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Welcome to How to Retire on Time, a show that answers your retirement questions. Say goodbye to the oversimplified advice you've heard hundreds of times. This show is about getting into the nitty-gritty so you can make better decisions as you prepare for retirement. Text your questions to 913-363-1234 and we'll feature them on the show. Don't forget to grab a copy of the book, How to Retire on Time, or check out our resources by going to www.retireontime.com.
Welcome everyone to How to Retire on Time, a show that answers your questions about all things retirement, including income, taxes, Social Security, health care and more. This show is an extension of the book, How to Retire on Time, which you can grab today on Amazon or by going to www.howtoretyearontime.com. My name is Mike Decker. I'm the author of the book, How to Retire on Time, but I'm also a licensed financial adviser, insurance agent, and tax professional, which means when it comes to financial topics, we can pretty much cover it all. Now that said, please remember this is just a show.
Mike:Everything you hear should be considered informational as in not financial advice. If you want personalized financial advice, then request your wealth analysis from my team today by going to www.yourwealthanalysis.com. With me in the studio today is mister David Fransen. David, thank you for being here today.
David:Hello. Thank you.
Mike:David's gonna be reading your questions, and and I'm gonna do my best to answer them. You can send your questions in right now or anytime this week by either texting them to 913-363-1234. Again, that's 913-363 1234, or email them to hey mike@howtoretyme.com. Let's begin.
David:Hey, Mike. How do the wealthy get around paying taxes? Look. We've we've teed this one up for you.
Mike:Yeah. This is such a polarizing question. And when I say polarizing, I'm not saying that, like, sharks versus the jets. Right? It's the poor versus the wealthy.
Mike:It's Okay. It's a lack of understanding.
David:Sure.
Mike:So first off, they don't get around paying taxes. Everyone pays the tax. Everyone has the same tax code. There is no special tax code that people want to believe exists Mhmm. To fall into some sort of victimhood.
Mike:And let me paint the case here. There was, a conversation I had a while back with someone that had $20,000,000 in assets, and he said, look, I'm coming to you for tax planning advice. I just I need to pay less in taxes. I said, well, we can do some efficiency here. But if I hear you right, you're wanting to get to a zero tax bracket.
Mike:That ship has sailed. It's not nope. You don't want that. It's not worth it. And the reason why is the person that sold their business.
Mike:So they had 1,000,000 of dollars that, that were were in dividend stocks, and he was reinvesting the dividend stocks. Well, you pay taxes on dividends being reinvested in brokerage accounts. And if you wanna look at your 10 40 lines, I if I remember off the top of my head, lines 23 on your 10 40, if you see a large number in there, that could be an inefficiency in your portfolio. Maybe you want to reinvest those positions into something that maybe doesn't pay a dividend. Maybe it's a stock that doesn't pay a dividend or something else.
Mike:The the portfolio was not tax efficient, but he he wasn't gonna get to a zero tax bracket. Because if you were to get rid of the dividend positions and put them into stocks with that don't typically pay a dividend, he'd still pay capital gains on the growth when he sold it again. So and maybe it was for inheritance purposes and all all I digress, but the ship was sailed. He was paying a lot for dividends. His cost of living was extensive.
Mike:He just wanted a lavish lifestyle. That's okay. If you have $20,000,000 and you want to live a lavish lifestyle, you could probably afford it. Yeah. That's okay.
Mike:But you gotta pay taxes. He had too much in his IRA, the pretax. It's actually very common that I'll get people in their late sixties saying, hey. We haven't been doing our IRA to Roth conversions, and RMDs are coming up, and it looks like it's gonna be pretty bad for us. And I say, yeah.
Mike:It looks like it's pretty bad. They say, how can you fix it? And I say, well, we can get started today, but if you want to touch the money, you're going to pay taxes. And most people want to spend their money. So the question is, how do you get it out?
Mike:To talk about those fun stories. Oh, Amazon didn't pay taxes in 1 year. These big corporations, they didn't pay it in tax. They also had significant losses to offset the taxes. Uh-huh.
Mike:So, you know, let's say, do you wanna lose, I don't know, a $100,000 to pay a $100,000 less in taxes? The conclusions claimed are not based on the evidence given because there's a lack of understanding of how the tax code works. Like Warren Buffett would say things like and he's accurate in saying things like, why pay a smaller percentage of my taxes than my assistant? Yeah. Because he's using long term capital gains to his advantage when his assistant is paying income tax.
