for mortgage debt.  The monthly cost of bad credit depends on the interest rate differential, the likely loan amount, and the maturity of the loan. The analysis presented here assumes a likely loan balance of $10,000 for credit cards, $15,000 for a car loan, $20,000 for a private student loan, and $300,000 for a mortgage.  The analysis also assumes the borrower only paid interest on credit card debt and loan maturities were 60 months for car loans, 240 months for private student loans, and 360 months for mortgages.  Based on these assumptions, the monthly cost of bad credit was $82 for credit cards, $49 for car loans, $124 for private student loans, and $277 for mortgages.
  • A person who fails to eliminate debt could end up with higher borrowing costs for their entire lifetime.
  • Increasingly, young adults are tapping 401(k) funds prior to retirement to meet current needs.  Often individuals who raid their 401(k) plan prior to retirement incur additional income tax and financial penalties.  A CNBC article reveals that nearly 60 percent of young workers have taken funds out of their 401(k) plan. A study by the Employment Benefit Research Institute (EBRI) reveals that 40 percent of terminated participants elect to prematurely withdraw 15 percent of plan assets. A poll of the Boston Research Group found 22 percent of people leaving their job cashed out their 401(k) plan intending to spend the funds.  New entrants to the workforce who prioritize the reduction of student debt over saving for retirement will be less like to raid their retirement plan and incur tax and financial penalties. 
  • Note from Tip #3 that people using Roth IRAs or Roth 401(k) plans are less likely to pay penalties and taxes on disbursements on retirement savings because the initial contribution to a Roth can be disbursed without penalty or tax.  People with debt should start saving for retirement through relatively small contributions to Roth accounts rather than large contributions to traditional plans.
  • Many people who fail to prioritize debt payments struggle with debt burdens for a lifetime and fail to realize a secure financial future. A CNBC portrayal of the financial status of millennials found many adults near the age of 40 were highly leveraged struggling to pay down student debt, using innovative ways to obtain a down payment on a home and barely able to meet monthly mortgage payments.  A 2019 Congressional Research Service Report found the percent of elderly with debt rose from 38% in 1989 to 61% in 2021.   The Urban Institute reported the percent of people 65 and over with a mortgage rose from 21% in 1989 to 41% in 2019.  A 2017 report by the Consumer Finance Protection Board found that the number of seniors with student debt increased from 700,000 to 2.8 million over the decade.  Many of these problems and financial stresses could have been avoided if the student borrower entering the workforce had initially focused on debt reduction and the creation of an emergency fund rather than saving for retirement.

These problems will worsen if borrowers don’t start focusing on debt reduction over saving for retirement because many in the new cohort of borrowers are starting their careers with higher debt levels.

Concluding Thoughts:  Many financial advisors stress saving for retirement over debt reduction.  Fidelity, a leading investment firm, says young adults should attempt to have 401(k) wealth equal to their annual income at age 30.  Workers without debt and with adequate liquidity for job-related expenses can and should contribute.   Their returns will compound overtime and they will have a head start on retirement.

The Fidelity savings objective is unrealistic for most student borrowers with debt. The current cohort of people entering the workforce has more debt than any previous cohort.  Average student debt for college graduates in 2019 was 26 percent higher in 2019 than 2009.  The decision by a new worker with student debt to go full speed ahead on retirement savings instead of creating an emergency fund and rapidly retire student debt can and often does lead to disaster.  The young adult choosing retirement saving over debt reduction pays more on debt servicing, invariably falls behind on other bills, pays higher costs on all future loans, and often raids their retirement plan paying taxes and penalties.   

Financial Tip #2: Maximize Use of Roth Accounts

Tip number 2:  Most households use traditional retirement accounts instead of Roth accounts.  The Tax Policy Center reports around 23% of taxpayers have a traditional IRA compared to around 12% of taxpayers with a Roth IRA.  According to CNBC, in 2016 around 70 percent of firms offered a Roth 401(k), but only 18% of workers used the Roth 401(k) option.  

