How do you react to what you read in the news or to what’s going on in the economy? Do you feel like you can make a difference? Doing nothing is often the easiest course of action. We can procrastinate and allow events to control us. This may be the default position for many especially those caught up in the daily challenges of living. That is a rough way to live – cast about by events beyond your control. 
The alternative is to seek the opportunities as they are presented. The opportunity may not be to your perfect liking; yet it is what it is – imperfect in an imperfect world. Several years ago, Peggy Noonan, in her Christmas 2017 Wall Street Journal article (Dec. 23-24, 2017) challenged business people with, “This may be the last opportunity for business leaders to do what hasn’t been done in generations, and that is defend the reputation of capitalism.” She was prophetic. How many candidates for 2020 presidential election are espousing some form of socialism? Their message, “capitalism is bad.”
Freeing up business from the burden of regulation and increasing the reward for calculated risk (lower taxes) has been highly positive for those wanting to work. At this writing, unemployment is at a half century low point. There are more jobs available than workers to fill them. Minorities are experiencing the best employment position since the late ‘60s.
The question to be answered is, does all this positive economic force serve in favor of capitalism? Or, have we raised a generation of young workers who have been given much without understanding what effort went into achieving these positive results? Will we tax “rich people” till there is no more money to tax?
My book, American Fathers, tells the story of a young entrepreneur who embraces capitalism. He sacrifices and struggles to overcome obstacles most privately held business owners must face. He is always forward focused and wants to grow his company. Our hero takes a number of unconventional paths to achieve a level of success.
There are three storehouses our hero used in his future focus. With the reduction of tax rates that run from 2018 through 2025 (under current legislation) a window of opportunity has opened wide for those who want to use a combination of these three silos working together. Each one has a different level of IRS participation. I do not provide tax advice, but I will briefly outline each of the rates. This should not be construed to be specific investment advice. Each person’s situation is unique. Involving an investment professional like myself, who is properly licensed is a much-preferred way to progress with specifics to your situation. Always remember to ask the professionals what they are doing for themselves. Their actions should reflect what they are saying. The three wealth storehouses that can work in concert for you are taxable allocations, tax postponed and tax aware.
TAX-POSTPONED
The most popular of the three is the tax postponed, i.e. 401(k) or IRA., sometimes referred to as “qualified” investment accounts. Here, one is betting that the tax bracket will be lower when you withdraw the money in retirement. I refer to this choice as a tax timing decision. You give up access to the funds till at least age 59 ½ in most cases. The biggest surprise for many is the Required Minimum Distribution (“RMD”) that is required at age 70 ½. The IRS has a specific table that must be met for RMDs or a 50% tax penalty can be added to your taxes. In an ideal world one would put away sufficient savings for the future and then find out that 100% of the distribution is exempt from income taxes in the future. The majority of this money put aside finds itself recycled back into the economy. Be it in the form of ownership (equity) or lender (bonds) used by business properly, value can be added to those original investments.
2017 tax law allows $12,200 standard exemption ($24,400 for couple-2019) for an individual or itemized (with caps). The IRS caps are $10,000 of property and state taxes, mortgage interest up to $750,000 for a new home loan and charitable contributions as your total deduction. Your tax advisor can provide details for your situation.
An example might be a hypothetical couple, giving away $15,000/year with $28,000 of interest deduction and the $10,000 state property tax.
The higher exclusion of your top income to be taxed in this example is $53,000.
Have your investment professional calculate, based upon reasonably agreed upon assumptions, what might be your expected withdrawals in retirement (at least RMD). Ideally, if they hit “$53,000” in this example, the IRS share of these tax proposed funds would be zero! That is a nice tax to pay – zero on distributions. Anything in excess of my $53,000 example would be owed to the IRS in tax postponed retirement focused plans. It is difficult to project in advance if your income may fall in retirement. A financial professional should be able to model all your sources of income in the future.
Wise tax planning, does not outweigh tax-postponed plans like IRAs and 401(k)s. Sadly, even with the prevalence of these plans, almost 50% of Americans are at risk of not being able to maintain their standard of living in retirement, according to Boston College’s Center for Retirement Research. (Wall Street Journal, January 6-7, 2018, page B2).
TAXABLE
The next option is taxable. This you share with the IRS, just to fund. What I mean is that you have already paid taxes on these investments when you earned them. Also, every year the IRS “passes around” their collection basket for their share of your taxable gains. Owning your own business is in reality owning a single stock. How you take money out of the business is subject to different levels of sharing with the IRS. A tax preparation specialist, usually a CPA, stays current with the regulations and can assist you in present strategies to withdraw money from your business.
Taxable investments are usually associated with risk. Owning one stock or your own business, generally invites a greater degree of risk. Circumstances, often beyond one’s control, can materially impact the liquid value available (in addition to potential taxes) especially for opportunities. Conclusion – a taxable investment has the greatest potential for paying higher taxes and therefore, should command a higher return than the third storehouse – tax aware.
