Joe Anderson
ABOUT Joseph

As CEO and President, Joe Anderson has created a unique, ambitious business model utilizing advanced service, training, sales, and marketing strategies to grow Pure Financial Advisors into the trustworthy, client-focused company it is today. Pure Financial, a Registered Investment Advisor (RIA), was ranked 15 out of 100 top ETF Power Users by RIA channel (2023), was [...]

Alan Clopine

Alan Clopine is the Executive Chairman of Pure Financial Advisors, LLC (Pure). He has been an executive leader of the Company for over a decade, including CFO, CEO, and Chairman. Alan joined the firm in 2008, about one year after it was established. In his tenure at Pure, the firm has grown from approximately $50 [...]

Published On
July 17, 2017

The top 10 tax saving strategies of the last 25 years. From tax loss harvesting to 529 education savings plans. From LLCs vs. S-Corps to asset location (that is, what type of assets you put in what type of accounts). From charitable giving to estate tax planning, and then some. Also, an overview of what happened in the market in the second quarter, and titans, tritons, sun gods and mermen.

Show Notes

  • (01:07) Q2 Wrap up
  • (14:02) Big Al’s List: Top 10 Tax Saving Strategies of the Last 25 Years
  • (25:48) Charitable Giving & Tax Loss Harvesting
  • (34:01) More on Tax Loss Harvesting
  • (43:16) Choice of Business Entity
  • (51:42) 529 Education Savings Plan
  • (1:04:13) After Tax Investing: Asset Location


Today on Your Money Your Wealth, Joe, and Big Al cover – in great detail – the top 10 tax saving strategies of the last 25 years. From tax loss harvesting to 529 education savings plans. From the pros and cons of LLCs and S-Corps to asset location (that is, what type of assets you put in what type of accounts). From charitable giving to estate tax planning… well, you get the idea. Also, an overview of what happened in the market in the second quarter, and titans, tritons, sun gods and mermen. Now, with all the info you need to know and then some, here are Joe Anderson, CFP, and Big Al Clopine, CPA.

1:07 – Q2 Wrap up

JA: Now we’re back to the grind.

AC: Back to the grind, huh? It’s not all that bad. We enjoy what we do.

JA: Yeah I would say 95%.

AC: Yeah I might say 99.

JA: Wow. There’s no way.

AC: (laughs) I’m just in a state of denial and bliss. Actually, I think life is what you make of it. I’m going to get philosophical. I think every day you have a choice whether you want to be positive or negative, and if you choose to be positive, it’s amazing how things tend to work out better. So that’s my lesson of the day. We’re done! Let’s close it out.

JA: Speaking of positive, I’m going to go through the Q2 market update. I think it’s a ton of numbers and it’s really bad radio, but I got nothing else. Alright, here we go. So Q2, here are the numbers: US stock market up 3.02%. 3.02 for the U.S. stock market in Q2 of 2017. Not bad.

AC: That’s the entire U.S. market?

JA: That is the entire U.S. stock market. Quarterly average, the average quarterly return, is 1.9%. So we are beating the average of the U.S. stock market once again. So, the last several quarters. So on average, we get about 2% per quarter. But we did 3%. International developed stocks up almost 6%: 5.63%. Emerging markets led the way at 6.27% just for a quarter.

AC: Annualized, that’s 24%, 25.

JA: The best quarter ever for emerging markets was back in 2009 at 34.7% for the quarter. A few months 34%. And then global real estate was up one and a half, 1.67. U.S. bond market was up a point and a half, 1.45%. And then global bonds, minus the U.S. So international emerging market debt, was up about 60 basis points.

AC: 60, so that’s a little more than one-half of a percent. Because a lot of people don’t know what a basis point is.

JA: Well that’s why you’re here, Al.

AC: 100 basis points equals 1%.

JA: So U.S. stocks – so if we break it down into just the U.S. stock component, it’s 52% of the market capitalization. So if you take a look at the entire markets of the world, the U.S. still has $25.1 trillion or market cap. That’s 52% of the world’s market capitalization is still here in the U.S.

AC: So that means all public companies, their values added together. That’s what the market cap is.