More people should choose a Roth retirement plan over a traditional one.  People should use Roth accounts in the following circumstances.

  • Workers at firms not offering a retirement plan with a marginal tax rate less than 25% should use a Roth IRA instead of a deductible IRA.
  • Workers at firms offering both a traditional and Roth 401(k) should choose the Roth 401(k) if their marginal tax rate is less than 25%.
  • Workers with marginal tax rates less than 25% at firms with 401(k) plans without employee matching contributions should select a Roth IRA or Roth 401(k) over a traditional 401(k) plan.
  • Workers who maximize receipt of employer matching contributions should place additional contributions in a Roth IRA.
  • Spouses of workers with family AGI below the contribution limit for Roth contributions should contribute to a Roth IRA, if eligible.


  • Gains from 401(k) contributions are relatively small when employers don’t provide a matching contribution and a worker’s marginal tax rate is low.  
  • Workers with Roth accounts are less likely to withdraw and spend all funds prior to retirement than workers with traditional accounts because they can access the amount contributed without penalty or tax prior to age 59 ½. 
  • The tax saving from Roth disbursements in retirement are high both because disbursements after age 59 ½ are not taxed and the Roth disbursement does not increase the amount of Social Security subject to tax.
  • Workers at a firm that do not match employee contributions, around 49 percent of employers, should contribute to a Roth IRA instead of a 401(k) plan unless the worker has a high marginal tax rate.
  • One effective contribution strategy is to take full advantage of the employer match and contribute all additional funds to a Roth IRA. Two common 401(k) matching formulas are 50 percent of the dollar amount contributed by the employee up to 6.0 percent of the employee’s salary and 100 percent of contributions up to 3 percent of the employee’s salary. 
  • Most new employees at firms with a vesting requirement, a rule delaying full ownership of 401(k) matches, should contribute to a Roth IRA instead of a 401(k) plan.
  • Stay-home spouses of workers with income should choose a Roth IRA over a traditional one if they are eligible. In 2021, a single filer with MAGI less than $140,000 and a married joint return filer with MAGI less than $206,000 cannot contribute to a Roth IRA.  Workers with income above these contribution limits should contribute to a Roth IRA.  Other workers should use a backdoor IRA.

Readers should remember to open their Roth IRA early in life as explained in financial tip number one.

Why Haley Will be the Next President

My views differ from the 2024 conventional wisdom of a close Biden/Trump rematch. Nikki Haley will get the Republican nomination and is in a strong position to win the general election by a comfortable margin.

Introduction:  Most pundits believe Trump has a lock on the Republican nomination and the general election will be close even though polls show that most Americans want new candidates.  My view is that Haley will get the Republican nomination and could comfortably prevail in the general election

The contest for the Republican Nomination:

Trump got the 2016 Republican nomination because the anyone-but-Trump field had too many options.  This time the Republican field is winnowing quickly and hopefully after New Hampshire there will only be one challenger to Trump.

Both Iowa and New Hampshire allow Democrats and Independents to participate in the primary or caucus of their choice.  Participation in the Republican contest by Democrats and Independents will cause Trump to underperform in these two states. 

The Trump lead in both states, especially New Hampshire, is narrowing quickly.

November 10-14 New Hampshire poll has Trump at 42 percent Haley at 20 percent, Haley at 20 percent, Christie at 14 percent, DeSantis at 9 percent and Ramaswamy at 8 percent. Haley will win New Hampshire because she will get virtually all of Christie’s voters once Christie drops out and will get substantial support from Democrats and Independents who choose to participate in the Republican contest.  

Once Haley wins New Hampshire it will become apparent that she is far more electable than Trump in swing states like New Hampshire.  She can already point to November 13, Emerson College polls which had Haley 6 points up and Trump 3 points down against Biden in New Hampshire.

The general election:

In a Trump-Biden rematch many people support Biden because they view Trump as an existential threat.  It will be impossible for Democrats to vilify Niki Haley because she is a fundamentally decent human being as shown here.