Mike:And you might say, well, that's not fair. And I would say, well, but Warren Buffett also spent a lot of years paying income tax. So are we really upset or are we just upset that in our current timeline, if we're 20, 30, 40, 50, 60, 70 years old, that we're upset of how we're structuring our income, whether it's from a business or whether we're a business owner. There's all sorts of ways to structure your income to be tax efficient, but it has to be within your current situation. And people don't like where they end up.
Mike:It's like, well, you made a lot of decisions to get there and they might have been right for you based on your emotional and economic limits. Not everyone should be a business owner, which means not everyone's gonna enjoy the benefits, the tax benefits that a business owner would get. But do you really wanna stress about a business and run a business just to get some benefits? We gotta call apples, apples, and oranges oranges. You can't compare the 2.
Mike:So all that said, let's explain just for a moment the most basic explanation that I can think of that I've come across, and this comes from a dear friend up in Washington state who's a CPA that taught me this. But he calls it the four flavors of taxes. So here are the four flavors of taxes. You've got tax credits. Dollar for dollar, you get, reductions.
Mike:So if you have $1 tax credit, that's $1 off your taxes, basically speaking. You with me, David?
David:I'm with you. Yeah. You're good to keep that dollar.
Mike:K. Then you got tax deferred, which means you're deferring the taxes until a later point, but at some point, you're gonna pay the taxes.
David:Pay it later.
Mike:K? You've got tax deductions. So let's say you spend a dollar, you can deduct, I don't know, 20¢. So for every dollar you spend, you get 20¢ back.
David:Okay.
Mike:You can't spend enough money to get enough deductions back to make it worth it. It's a nice benefit, but it's just a deduction. It's not a credit. And then you've got let's see. The last one is tax free.
Mike:So it's something that can grow tax free, so there's no capital gains to it. And then you can enjoy income from a tax free standpoint because, well, you've already paid the tax on it. Right?
David:Okay. And so
Mike:you'd think of a Roth IRA for the tax free category. Alright? So when it comes to spending money or tax returns or all that, tax credits are great, hard to come by. Tax deductions, okay, if they're applicable, but that's only if they're applicable. Most people I see are taking the standard deduction, so their deductions or the ability to deduct is irrelevant.
Mike:So now we're looking at 2 other categories here when it comes to how the rich get away with this, so to speak. Tax deferred. You'll pay the taxes later. Alright. So the first part of this category in building your portfolio to be tax efficient, you've got long term held positions.
Mike:So you buy a stock and you hold it for a very, very long time. You're not paying taxes until you sell it.
David:Okay.
Mike:Simple enough. Real estate does this very, very well. You buy the real estate. Yeah. You're paying real estate tax on the property itself, but you're not paying a tax on the gains until you sell the property.
Mike:And you could do all sorts of fun things, with that, which I'll talk about a little bit later. Let me just kinda outline this real quick. Sure. When it comes to tax deferred, you've also got annuities. So annuities, you can put money in there and they can grow.
Mike:The cash value can grow, and it's deferred. So if you put in after tax dollars into an annuity, it'd be deferred so you wouldn't pay taxes until you do touch it, and then you're paying income tax on the gains. Or if you turn on the income stream, then a part of that income would be subject to income tax. But it's deferred along the way. So for higher net worth people, they might and if they have a lot of assets in brokerage accounts, they might put it into an annuity just to say, stop making this money, pay taxes.
David:Okay.
Mike:I've seen people do that. You've got then also your traditional IRA that's deferred as well. And I think most people understand how an IRA works. It grows tax free, but when you take it out, you're paying income tax. So just some ideas of tax deferred and and and different examples.
Mike:Then you've got tax free. So what I like about tax free, the difference. So tax deferred and tax free, they both can grow without paying taxes along the way. But tax deferred, you pay the taxes at the end. Tax free, you don't.
Mike:Your Roth IRA, which is one of the harder tax qualifications to get money into, they limit how much you can put into a Roth IRA every year. That's by design, but they're really nice to have.
David:Right.
Mike:Municipal bonds, in some sense, could be considered tax free in the right state with the right situation. You bought the right municipal bonds. That works. Cash value life insurance, if funded correctly, can be a tax free source. So you can put money in there.
Mike:It can grow tax free according to the IRS code 7702, I believe. It grows tax free. You can borrow against the policy without paying taxes. And then when you pass, it settles all the loan against the policy that you know, the debt associated with it. It settles all the accounts and then beneficiaries get the income, hopefully tax free.