JA: Yeah but of course you have countries in there, like China, that kinda cooked the books a little bit?

AC: Ya think? So it’s maybe a little misleading?

JA: It could be. But I don’t know, I’m not an economist, that’s just my opinion. Some really smart people are listening, they’re like “Anderson’s an idiot.”

AC: Well they can call in and tell us the real truth.

JA: So large growth led the way at 4.67%, so large cap growth companies. Small growth was about 4.39% for the quarter. Large cap all together was 3%. Small caps were up two and a half. Large value 1.34 and small value up about 67 basis points.

AC: Okay. So in this particular quarter, growth beat value.

JA: Yeah. And large beat small.

AC: Right. And when you chart long term, it’s usually the opposite.

JA: If you take a look at the fourth quarter of last year, it was the exact opposite. Small value crushed.

AC: And what’s hard, I mean you can’t really take one quarter and call that a trend. But when you take 10 or 20 years and look at it that way, small and value tend to outperform large and growth.

JA: Right. Because there’s more risk associated with those types of companies.

AC: But also it’s more volatile. And so you may have some quarters where it significantly outperforms and some quarters where it significantly underperforms.

JA: Let’s go international, developed stocks. Small cap led the way there. If you invest in small companies internationally, up about 7.28%.

AC: Oh, that’s the best one.

JA: Growth companies, 7%. Large caps up 5.6 and value companies were up about 4.3. So that’s international. Let’s go to emerging markets, shall we? What led the way there? Growth. 9.5% for emerging market growth oriented companies.

AC: We have a new winner. OK.

JA: Large caps did about 6.5. Value companies in the emerging markets sector did 3.5%. Now, this is for the quarter. This is just for the past few months.

AC: One-quarter, this is not the average for the year.

JA: No. That’s just what it performed for the quarter. And small companies were up just shy of 3%, 2.7.

AC: OK. So what do we do with all that?

JA: Hey, I’m not done yet. (laughs)

AC: Oh really? Do we have to keep listening?

JA: Yes, because now it’s going to get fun! Ranked developed markets. So we got different countries here. Which do you think is the highest performing country for the quarter?

AC: Let me see. I’m going to guess the Netherlands.

JA: Oh, the Netherlands. That wasn’t a bad guess. The Netherlands were up about 8%. That’s pretty good. Austria. 18% for Austria. Denmark 15%, Finland 13%, New Zealand 11%. The reason why I’m sharing this with everyone Alan is that it’s impossible to predict that Austria was going to do 18%.

AC: Well, in the time you talked to I already moved all my assets to Austria.

JA: How about emerging markets? So emerging markets would be China, Taiwan, Mexico, Peru, Turkey, Greece, Poland, South Korea, Czech Republic, Egypt, things like that. What do you think is the highest performing emerging market country?

AC: Brazil.

JA: Brazil. No, that was at the bottom.

AC: (laughs) Okay. China.

JA: Greece.

AC: Oh I was just there. I should have guessed.

JA: Greece. So how much bad news do we hear about Greece?

AC: A lot.

JA: Here’s what Greece did over the past quarter: 34%, In one-quarter.

AC: In one-quarter, really, 34%. It’s because I went on a cruise and spent a lot of money.

JA: Yeah, exactly. You just helped that GDP there, Big Al.

AC: It raised at least 10%. All those trinkets we bought.

JA: Oh my goodness. Yes. Just killed it right there. I think it’s because it’s a little bit less expensive to travel there now? I don’t know. I wouldn’t wanna.

AC: (laughs) It was good. I recommend it. We even went to Turkey, and a lot of people don’t want to go to Turkey anymore.

JA: Turkey was up 18.8%.

AC: Really. OK.

JA: News You Can Lose. Commodities Most people like to talk about gold. Down 1%. But if you bought Kansas wheat, Europe 17 and a half. And then just wheat. How about lean hogs? Lean hogs were up 14.4%. Live cattle were next 8.5. Sugar was down about 20%. Coffee was down about 12%.

AC: So it’s either hogs or coffee. So the last quarter was hogs. So does any of this apply to going forward?

JA: Well no, I think yeah, you want to be globally diversified in all different areas and all different countries.