Biden is presiding over a reasonably strong economy, but people do not feel good about their economic situation or Biden’s achievements. Inflation has fallen but many prices including food remain high and as discussed here there is a difference between inflation and the cost of living.  Homeownership is unaffordable to young adults. Insurance premiums for state exchange health insurance and student debt payments on some student loans now increase with income leaving many people paying more when they work more.

I don’t believe economic issues will be determinative in 2024.  Democrats respond to fiscal stresses with more taxes.  Republicans respond to fiscal stresses with budget cuts. In reality both are now needed to respond to the growth in the debt to GDP ratio and shortfalls in entitlement programs.

Biden talks about his bipartisan achievements including the CHIPS act and infrastructure spending, but these spending initiatives don’t help most low and middle-income workers.  I fail to see the point in giving $52 billion to major corporations when new ACA premium subsidies are due to lapse. 

Foreign affairs may be more important than usual in this presidential election.  The withdrawal from Afghanistan did not go well, and Biden’s position on both Ukraine and Israel has critics on both sides.

In a Trump/Biden contest the mainstream voter who is concerned about the world and national security votes for Biden and the isolationist votes for Trump or RFK jr.

In a Haley/Biden contest, the mainstream voter who is concerned about the world and national security could choose Haley while the isolationist votes for RFK jr. or stays home. 

Biden has supported Ukraine but has not given Ukraine the weapons it needs

The Democrat party is bitterly divided over Biden’s approach to the Israel-Hamas conflict.  The press and some polls believe that the “progressive” base will stay home because of Biden’s support of Israel.  A more realistic fear is that moderate Democrats, me included, will find Haley’s approach to the conflict more realistic. 

It is hard to condemn Israel for attempting to eliminate Hamas given the October 7 massacre.  It is Hard to justify Biden and Obama’s outreach to Iran given Iran’s support of HamasHezbollah,  and the growth of Iran-backed militias in Iraq.

American Jews are politically homeless if Trump is the nominee.

 American Jews and others who support Israel have nothing in common with the part of the party that calls for an immediate cease fire which would leave Hamas in power.

Supporters of Israel have nothing in common with politicians who would have denied Israel funds for the Iron dome, a step that would have led to even more death in both Israel and Gaza.

Supporters of Israel have nothing in common with “progressive” protestors chanting “Free Palestine from the river to the sea” others in the party push for an interim two-state solution.

Haley is resolute both in her support of Ukraine and her support of Israel. Many Democrats and Independents will vote for Haley and move towards the Republican party if Haley is the nominee.    

Biden does have one tail-wind issue — abortion.  But Biden/Harris need to discuss the actual consequences of new abortion law in much more detail.  These consequences include:

Haley and moderates will not be able to mitigate the abortion issue by claiming they are against a national ban because these other issues significantly impede abortion rights. The abortion factor won’t save Biden if voters perceive he is not getting the job done but it may cause some voters to split their vote if it becomes apparent that Haley will win the White House. I will soon provide my first take of the contests for the House and Senate.

Authors Note: I hope interested readers will subscribe to Insightful Memos and others will read my papers on FinanceMemos.   LinkedIn members can subscribe to Insightful Memos. I usually write on economic topics like Social SecurityInflation, and Student Debt.  I am also seeking work as an economic, political and data consultant. Let me know of any opportunity by contacting me on LinkedIn

Evaluating 2024 Social Security Reform Proposals

Republicans and Democrats are extremely far apart on how to reform the Social Security system and Medicare. This post examines and evaluates various proposals.


  • Two candidates, Haley and Christy, support phased in increases in retirement age and other changes in benefits for younger workers
  • Three candidates, Trump, DeSantis, Ramaswamy, do not support immediate actions.
  • Proposals by Democrats involve substantial increase in taxes on Americans with relatively high income and include expansions in benefits.
  • Republican proposals would not prevent automatic benefit cuts that are projected to occur under current law.
  • Democrat proposals could lower economic growth, reduce fiscal discipline, and increase the dependence of the elderly on Social Security.
  • There is a need for a compromise proposal that adjusts both benefits and revenues combined with improvements and expansions of private savings for retirement targeted towards households struggling to save.