Mike:So those are tax free sources. But notice, everything I've just mentioned has benefits and detriments, has restrictions to getting money into it, and it has to be funded correctly. And then pulling the money out could have issues. So it's just this idea, well, how do the rich get away with it? You you gotta understand the instruments at hand.
Mike:Here are some basic tax strategies that most everyone probably could implement, and then I'll talk about some more advanced stuff. That sound good?
David:Okay. Yeah. So this is something maybe even I could do, these these next few ones.
Mike:Yeah. Your average average person probably could understand these and implement them.
David:Alright.
Mike:First one is just funding the right balance between IRA and Roth. So you don't wanna necessarily put all of your money into an IRA and your 401 k or all of your money to the after tax side or the Roth side of your 401 k. Same would be with a 403b. You might maybe pay some taxes now or take some money out of your brokerage account and put it into a Roth with your contribution limits. It's funding the right pretax and after tax of qualified accounts, aka IRAs or Roths or 4 one k's or 4 zero three b's and all of that.
Mike:K? And the reason why the funding is so important is because how you fund is going to affect how you distribute. So for 20, 30, 40 year olds, you're probably not in your highest earning income years in your employment, which means you may want to favor paying taxes now and paying money into the Roth side of your 401 k.
David:Okay. Right.
Mike:If you're in your highest earning years, think of, like, software engineers, pilots, where their their income exponentially grows for the last 5, 10 years or so. You may actually want to put money into your IRA, the pretax, because in retirement, you might actually have a smaller income because that's all you really want. So you gotta understand the funding side of it. Yes. Another basic tax strategy to consider as you prepare to retire on time is IRA to Roth conversions, which you can do, by the way, any year of your life.
Mike:Many people will will wait until they're 59a half and then start doing it. That's the most common thing that I see. But you can convert IRA assets to Roth. You just have to pay the taxes out of pocket.
David:At the time you do it.
Mike:Yeah. So out of your, like, your savings account as opposed to in the conversion, you're taking a distribution to pay the taxes. That's a penalty if you do it that way.
David:Right.
Mike:But you can slowly start doing IRA to Roth conversions. Just depends on your situation. If you're 59a half or 60 years old, you might start doing that because you might run some issues at 65 with IRMAA, the Medicare surcharges. You might run into issues at 70 whatever it will be, 73 or so, for required minimum distributions that are subject to your pretax accounts. What you don't wanna do is you don't wanna get backed into a corner because of the regulations around pretax qualified accounts like an IRA.
Mike:So a little bit goes a long way. A little conversion here, a little conversion there. Each year, you're doing a little bit of a conversion. Then you've got spending IRA funds first in your retirement plan to a certain point. And the reason is, let's say you retire at 60 years old, maybe you wanna spend down those pretax dollars and save your Roth for later in the plan and save your nonqualified assets like the brokerage account.
Mike:You've already paid taxes on it. Right? Because you could strategically take that out with some long term capital gains maybe or whatever the the plan might suggest. There's more flexibility with that. IRA assets, there's limited flexibility because of these things like RMDs.
Mike:K? Let's keep going. Yeah. So long as these are these are basic tax strategies here, but pushing back Social Security is one a lot of people don't think about. They think about Social Security as a siloed event, as in how much can I take my Social Security and how do I take the most overall based on my longevity?
David:Right.
Mike:Well, if you push back Social Security a couple of years, technically, you'd have more room to do IRA to Roth conversions or spend down your accounts.
David:So don't file. Don't take Social Security. That's what you mean by pushback?
Mike:Yeah. Yeah. Maybe maybe take it at 67 years old so you have a few more years Uh-huh. To do IRA to Roth conversions or spend down the it sounds weird to spend down your IRA assets, but when you look at that decision from a comprehensive position and the ripple effect it can have on your overall plan, it actually can be quite beneficial overall for your income, for your risk, for your preservation of the portfolio, for legacy planning, and so on. It's just everything has a ripple effect on everything else in the plan.
Mike:It's just it's all connected. And so sometimes you actually want to push out Social Security so you can spend down or do more conversions so that maybe your Social Security is more tax efficient or maybe it's just you got more assets to your Roth. It just depends. Tax loss harvesting can be another effective basic strategy. I know it sounds weird.
David:It does. I'm trying to imagine what that even is.