AC: Because every quarter it’s completely different.

JA: It’s going to be a little bit different because when you hear bad news, we’ve heard a lot of bad news about international emerging markets. But that doesn’t necessarily mean you don’t want to invest there. The proof is right here that emerging markets led the way again, extremely volatile asset class, so it’s not like you want to put 100% of your assets there, but you want to be diversified within different areas of the overall globe. If you look at market capitalization, still the U.S. – we have such a home bias. And for all of you listening, even though I’ve never seen your portfolio, I can probably predict exactly what it looks like. You probably have 60% stocks, 70% stocks. And you I would say about 90% of the stocks that you own is all large company growth.

AC: That would be a good representative of what we see.

JA: And we’ve seen thousands. And we analyze portfolios, we take a look, and there’s a home bias.

AC: Case in point in terms of how people do this emerging markets, until last year, Joe, it was probably the worst asset class, for like three years in a row. And everyone said, “please don’t invest in that because that one doesn’t work.” And last year was great. And this year, here we go.

JA: Yeah, give me more than that. But then that’s where the greed factor comes in. Then you have to rebalance and tax manage this, and you have to understand, first of all, what are you trying to accomplish? What in return are you trying to achieve in the overall portfolio to accomplish your goals? But then the wheels come off every time when the markets move, because it’s like, OK yes I want to maintain a 4%, 6%, 7%, whatever rate of return that you need to generate to make sure that you have long term success in the overall investment. But when you see one asset class outperforms another by a significant margin, the likelihood of that person keeping with their own strategy is very very low, because they will be like, “let’s just take a look at the overall performance. Oh, emerging markets were up X and then the US was down. Well, I don’t want to buy that. Let’s kind of follow the lead here, follow the herd.” It’s the herd mentality. So you’ve got to be careful. You want to make sure that you examine your portfolio, where are sitting? Did you miss on on a couple bucks in your overall return? I would guess yes. But diversification is your best friend, but it’s also in some cases where it blows people up. Your portfolio, if it’s diversified appropriately, you’re not going to achieve the highest rate of return.

AC: Yeah, you’ll never be the top performer.

JA: You’ll never ever become the top performer ever.

AC: But the point is it’ll never be the lowest either.

JA: Yes. So it’s not necessarily managing return, you want to manage risk. And I think a lot of our listeners are looking at, “I want to hedge my risk as much as I can because I’m retiring soon, I need cash flow, I need income. But I also want to make sure that I generate a return that will outpace inflation and taxes, and then maybe I have a couple of bucks to give to the kids, grandkids” or whoever that you want to give your money to. But that fear and greed will drive you nuts. When the markets are performing, U.S. markets, what do we hear? S&P 500, Dow Jones inundated. And then so people compare their overall portfolio. If they’re globally diversified, maybe to the wrong benchmark. So that’s where you have to understand what the heck you’re doing. And knowing that, OK, well, certain asset classes are going to perform in different ways. They’re going to be more volatile. There’s going to be more risk associated with them. They’re going to go up and down more violently than other asset classes. I don’t want bonds because interest rates are going up. OK, well you need to cushion the blow if the markets implode. So it’s not necessarily always about getting the highest rate of return, it’s measuring the risk that you’re taking in the portfolio, mitigating that to give you the highest probability of return. So that’s my 10-minute market spiel. I’m sure we’ve lost most of our listeners.

AC: Those that stayed are much smarter for it.

JA: Oh yes they are.

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It’s time now for Big Al’s List: Every week, Big Al Clopine scours the media to find the best tips, do’s and don’ts, mistakes, myths and advice to improve your overall financial picture – in handy bullet-point format. This week, Top 10 Tax Saving Strategies of the Last 25 Years

14:02 – Big Al’s List: Top 10 Tax Saving Strategies of the Last 25 Years

AC: This is Worth Magazine. These are solid gold. Every single one of these. Time true tested. (laughs)

JA: Really? See usually with these “Best Moves”… I mean it is bad. They’re like, “really?”

AC: Well, every one of these we talk about. But here they are all in one place. Some will seem elementary to you, but they’re worth discussing. Number one is municipal bonds. Why is that a good tax planning strategy?

