Why I Dislike Taxes and How I Minimize What I Owe
I want less government in my life and I will do everything I legally can to give Uncle Sam as little of my hard earned money as possible. If you want more government intervention in your life and you want the government to redistribute more of your money than this article is not for you.
Uncertainty of future tax rates
By now most people should be aware that the U.S. has a deficit of $15,400,000,000,000 (see live debt clock) or over $136,000 per taxpayer! This number is growing rapidly at an accelerating rate. Every year the U.S. (and IL) government is spending more money than is taken in from taxes. Government entitlement (SS, Medicare, Medicaid, food stamps, etc.) expenses are mushrooming out of control. Almost half the country is dependent on the government for a paycheck and about 50% of the country does not pay any income tax( My high school intern wondered how people got away without paying any income tax)! That leaves the HUGE TAX BURDEN on the rest of us. By the way, if the U.S. Government confiscated all the wealth from the top 1% of the richest people in this country it wouldn’t make a dent in this problem.
While I think we could climb out of this mess by significantly growing the economy and reworking entitlement programs, I have little faith in this happening. This leads me to believe that tax rates are headed higher.
Given this premise, what vehicles do I choose to invest in?
529 College Savings Plans
I have three children that I will help pay for college. By using a 529 College Savings Plan, the growth in the account is tax-deferred. That means zero tax on the growth while the money is in the account. When I pull it out to pay for college, zero tax is owed. In summary, once I put the money away, I should not have to ever pay tax on it again. As an additional bonus, I use the IL Bright Directions plan and I get to take a state tax deduction for the first $20,000 I invest each year. This is true for grandparents as well.
Health Savings Account
By the government mandating policy coverage for so many items, medical insurance costs have been going up significantly over the years. I save probably $8,000 in premiums each year by insuring my family with a high deductible health insurance plan. For my family of five, I pay a little over $400 per month. By having a high deductible policy, I am allowed to contribute $6,150 annually to a health savings account. This contribution is federally income tax deductible. I can use the money to pay for my out of pocket medical costs and whatever I do not use is mine to keep and stays in my account. The growth of the money in the account is tax deferred, that means I pay zero income tax on the growth and when I use it for qualified medical expenses, there is no tax on the distributions. Zero Tax owed, plus an annual tax deduction, not bad.
This is an employer sponsored plan option, but different than the 401k that most people are familiar with. With the Roth 401k, you do not get to deduct your contribution on your income tax return. The money in your Roth 401k account grows tax deferred while it is invested. When you take the money out, it is INCOME TAX FREE. This is my favorite part, since income tax rates may go up substantially in the future. I love the idea of having a lump sum of money that I can choose to pull from tax free. Unlike a traditional 401k or IRA I do not have to take distribution at age 70 ½ and it passes to my survivors tax free. Once I invest, I never pay tax again.
Permanent Life Insurance
I have owned permanent (as opposed to term) life insurance since I was 26 years old. I bought it while I was single hoping that one day I would find a bride, have kids and an income that was worth replacing should I die with dependents. I guessed right and while the policy is funded with after-tax money, the growth of the cash value is tax deferred. If I need to get at the cash value ( I used about $40,000 a few years back toward an addition on our home), I can take cash up to the amount of my premiums tax free or borrow against the death benefit tax free. One day, I will die and you guessed it; the death benefit will pass to my survivor’s income tax free.
Tax Managed Portfolios – Mutual funds are required to pass through their capital gains and dividends to their shareholders. When you have a typical portfolio of mutual funds, there is no coordination between the different fund manager’s regarding what their gains or losses are throughout the year. In a Tax Managed Account Solution those payouts will be minimalized. Through proper coordination and communication managers can take portfolio losses to offset gains and leave the shareholder with little or no capital gain tax to pay. Yet another way to get more tax deferred growth.
What else should be considered?
Non-Dividend Paying Growth Stocks – I own a little Apple stock (wish I owned more!). While the value has been going up, that growth has been tax deferred (no tax). When I sell the stock, I will pay tax, but usually at a preferential capital gains rate.
Municipal Bonds- Believe it or not, not all states are financial disasters like Illinois. If you loan money to state municipalities, the interest you receive is federally income tax free.
Commercial Real Estate – I own several rental properties and even though they are fully rented, I pay very little or no income tax each year because of the depreciation of the buildings. Again the growth in value (if there is any) is tax deferred. Upon the sale of the property, I could either pay tax at a capital gain rate or potentially role the proceeds into another property or continue to defer the tax.
Roth IRA – I love the Roth IRA as investors can save $5,000 per year of their after tax money. It works just like the Roth 401k in that the money grows tax deferred and can be withdrawn after age 59 1/2 income tax free. The downside is that the contribution limits begin to get phased out when your joint income is over $173,000
Why didn’t a traditional 401k make my list?
For starters, you have to take money out of your 401k sooner or later and when you do it is taxed at ordinary income tax rates. Therefore, the balance you see on your statement is not really all yours. Part of it is yours to keep and part is going to the Government. You won’t know how much you get to keep until it is time to pull it out. If you had a $1,000,000 account balance with a the 35% tax rate, your true account value is $650,000. Not knowing how much we will get to keep down the road scares me. I prefer investments where I use after tax money now and can pull from tax free later.
These choices may or may not be good for you and your situation. If you would like to discuss which ones make the most sense for you, please contact me at 630-942-9007 or send me an email, firstname.lastname@example.org