Mike:Yeah. So tax loss harvesting let's say you got a hundred positions, a 100 stocks in your portfolio just for a sample.
David:Alright.
Mike:And 20 of those stocks have lost money since you purchased them. Well, you could sell those stocks at a loss and then sell some of your other stocks at a gain, and that's you're not paying taxes on on all that liquidity. So if you if you need to generate some income, maybe sell some of the loss, some of the gain that creates some income. You could sell some amount of loss, wait 30, 31 days, and then buy back in. And now you have some losses that can offset some of your gains later on.
Mike:Maybe you don't use it this year. Maybe you use it next year. It's deliberately selling at a gain and then moving it to something else. So you have these losses. They're almost intentional.
David:Okay.
Mike:Think of it as like, you know, the ship's going down. You don't expect that position to go up anytime soon. Cut your losses, enjoy the tax benefit, and move to something that has more growth potential that you believe in. That's the idea.
David:Okay. Yeah. So the IRS just sort of tracks the the amount of loss, and there's a certain amount that's allowed.
Mike:Your your brokerage accounts and your whoever's doing your taxes is gonna report that.
David:Okay. Right.
Mike:Right. The IRS really only checks when the IRS needs to check.
David:Yeah. Yeah. Yeah.
Mike:So hopefully, you don't get audited. But it happens. Yes. And the last one for basic tax strategies I would suggest is income flexibility in retirement. So I can't say this emphatically enough.
Mike:In my opinion, you want to plan your retirement taxes based around an effective tax rate. It's not, oh, I'm just gonna take x amount of money before taxes and whatever happens, happens. It's no. You're looking at an effective tax rate overall. And so if taxes go up, maybe you take a little bit less from your pretax accounts and a little bit more from tax free accounts to preserve your overall portfolio.
Mike:You've got to have enough in both and include the other tax strategies to have that flexibility to kinda maintain the proper equilibrium of your overall taxes. And here's the example I like to give. Let's say you have $1,000,000, you know, the cliche, I guess, amount we have saved for retirement.
David:Yeah.
Mike:If the IRS were to say, we have simplified the tax code. Hypothetical here, everyone, has not happened.
David:Right.
Mike:Let's just say for simplicity's sake, the IRS has simplified the tax code and you could convert all of your IRA assets, your $1,000,000 to Roth today. 20 percent's all you'd pay. That's it. Or you could lock in taking little distributions at 15% for life. Which would you do?
Mike:The, person that converted everything would pay 200,000 in taxes. So a $1,000,000 convert it at 20%. 200,000 goes to taxes. 800,000 is now tax free. It grows tax free, and it pays income tax free.
Mike:You're done with taxes. 0 tax bracket for life. And then you've got someone that's doing the 15% for life. If all things are equal, equal growth, equal net of tax income per month, and so on, the person that would have taken the 15% route would have paid $415,000 in taxes, almost double. Yeah.
Mike:So you'd think be more aggressive up front would be better, but what people miss is the person that was slow and methodical, the 15%. They had, in this example, 690,000 more dollars left over in their portfolio because they were slower in their approach. They targeted a lower percentage effective tax rate for the duration of the retirement, and it ended up working in their favor. It's not tax brackets. It's effective tax rates.
Mike:It's targeting effective tax rates, and you've got to have some income flexibility or the ability to take income from different sources and different accounts at different times to preserve assets and to preserve the legacy intentions or future income or whatever it might be because we can't control tax brackets in the future. We can't control the debt. We can't there's a lot of things we can't control, but we can control how we take income each year and making it dynamic in my mind, though I do put this in the basic tax strategy category. I think it's to your advantage. I know that's not as basic or simple as the other ones may be, but, I mean, you worked hard for your money.
David:Yeah.
Mike:So don't you wanna have the most of it during your the rest of your life and when you pass? And then here's some advanced tax strategies. This is the ones you you hear about, but maybe don't fully, hear the explanation or the benefits and detriments. So you can fund life insurance to help pay future taxes. I talk about this in my Kiplinger article retirement planning with life insurance.
Mike:But the, the idea is you could fund it, let's say, with nonqualified or after tax money over a certain period of time, typically over 5 to 10 years. And then once it starts growing and gaining momentum, let's say then you retire. You could take income out of your IRA assets, but don't pay taxes on those distributions, but you'd pay the taxes out of your IUL each year. As long as it's set up correctly, the taxes that you've paid are a loan against the policy. This is extremely complicated.