JA: Well that’s a double edged sword right now. A municipal bond is a tax-free income. And if you buy that municipal bond in the state that you reside in then, it’s going to be state tax-free as well, and municipal and county and whatever. Triple tax-free is the terminology. So you do not pay any income on the interest that that municipality or the municipal bond is generating. You could buy a municipal bond in a state that you don’t live in. It would still be federally tax-free, but then you would have to pay state tax, if you have a state tax in your state, on the interest. So that’s a pretty good thing.

AC: Yeah and of course this one depends on your tax bracket.

JA: Yeah, you’ve got to be careful. if I’m in the 15% tax bracket, 25% tax bracket. If the numbers are probably not going to jive to where you think it’s going to benefit you because you’re going to receive a lower yield on that interest payment because it’s from a municipality. They’re building the tram or something. The school district. The water district or whatever it is. And it’s not like they’re making significant profits, so the interest payment is going to be lower. But to entice you as an investor, they’re going to say the interest payment that we’re going to give you is going to be tax-free, because it’s a little bit lower than you could purchase, let’s say a corporate bond, that is for profit.

AC: Yeah, so it depends upon your tax rate. You’ve got to look at after tax returns. So a little example: 6% rate of return on a bond, if you could find one. (laughs) We’re going Greece!

JA: (laughs) What is this, the 70’s? Yeah, Puerto Rican bonds!

AC: I just want to do the math simple. So maybe it’s who knows, maybe it’s a risky bone. 6%. (laughs)

JA: Yeah, that’s going to default. If you get a 6% deal…. (laughs)

AC: But let’s say you’re in a 50% tax bracket, which you could be in California, because of the federal tax rate, the highest rate is about 40%, and then California can be another 13.3. So we’ll just say 50% tax rate. So your 6% rate of return is going to feel like 3% net to you because the other half of it goes to taxes. Well, if you get a municipal bond for 4% or 4.5%, that’s lower than the 6, but you got more money in your pocket. That’s the idea of the net after tax returns. And to put it in current numbers….(laughs) It’s probably a 4% corporate bond, and a 2.5, 3% municipal bond, depending upon the term.

JA: Sure, if you’re going long. I don’t know, does that make sense? If you look at right now, with municipalities, and if the change of the tax code, and things like that, it’s a risky proposition I think. Let’s say there’s tax reform, and then I was in the 39.6 % bracket. Now I’m in the 35%. Now that tax equivalent yield is not necessarily going to look as good.

AC: Right. And let’s say I move to Washington state. Now I don’t have any state taxes. Or Nevada for example. And of course, as you were alluding to, if you’re in a lower tax bracket, then that net after tax return, it’s not going to be that different than the regular return. So anyway, it depends. One other thing is, some municipal bonds are an alternative minimum tax adjustment. So if you’re subject to alt min, then be aware of that.

JA: So let me put this in perspective. So you want to go five years, ten years, three years, you want to see an average here?

AC: I want to go five years.

JA: Five years. OK. So let’s just take a look at long U.S. government bonds over the last five years. 2.82%.

AC: OK. That’s the US government, not corporate.

JA: Now we go into, you want to go to corporate high yield. So it’s junk, risky. That’s 7. 6.89%. So then you look at just the aggregate bond index. So that’s kind of everything all hodgepodged in there. 2.2.

AC: 2.2. Yeah. We know bonds have not paid that well. Over the long term though, bonds, if you go back decades, they returned 5 or 6%. We haven’t seen it lately.

JA: Let’s see, bonds over the last 10 years, it’s about 4.5. So if I look for the last year, U.S. government bond index is down about 7%. Municipal bonds are down about 50 basis points. But high yield is up 12. Past performance is not a guarantee of future results. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of the actual portfolio, yield curve data from the federal reserve…

AC: I’m so glad you mentioned that. Okay, we’re compliant now.

JA: We are. So right, next.

AC: Roth conversions. Right off the bat. Why is a Roth conversion good?

JA: What is this, a quiz? (laughs) Testing my competency?

AC: I just talked to somebody that had watched our TV show, and he said he liked the quizzes the best.