The October 2024 Presidential debate helped clarify where Republican candidates now stand on entitlements – Social Security and Medicare.

Two candidates, Haley and Christie favor a higher retirement age for young adults now entering the workforce and for means testing Social Security benefits.  Haley also called for adjusting the rules governing the Social Security cost of living adjustments.

Haley supports increased use of Medicare Advantage plans to address imbalances with the Medicare Trust fund.

Trump, DeSantis, Scott, and Ramaswamy all appear to oppose reductions in Social Security benefits.

Ron DeSantis has said on the campaign trail that he would not mess with entitlements, but he had previously voted for an increase in the retirement age while in Congress.  DeSantis stated that part of his opposition to now raising the retirement age stems from recent declines in life expectancy.

Scott was concerned about the increase in the retirement age on people in jobs that required physical labor. 

Both Scott and Ramaswamy argued that cuts to the discretionary budget and economic growth could alleviate pending problems with the Social Security trust fund.  

The Biden Administration and Congress are grappling with the budget and there is very little active debate over ways to deal with the impending projected automatic benefit cuts to Social Security or long term reform proposals.

The Biden budget proposals includes higher taxes to fund Medicare but does not include a similar tax increase for Social Security.    Haley is supportive of increased use of Medicare Advantage plans to reduce costs.

Most Democrats do not support reductions in benefits or increases in the retirement age.  The approach preferred by many Democrats in Congress summarized here involves several substantial new taxes and more generous benefits.

The Congressional proposal includes three tax provisions. It would subject all wage income over $250,000 to the combined employer and employee Social Security tax.  Apply a 12.4 percent tax on investment income for high earners as stipulated by the provisions of the Affordable Care Act.  Apply a 16.2 percent net investment income tax on owners of S-corporations and limited partners.

The Congressional proposal includes several increases in benefits both for existing beneficiaries and future beneficiaries, increase the special minimum benefit, bases cost of living adjustments on a price index that reflects purchases by the elderly, and expands benefits for children of disabled and deceased workers until age 22.


The Republican Proposals

One of the reasons why Social Security should be a high priority 2024 issue is that under current law and current revenue projections Social Security benefits will be automatically cut by 23 percent in 2033.   None of the Republican proposals would prevent projected automatic benefit cuts.

The proposals for a higher retirement age applied to new entrants to the workforce offered by Haley and Christy would not prevent the automatic benefit cuts in 2034 because these future cuts would not be implemented until the new cohort of workers retires in 30 or 40 years.   

Proposals to do nothing will not prevent the automatic benefit cuts if trust fund revenue projections are accurate.   The idea that Republican policies that lead to higher economic growth will lead to increased trust fund revenues that will increase trust fund revenue is wishful thinking contradicted by the past relationship between Republican policies and economic growth.

The implementation of automatic benefit cuts to Social Security would be an economic disaster leading to a sharp decline in aggregate demand and a sharp increase in poverty among the elderly.  The failure to implement meaningful changes to either Social Security benefits or taxes sooner rather than later will lead to a political and economic shock substantially more severe than the annual debt crisis or government closure disputes. 

The proposal to increase the retirement age for younger workers is premised on the view that younger workers will be able to increase private retirement savings prior to retirement.  However, younger workers are failing to save for retirement due to record levels of student debt and increased use of retirement funds prior to retirement.    

It is very difficult to evaluate proposals for means testing of Social Security benefits without knowledge of the means testing formula.  Specifically, how many high-wealth households will be ineligible for Social Security benefits under the proposal.  Also, the proposal could reduce charitable gifts since many wealthy families give away most of their wealth.

The Democrat Proposals:  

The Social Security Administration projects the Congressional reform package would lead to a balanced trust fund for a 75 year period. However, some of the revenue would likely be diverted to Medicare given that the current Biden budget includes a proposal to raise the high-earner tax on investment income from 3.8 percent to 5.0 percent for Medicare related expenses.   

