Having invested over 100,000 hours into my professional career discussing money with people, well into the “red zone” of my career; here are five observations:
- Taxes most likely will be higher in the future!
When I came into the business, tax rates stood at 70%. That’s right, 70% of your gross income went to the government. Many deductions were allowed. According to www.thebalance.com/usdeficit-by-year; the national debt was $320 billion. The year I started, this represented 46% of the economy as measured by the GDP. When the US entered the Vietnam War, I started my career while in graduate school as a phone solicitor. People actually answered their landline phones. If you were polite to them, they listened, and I lived in their town. Reagan broke the first trillion dollar deficit in 1982. The debt had come down to 34% of the GDP. In 1986, Reagan lowered taxes and the Democratically controlled Congress, led by Tip O’Neal, pushed over our country overdraft (deficit) above $2 trillion and back to 46% of the GDP. As you know, Congress sets spending.
The Reagan tax cut essentially established a flat tax of 28%, the second lowest rate, once income taxes were expanded beyond the rich as a temporary tax to finance WWI. So, clients of mine who had put away money at 70% could now take those funds out at 28%, and have five years to pay the tax bill. This enabled my clients to:
- Defer taxes at a higher bracket
- Withdraw at a lower bracket
- Position funds to be taxed at capital gains rates rather than higher income tax rates
For the fiscal year 2020, the government is projected to be overdrawn more than $24 trillion (trillion has 12 zeros behind the number) or 106% of the GDP. These are taxes spent, not yet collected.
- I believe the highest transaction cost are the taxes generated from investing.
We are in 2020 at 37% top federal income tax rate (plus 3.8% Obama Care Tax on investment income). That is the fourth lowest rate once everyone started being taxed. Most deductions are gone! We are still over a third lower than the historical average of rates. What would you call something that cost 1/3 less than the average? I say taxes are a bargain. Corporate rates are even lower, flat 21%. Whatever your rate, taxes are still far higher cost than transaction fees. Much of the focus on leveling the playing field during the Obama administration was on lowering fees. Recent moves by large firms have significantly reduced trading fees. Yet, do taxes get any attention in the press? Where are funds that today exceed the value of the deficit? Retirement accounts, like 401(K), IRA, SEP, pensions, and 403(B), etc. Do you calculate the imbedded taxes in these accounts when looking at the statement? What rate is reasonable to use?
- If the majority were right the majority would be rich!
Do you follow what your neighbors do with their money? Maximizing your 401(K) above the match could potentially push you into higher tax brackets in retirement. The government has a “thou shall” rule, that today starts at 70 ½ on all retirement plans. It is call REQUIRED Minimum Distributions (RMDs). When you do your taxes, ask your tax advisor to calculate your average tax on all your income. Ask yourself, what do you think your tax bracket will be in retirement? Will it be higher or lower than today? If you find yourself in a lower tax bracket, you may have less income to enjoy and may miss out on a secure, comfortable retirement.
- Having a portion of your portfolio with uninterrupted compounding is a vital component for wealth creation.
Most investments compound at an interrupted (inconsistent) basis. They grow some years and lose value in other years. The wrapper could be your business or investment related to your business. Tax timing recognition is always a consideration, especially if you agree with #1 (discussed above) about the future direction of taxes.
Our designs always include tax aware choices. Popular tools today can include a Management Service Organization (MSO) and Opportunity Zones where appropriate. We have the ability to do feasibility studies based upon your situation, goals and objectives. The dialogue should include your tax advisor. So, what is an MSO?
Management Service Organization is a separate tax payer that came out of the Tax Cuts and Jobs Act of 2017. The IRS has rules about avoiding abuses. It allows you to store up wealth taxed at 21%, so $79 out of every $100 of profits can work for you. Later, the IRS will collect taxes when the MSO is closed. We have ways to mitigate some of that bite. If your personal average tax is in the low 20’s, this may not be an attractive alternative. However, should you want a feasibility study, let’s talk.
Another popular tool today are Opportunity Zone (OZ) funds. Like anything else, one must weigh the positive and negatives before jumping in. OZs work nicely if you have a large realized capital gain and are not interested in current income. The rules allow you to defer tax on the gains and potentially have very favorable rates on the way out. We encourage you to think of this as 10 year or longer money for the future. Again, we can do a feasibility study and meet with your tax advisor.
- Often people chase returns and take excess risk.
I love to watch the ads on TV or listen to radio “experts” talk about some “hot” choice that will “exceed returns of the stock market.” Unrealistic expectations are set ups to encourage people to risk their money. Why would you want to do that?
Taking a complete look at everything you are doing, building a plan based upon your unique objectives and desires, monitoring the progress and making adjustments according to what life throws at you is the way I have found works.
Would you go to a hardware store to buy bread? No. Then why compare one allocation that is built to provide “bread” with another allocation that has numerous choices to repair or build? Want to talk specifics? Call me, together we can find an agreeable time for you: (713) 984-8044.
This is not a solicitation for or recommendation of Opportunity Zones.
Securities and investment advisory services offered through World Equity Group, Inc. Member FINRA, SIPC, a Registered Investment Adviser. SMART Group Houston is not owned or controlled by World Equity Group, Inc.
Neither SMART Group Houston nor World Equity Group, Inc. provide tax or legal advice.