Mike:So if you don't get it all, that's okay. Just understand the idea with life insurance is you're borrowing against the policy. And if the total gross cash value increases at a faster rate than the loan against the policy, you can actually make some of the money you spent on taxes back. It's a way to absorb it. It's extremely complicated.
Mike:Oftentimes, they're not structured correctly. They're not explained right. The policy itself is overstressed in the beginning. This is not a perfect product. There's a lot of detriments associated with it.
Mike:So do read that article, retirement planning with life insurance by Mike Decker. But it is a it is a more advanced strategy. I think life insurance is the most complicated instrument in the financial markets. It's extremely complicated. But when implemented correctly, it can act as a way to do some advanced tax planning.
Mike:Can. Doesn't always work out. Gotta be healthy. Gotta fund it. For all those that are 50 years or so, this is for you.
Mike:For all of you that are 65 years old or older, this is probably not for you. Right? If you're 20 to 30 years old listening to this, this is probably very certainly something you might wanna consider, because it can replace your term life insurance and you're slowly growing an asset. So anyway, there's a few others as well. Qualified Opportunity Zones, if you're selling a business.
Mike:So the idea is you could sell a business, defer the taxes, defer, keyword there. Yep. And then you pay the taxes a couple years later, but your qualified opportunity zone, which is a real estate investment asset class, can grow for 4 years, and then you start paying taxes later. So, hopefully, the growth kinda helps offset the taxes. You've got Delaware statutory trust, which is a more advanced strategy.
Mike:The idea is you can sell your real estate and then do a 10 30 one exchange into a Delaware statutory trust, which is fractional ownership of actual real estate. So it qualifies for 1031. David, would you rather get, let's say, 5% income of a $1,000,000 property or 5% income of a 700,000, the leftover of the property? It's you want Yeah. You want the percentage on the higher amount.
David:Right.
Mike:So the idea is you can sell and defer all of your taxes into a Delaware statutory trust and then just have higher cash flow and defer deferred for the rest of your life, then your kids get the step up in basis. That's Okay. The simple version. And then you've got oil and gas partnerships, which is basically your it's a risky bet, but you're you're putting money into a partnership that's intentionally going to try and spend a lot of money and have no returns, no growth, no gains, so you can help offset some of your other gains in your portfolio. Remember that we we talked about great losses to offset great gains?
David:Yeah. I was just thinking this sounds a lot like tax loss harvesting.
Mike:But what if you don't what if they don't create oil? What if they don't find oil? They did their best to figure it out. But what if they didn't? Yeah.
Mike:You're taking a risk there. You may get your money back. You may not get your money back. So, you you know, work with the big boys if you're going down this route, but that Yeah. There's risk associated with it.
Mike:So if you're selling a business, if you're selling large amounts of real estate, these are things you may wanna consider with it, but it's it's a more advanced situation. You can't get an IUL without a licensed insurance agent. You can't get a qualified opportunity zone without a licensed financial adviser. You can't get a Delaware statutory trust without a licensed adviser. You can't get access to oil and gas partnerships.
Mike:The advanced stuff you can't do on your own. So when people say they wanna DIY it Yeah. Great. You're limiting your ability on what you could do when it comes to tax planning. That's how it was set up, whether it was the SEC or the DOL.
Mike:I don't I really don't know who made these rules or restrictions, but that's just how it is right now. So remember overall, 0 tax bracket's probably not the best. To do advanced tax planning, you might need to go through a finance professional. The lower tax brackets are great, but you wanna target the effective tax rate over a longer term period of time. And RMDs are coming.
Mike:You don't own all of your assets of your IRA. The IRS or the government is going to claim what they believe is theirs. So, yes, being proactive is going to matter. Doing your tax planning does matter. There is no benefit just for the rich.
Mike:It's just whatever your situation is is gonna give you certain strategies that you can choose to implement or not implement based on your lifestyle and legacy goals. That's all the time we've got for the show today. If you enjoyed the show, consider subscribing to it wherever you get your podcast. Just search for how to retire on time. Discover if your portfolio is built to weather flat market cycles or if you're missing tax minimization opportunities that you may not even know exist.
Mike:Explore strategies that may be able to help you lower your overall risk while potentially increasing your overall growth and lifestyle flexibility. This is not your ordinary financial analysis. Learn more about Your Wealth Analysis and what it could do for you regardless of your age, asset, or target retirement date. Go to www.yourwealthanalysis.com today to learn more and get started.