Revenue will invariably be lower than projected by forecasters.  High earners will respond to the new taxes by increasing contributions to tax-deferred accounts, which reduce AGI and investment income.  The tax increases in the Democrat proposal could reduce economic growth, which could reduce projected improvements in trust fund solvency.   

The new Social Security taxes would likely motivate future congresses to spend more or reduce general taxes applied to the elderly since money is fungible and the new taxes reduce the amount of funds the Treasury must borrow from the public.

The Democrats claim that the new taxes only impact rich people but some people who have high income in one or a few years do not have high lifetime income.  An analysis of lifetime earnings and lifetime tax payments could reveal that the Democrat tax proposals adversely impact some households with modest lifetime earnings.

From a perspective on inter-generational fairness, it is difficult to justify the use of taxes on the next generation to fund current increases in Social Security benefits, even current wealthy Social Security beneficiaries.   

The proposal for linking cost of living adjustments to a price index geared towards a basket of goods consumed by the elderly does not account for the fact that due to differences in insurance coverage elderly American households have lower out-of-pocket health costs than working-age American households.  Go herefor an explanation.

The expansion of Social Security benefits for children of disabled and deceased workers would affect a small slice of the population in need while ignoring the large number of young adults who are leaving college with substantial student debt.  The proposal is not means tested, hence some of the beneficiaries would be quite wealthy and not in need of the additional funds.

In general, the Sanders Social Security reform package would increase the dependence of Americans on the Social Security system.  They are likely motivated by previous efforts described here, which appear to primarily benefit the affluent.  My view is that progressive changes to private retirement savings are an essential part of a Social Security reform package.

An Alternative Approach: 

An alternative approach would include both relatively minor phased in adjustments to the retirement age, new revenue sources for both Medicare and Social Security, and new incentives designed to increase private retirement savings by younger workers who must prepare for a higher retirement age.

Relatively minor additional taxes are needed to prevent automatic cuts to the Social Security in 2034 and the adverse impact of these benefit cuts on the general economy and the elderly poverty rate.

The existence of new revenue will reduce the increase in the future retirement age and reduce pressure on future workers who due to health considerations cannot increase the length of their careers.  This combination will reduce future demand for disability benefits relative to the Haley and Christy proposals.

A strong argument could be made that policies expanding private retirement savings among the portion of the population that is unable to save for retirement would be more effective than expansions of Social Security benefits.  These reforms include:

  • Savings incentives for new entrants to the workforce as early as high school.
  • Incentives for automatic enrollment and contributions to Roth IRAS for workers without employer-based retirement plans.
  • Changes to Flexible Savings Account and Health Savings Account plans to reduce loss of retirement income due to out-of-pocket health expenditures,
  • Limited student debt relief households to facilitate increased retirement saving.

A first draft of an alternative approach to Social Security reform was published here.

Electric Vehicles Versus Hybrid Vehicles

Biden Administration policies and tax incentives favoring electric vehicles over hybrid vehicles will backfire. The subsidies are too expensive, the demands on the electric grid too high, the dependence on foreign sources of lithium problematic, and the battery disposal problem unresolved.

Current environmental policy in the United States, both subsidies and regulations, favor the growth of electric vehicles over hybrid vehicles.  

Is this focus on EVs over hybrids misguided?  

Have policy makers underestimated economic and environmental costs associated with the use of EVs and the transition?  

Would subsidies for hybrid vehicle provide a quicker more economically efficient path to a clean energy future?

Background on Incentives and Regulations:

This IRS bulletin describes a new clean vehicle tax credit with a new tax credit, up to $7,500 per vehicle, for new clean EV vehicles purchased after 2023.  Certain vehicles including foreign built vehicles and vehicles with prices above a cap are ineligible.  Electric vehicles (EVs) are more likely to be eligible for the clean vehicle tax credit than plug in hybrid electric vehicles (PHEVs).  Car and Driver reports that 7 PHEVs are eligible for the clean tax credit compared to 15 EVs.  Hybrid vehicles without a plug in feature are not eligible for the clean tax credit even though they get excellent gas mileage.    