JA: Oh, OK. All right, so why is Roth conversion good. Well, it could be good, and it could be bad. It really depends on your specific situation.

AC: That’s not a very helpful answer.

JA: The idea behind a conversion is taking money from a retirement account that is either a 403(b), 401(k), TSP. It’s a defined contribution plan. You put pretax dollars going in. So you get a tax benefit today, and its growing tax deferred, and then you’ll pull those dollars out and you’ll pay taxes at a later date. All of that is great. But in some instances, what we find is that, if you’ve saved a lot of money in these overall retirement accounts and they build to a certain dollar figure, we see that sometimes the old adage of you’ll be in a lot lower tax bracket in retirement is not necessarily true for those people. So tax diversification is a key component of a tax efficient retirement strategy. By having money from a retirement account that would be taxed at ordinary income. But also, if you have money that’s in a Roth IRA that would come out of those dollars tax-free. So conversion, as you’re converting some of those dollars to a Roth, you’re paying the tax today, but then all future dollars are going to grow 100% tax-free. And if you do this correctly you could save yourself significant tax dollars long term because there is no required minimum distribution in a Roth IRA. You’re going to, let’s say, pass at some point. It goes to your spouse tax-free, it would go to the kids tax-free. Now if you believe that tax rates are going to stay the same or potentially go up on you, now it might make even more sense to take a look and say, “I want to start chipping away at this retirement account. Get it into a Roth, so I don’t have to ever worry about the tax again. So I’m a huge fan of Roth conversions and so are you. We’ve been talking about them for the last 10 years because it gives you power, it gives you control over your taxes in retirement. Then you know exactly what you can manipulate your tax bill to be, based on the assets and how they’re taxed.

AC: Yeah what’s a little trickier, or what would seem a little tricky right now is, do we convert now, in what could be a higher tax bracket based upon tax reform, which may or may not happen and we may have lower brackets? And Joe, I think a lot of people don’t realize, when you do a Roth conversion, that’s simply taking money out of your IRA, converting it to a Roth IRA. You pay taxes on what you convert. But then, all future growth income principal is tax-free. So if you do a conversion right now, let’s say Monday, you go to your broker and say, “I want to do a $100,000 conversion.” Whatever. And then you have until October 15th, 2018 to undo it. Let me say that again. October 15th, 2018. Not this October, next October. Why that date is that’s the final extended due date of a tax return, and the IRS says you can undo it if you want to. So here’s the strategy that almost nobody considers is, when you do a conversion, you also have to look at what the account has grown to, or decreased to before you make that decision. For example, we may find out that you’re in the 28% bracket now. You did a $100,000 conversion, 28% bracket means you pay $28,000 in federal taxes, plus state. And next year, you’re in a 25% bracket. So you would say, “well, I’m just going to characterize it because I’ll be in a lower bracket next year.” But what if your account went from $100,000 to $125,000? Well, you’re actually paying that 28% on $100,000, whereas next year, if you want to do basically the same transaction, you’d be doing 25% of $125,000. If you do the math, you’ll actually do better converting in a higher bracket, based upon the growth of the account. And this is just a big mess. I don’t think a lot of advisors, and a lot of even tax preparers, are not really aware of this strategy.

JA: You’ve got to look at the tax equivalent rate. The effective tax rate.

AC: Right, it’s kind of like a muni bond, if you will. What did that really cost you in terms of, when I do the recharacterization, or when I’m thinking about the recharacterization. What’s the account worth versus what’s the amount of tax that I have to pay? Do a new mathematical calculation to find out your real tax rate. And in my example, I don’t have my calculator in front of me, but it’s going to be below the 25%, actually would be a good deal in that case. Even though tax rates go down.

JA: But then I got $100,000 in a Roth IRA that I pay tax today, and when I need that money 10, 15, 20 years down the road, I potentially now that $100,000 could double, could triple in 20 30 years, depending on what you’re invested in. Hypothetically of course. But then you have that money that you can draw from, in addition to your retirement accounts, in addition to your Social Security, in addition to your pension plans. That is not going to jump you up potentially even into higher brackets if you need more cash flow in a given year. It’s giving you the control that we believe that you absolutely need, because when you need the money the most? It’s in retirement. You have the cash flow today as you’re working. You’re not going to have a paycheck, in most cases, when you’re retired. You’re going to have to create your own. And you can create some of that paycheck tax-free, that’s key.