TAX AWARE
That moves us to the tax aware wealth storehouse. This may be the least risky for the long- term of the three. It is also the most maligned and misunderstood. Like a taxable investment, the IRS takes their share first to fund this tax aware choice. Once established, if operated within prescribed IRS rules, that is the last time your partner (the IRS) is involved in this tax aware choice– unless your total estate currently exceeds $22,000,000 under current rules. That is a big number for most of us.
This choice includes building up the cash available in a life insurance policy that may be pledged to a bank or collateralized to a financial institution. This collateral may help satisfy your share of cash in a business opportunity. For more details see my blog, Like Disney. It is beyond the scope of this piece to get into details of different life insurance policy designs. I recommend a properly licensed insurance agent, preferably with a Chartered Life Underwriter (CLU) or Chartered Financial Consultant (ChFC) designation to help guide you.
One of the living benefits of living (life) insurance is the option to withdraw the cash value in the policy to potentially provide supplemental income. This normally would require excess funding of the policy. Overfunding may be an alternative, but the IRS limits how much in premiums that can be made to a life insurance policy. The IRS has a limit to what is the maximum funding allowed before the policy is considered to no longer be classified as life insurance. Also, it is important to note that withdrawals from the cash value of a life insurance policy if not done correctly could cause the policy to lapse. Companies with transparent cost structures for their life insurance policies can model current cost and internal (tax free) rates of return. It is important that one model and monitor this withdrawal choice beyond life expectancy as the IRS does require that all policies ultimately mature as a death benefit in order to qualify for this tax aware stream of income. If taxes rise in the future, having this potential supplemental source of income may become an option. Done properly, after returning your original premiums, income can be withdrawn tax free under the same tax rules as used for reverse mortgages.
Properly structured, your tax aware and tax postponed accounts may have the potential benefits without sharing so much with the IRS. That leaves only your taxable wealth silo subject to the IRS sharing. We are required to pay our “fair share” of taxes – nothing more. Are you pursuing strategies that cause you to pay voluntary taxes? Socialism is coming back in vogue for the 2020 election. All these “free” promises require one thing, higher taxes. We are seeing calls for 70% tax rates. I started my career at those tax rates. It will be interesting to see if in the red zone of my career these rates return.
Ever wonder why term insurance gets so heavily promoted? The insurance company is able to keep most of the money it receives (minus commissions and operating expenses) plus any earnings on that money. This is because most people who purchase term do not keep it long enough to have the death benefit paid to their beneficiaries. People usually live longer than the term (10/15/20 years) of the policy or let the policy lapse. Therefore, the insurance company pays no death claim and keeps any profits from the money it’s collected. All other types of life coverage or annuity have a payout benefit to the insured or the person who paid the premium as well as other benefits that allow usage before your departure date.
We all have a departure date. If we knew the date, it would be easy to design a life insurance policy that lasted one day longer than our departure date. At this writing nothing yet has been developed to give us our “use by” or departure date. Therefore, policies that provide a current cash option have been developed.
Some talk about the 75 year plus returns in the stock market. There are many problems with this one data point. First, most of us do not start investing seriously until we are into our 20’s or 30’s. If all of us could know our departure date was past age 100, we could invest for 75 years and never want life insurance. How many of us will make it to 100? One or two out of 100?
Next thought – do you think opportunities or emergencies might arise during that 75 years? Where do you get cash when the market is down; or worse yet, when your individual stock has fallen out of favor and is deeply depressed! Banks are reluctant to lend on collateral with questionable value, and then there is our partner, the IRS, who takes their fair share each year – taxed depending upon how the distributions may be classified. All these factors plus one, timing, are ignored when looking at a hypothetical 75 years of investing. A tax aware storehouse helps act as a buffer to negative events such as illness, legal judgment against you, or loss of job before age 59 ½ when one can access their tax postponed storehouses without an extra penalty.
These three wealth storehouses are all important. Working with properly licensed professionals, your goals and aspirations can be realized. Reducing or eliminating worry and your most expensive cost, taxes, are the prudent way the minority proceed. “If the majority were right, why isn’t everyone rich?”
Doing nothing now is a huge missed opportunity. When is the last time you did a complete evaluation of all your financial strategies? The 2017 tax law opened many positive opportunities. Capture them now!
The difference between our view on taxes is your CPA looks at taxes for the year just ended. We model and look at how investment strategies may affect taxes over your lifetime. Our desire is for you to pay your fair share, not extra, because of a passive approach to tax strategies.
Closing note: When will Washington start looking at spending and reducing the DEBT? According to the US office of Management and Budget the US Census Bureau a child born in 2016 arrived with a <$42,527> debt. Doing nothing by the time they finish high school (age 18), their share of DEBT could be <$68,454>. By age 34, in 2050, <$116,904>. Not exactly the inheritance our forefathers planned.
Securities and investment advisory services offered through World Equity Group, Inc. member FINRA and SIPC, a Registered Investment Adviser
SMART Group Houston and Ron Schutz-Planning Business Transitions, LLC, are not owned or controlled by World Equity Group, Inc.
Neither SMART Group Houston nor World Equity Group provide tax or legal advice
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