The infrastructure law included $5.0 billion in funds for states to build charging stations for EVs and an additional $2.5 billion for grants administered by communities.  These subsidies benefit plug-in vehicles but do not benefit non-plug-in hybrids.

California emission rules requires that all vehicles sold in the state by 2035 will be zero emission vehicles (ZEV).  ZEV vehicles include EVs and plug in hybrids but do not include non-plug-in hybrids.   The super ultra-low emission vehicles on this list will no longer be available for sale in California or on states with emission standards linked to the California standard.

Analysis of incentives and regulations:

The EPA strongly supports the transition to EVs despite evidence indicating benefits of EVS relative to hybrids are low and the adoption of EVs will be slower and more costly to the economy than the adoption of hybrid vehicles.

Some hybrid vehicles like the Prius have a fuel efficiency of over 50 miles per gallon and this article indicates the difference in EV and hybrid emissions is small. EV emissions are likely higher than hybrid emissions in states where the electricity is obtained from coal-powered plants.

The manufacture of EV batteries creates substantial emissions, which partially offset the lower tailpipe emissions.

Pollution from lithium mining has had devastating environmental impact on the developing countries that are the source of this material.

Currently, around 5 percent of EV batteries are recycled.  Unless recycling is increased there will be substantial health and environmental problems associated with battery disposal.

The limited range of EV batteries would result in multi-vehicle households using a traditional EV on longer trips, thereby, reducing the lifetime emission reductions from the purchase of EVs.

There are wide differences in opinion on the likely adoption rate of EVs.

Despite very large subsidies and favorable regulations described above, some recent evidence supports the view that EV adoption will be slower than anticipated.  This CNBC article found two reasons — concern about public charging and the EV range on long trips – for low EV sales.  Companies like Hertz have overstocked EVs given current demand.

A rapid adoption of EVs could lead to electricity outages if the grid is not improved and expanded.  Again, the environmental gains from the growth of EVs depends on the growth of clean energy sources, which is uncertain.   Failure to expand the electricity grid will slow the rate of EV adoption and increase cost of their use.

China is the major source of most materials used in EV batteries.  The growth in the adoption of EVs could increase the dependence of the United States on China.  An increase in the cost of materials like lithium used in EV batteries could slow the rate of EV adoption and increase costs.

It is highly possible that a smaller subsidy targeting hybrids and ULEVs over EVs will lead to a faster transition to cleaner vehicles than the current approach.

Concluding Remarks:  Most EV buyers and recipients of EV subsidies are relatively affluent.  I would guess that the average Tesla buyer is wealthier than the average Prius buyer.  The Prius buyer did not have to be bribed to reduce her carbon footprint.  I have a hard time justifying government subsidy for clean cars when some important health care subsidies phase out in 2024.  A likely scenario from current policy is large subsidies leading to increased debt, which provide only modest environmental benefits. 

Authors Note:  LinkedIn members should subscribe to Insightful Memos.  Many posts like this one on the difference between the cost of living and inflation can be found at Finance Memos.

Observations on October 7 political aftermath

A strong center is needed in both parties for America to be a positive force in the world.

Observations on October 7 political aftermath 

It is instructive to compare Donald Trump’s and Hillary Clinton’s reactions to October 7.

Trumps’ response was to call the Lebanese terror group Hezbollah “very smart” and to call Israel’s defense minister a jerk. 

Clinton’s response was on calls for a cease fire in Gaza would be as “gift” for the terrorist government and that people calling for a ceasefire don’t know Hamas.

Also, Hillary Clinton’s response to a heckler calling her to denounce Biden as a warmonger was “Sit Down.”  

Americans who support Israel and Ukraine and believe the United States can do good across the world have a huge problem with the titular head of the Republican party but there are bad actors in both parties.

A substantial share of the Republican party has no principles, no believe in human rights, supports Putin and tyrants, and is entirely transactional in their governing approach.  Today 93 House Republicans want to abandon Ukraine.  Tomorrow they could, depending on the polls du jour, abandon Israel.

A substantial share of the Democratic party is either blatantly antisemitic or virulently inconsistent.  Even after the horrific attack 15 House Democrats did not support a resolution supporting Israel and condemning Hamas.  

The mantra “Free Palestine from the river to the sea” is a call for genocide.  

The claim that October 7 needs to be examined in “historical context” is bizarre and inconsistent with the way any other conflict in the world is considered. 

How would Turkey or Iran respond to violence by Kurds?  Where are the calls for “historical context” in these instances or in any of a dozen other situations around the globe?

The calls for historical context ignore the wars and the violence on both sides which exacerbated the Palestinian exodus.  Historical context does not clearly support the Palestinian cause and provides absolutely no rationale for October 7.

So, supporters of Israel, Ukraine and the cause of freedom have opponents in both the Republican and Democratic party.  The most viable solution is a stronger bipartisan center, perhaps created through a third party.

Authors Note:  The author is an economist.  One of his latest articles explains why people are so unhappy about the state of the economy even though aggregate economic numbers appear strong.

Inflation and the actual cost of living

The misery index, the sum of unemployment and inflation, may understate misery because the cost of living to households and the affordability of key products are affected by myriad factors in addition to the rate of inflation.


Many analysts confound the concept of inflation and the cost of living.  Inflation is the change in the average price of goods and services in a basket of goods.   The cost of living is the total amount of money needed to meet basic expenses. 

The cost of living will increase with inflation, but this relationship is impacted by the way inflation is measured and other factors specifically loans and interest rates.

Economic or political arguments based on current and projected inflation numbers, which ignore other factors impacting the cost of living, often lead to specious conclusions. 

Often advocates of a particular policy argue that aggregate price indices either over or under state inflation to support their policy position.

  • An economist in a recent CNBC argued that the Federal Reserve Board should cut interest rates because the housing shelter cost component of the CPI provided a misleading estimate of housing cost increases.  (Saw on TV, sorry can’t find link.) 
  • Several economists, most notably the Boskin commission, argue a failure to adjust product prices for quality improvements has led to an overstatement of the CPI and inflation. 
  • Some politicians and economists have called for linking Social Security benefits to an alternative price index, which has a higher weight on health services.

Another major difference between inflation and the cost of living is that the later concept is substantially impacted by lending, loan terms, and interest rates while the former concept is exclusively based on prices of goods and services. 

This memo discusses the impact of different measures of inflation, cost of living and affordability on the current economic situation.

Analysis of components of the Consumer Price Index:

The measurement of three components of the CPI – shelter, health insurance, and advanced goods like computers – does not reflect the impact on affordability of these goods for many households.   


The cost of shelter in the consumer price index, the single largest component (around one third of the basked of goods) is determined by  actual and imputed rents.

The use of imputed and actual rents to measure shelter costs makes more sense than the use of house prices because volatile asset prices increase wealth and inflation can decrease real wealth.  Actual shelter costs as measured by rent and imputed rent are sticky and tend not to fall, hence actual and imputed rent does track annual changes in costs. 

However, housing affordability, especially for first-time home buyers has fallen.  The Goldman Sachs housing affordability index (based on three factors household income, housing prices and mortgage rates) reached a record low in October 2022.  Recent research has documented the link between housing prices and homelessness.   Moreover, unaffordable housing situations has led to an increase in the number of people retiring with mortgage debt.  

Housing affordability may be more closely related to financial stress associated with high house prices than the shelter component of the CPI.

Health insurance

The CPI uses an indirect measure of health insurance premium inflation.   The CPI health insurance premium cost estimate is the portion of insurance premiums not used for medical 

Medical services and goods have a separate index.  

Most private health insurance in the United States is obtained through employers.  Typically, both the employer and employee pay a portion of the health insurance premium with the employee share varying across firms and changing overtime.  

The CPI price inflation index measures the combined cost of the health insurance to the employer and the employee.  It does not measure the cost to the household which is impacted by the employee share of the health insurance premium, the deductible and coinsurance and copay rates.   By contrast, a cost-of-living statistic would directly measure the amount households spend on their own insurance premium.  Note that an increase in total premiums will increase household expenses even if the employer share of the health insurance remains constant. 

Health plans require insured households to share in the cost of health expenditures with the share being determined by the deductible and coinsurance rates and other terms in the plan.  These health plan features also change over time and vary across firms.  A report by the Kaiser Family foundation founds the average general deductible of covered workers rose by 13 percent over the past five years and 68 percent over ten years.  The CPI does not account for the increased share of premiums paid for by households. A cost-of-living statistic would account for this shift.

Deductibles are not the factor impact the cost of health insurance for households.  Co-insurance rates define the portion of health expenses paid for by the household.  The in-network and out-of-network health coinsurance rate will often vary, and some health plans do not allow out-of-network service.  Coinsurance rates also differ for different types of services. Copayments are often charged for lab or doctor visits. The CPI does not account for any of these factors, but all of these factors impact the cost of health care and the cost of living.

The enactment of the Affordable Care Act allowed people to use a tax credit that is linked to income to purchase health insurance on state exchanges.  The total premium is linked to age.  It is higher for older people than younger people.  Many middle-income and upper-income people pay more for their health insurance under state exchanges than under employer-based plans because many employer-based plans pay a substantial share of the health insurance.  (Middle-income young adults could typically pay 100 percent of state exchange health insurance and around 30 percent of the premium of employer-based plans.) 

The CPI does not capture the increase in costs stemming from a shift towards state exchange health insurance.  A weighted average cost of living index would measure the higher cost imposed on some households.

Computers and other advanced goods:

Several products in the basket of goods used to calculate the CPI are adjusted for changes in quality via a hedonic price index.   The adjusted price used in the calculation of the aggregate price index and underlying inflation is lower than the actual price because the new computer or cell phone or software is better than the old one.    The theory is that the improved product causes increased productivity and utility, hence the higher price of the new product is not reflective of inflation.

One problem with this argument is that quite often the old product is unavailable, and consumers have no choice but to spend the actual price on the new product.  A replacement purchase is mandatory if new software does not work on the old device.

Second changing social norms can make the purchase of a new product unavoidable.  A cell phone is now almost mandatory for most people in the workforce.  The improved quality of the cell phone does not obviate the fact that it is now an essential product.

Third, some improvements in quality prove illusory.  Hertz is cutting back on its purchase of electric vehicles partially because of higher than expected repair costs.  EVs also have limited range. 

Fourth, increases in prices due to quality improvements lead to higher insurance costs.  Even if insurance prices remain constant, an increase in the amount of insurance purchased due to the higher price of the vehicle will increase the cost of living. 

It may be appropriate to adjust the CPI for quality improvements, but quality improvements don’t always lead to lower living costs.

The impact of debt and lending terms on the cost of living:

The CPI and inflation measures do account for the increased use of debt and alterations in the terms of debt on the cost of living.  

The largest impact of debt on living costs pertains to the increased use of student loans.  Debt per student has risen from $18,230 in 2007 to $37,650 in 2023.  This increase in debt is larger than the rate of inflation.  (Figures adjusted for inflation are $26,720 in 2007 to $37,650 in 2023.). The increased use of student debt will result in an increased use of unsubsidized student debt, which leads to higher total repayments because interest because the federal government makes interest payment on student loans while the student is in school. 

The average maturity of car loans, which is now near 70 months, has increased over time.

The CPI and measures of inflation do not account for higher living costs induced by increased debt and changes in the terms of debt.

Concluding Thoughts:

The misery index, the sum of the unemployment and inflation rate, suggests the economy is moving in the correct direction.  However, official inflation rates understate misery because changes in average prices do not measure all factors impacting the cost of living.

Authors Note:  Recent posts by David Bernstein include, The Case Against Medicare AdvantageAn Interest Rate Forecast and Investment Advice, and Questions and Answers on IDR loans and the SAVE program.