There are many tax saving strategies, in addition, the ten we’re covering today. Which ones work best for your situation? Find out! Visit YourMoneyYourWealth.com to access white papers, articles, webinars and over 400 video clips on tax planning, as well as investing, retirement planning, Social Security, estate planning, small business strategies and more. It’s a veritable treasure-trove of information just waiting for you atYourMoneyYourWealth.com. If you need more help, you can always email us at info@purefinancial.com, or pick up the phone and call us at 888-99-GOALS. That’s 888-994-6257.

25:48 – Charitable Giving & Tax Loss Harvesting

AC: This is Worth Magazine. What have been the top ten tax saving strategies of the last 25 years, and the third one is charitable giving. I think most of us know, if you give money to charity, you get a tax write off. But a lot of people, kind of, that’s the end of their knowledge. And let me give you a few basic things that if you don’t know you should know, and if you do know, maybe it’s a good reminder. First of all, a charitable deduction is what’s called an itemized deduction, and every year you add up all your itemized deductions and you see if it’s more than the standard deduction. And if it is more than the standard deduction, then you get to take your charity.

JA: Right. If you’re not itemizing your deductions, so let’s say you don’t have a mortgage, you don’t have medical expenses. The state taxes are low. You don’t have unreimbursed employee expenses and things like that. So you have to look at, well how much are you giving to charity? If you’re giving $5,000, $10,000, what, the standard deduction is 13 something?

AC: Yeah, for 2017, the married filing joint, $12,700 is the standard deduction. If you’re single it’s $6,350. So in other words, if all your itemized deductions don’t add up to those figures, then you just get the standard, which means that extra charity payment that you made didn’t affect your taxes at all. So if you’re looking for a tax deduction…

JA: Well, I think people give for the giving.

AC: They do but sometimes they’re misgiven. They think that they’re getting a tax benefit, and they’re not. So that’s the first thing to be aware of. The second thing that a lot of people don’t realize is, you don’t have to give cash. Most charities will accept your stocks. Your mutual funds and why would that be an advantage to you? Well, if you give them some shares of stock that are appreciated, well, you don’t have to pay taxes because you never sold it, you gave it to the charity. And by the way, your charitable deduction is what the stock is worth on the date that you donate it. So think about this – if you’d sold the stock, then you pay the tax and then whatever the difference is, you give that to charity. $10,000 stock, you pay $3,000 of tax, you give a charity $7,000. Or, $10,000 stock, you just give it straight to charity. There is no tax to pay, and the charity gets the $10,000.

JA: And then you get a tax deduction for the $10,000.

AC: That’s right. That’s exactly right. And this I think is surprising to a lot of people, even well-educated people, that they can actually give stocks to their church or to – a number of organizations will accept them, so then that means if you have appreciated stocks instead of selling them all, maybe designate some for future gifts to charity.

JA: Right, because those stocks probably are earmarked for something. So then you look at, what is it earmarked for? Is it earmarked for income? So let’s say you have high dividend paying stock, you loved the stock. You’re like, “no I’m not going to sell the stock, I’m just going to give cash.” You could buy the stock back with the cash. So you give your highly appreciated, high paying dividend stock to the organization of your choice< the charitable organization, you get the tax deduction, you don’t pay tax on selling it. And then you take your cash, and you buy back the stock the same day. So you’re not going to disrupt your portfolio one bit, but it’s going to save you quite a bit on the other side in regards to the tax. You gotta look at your total return.

AC: You gotta look at your total return. Something else that a lot of people don’t know is, you can bunch up your charitable deductions all in one year. Let’s say you have a high-income year, for whatever reason, this is the year you got a huge bonus or severance or who knows what. Well, you can actually put money into what’s called a donor advised fund, and you can do that through Schwab or T.D. Ameritrade or Fidelity, they all do them. It’s an account that you control. You’re the trustee of that account. And this is an account to be divvied out to the charities of your choice in the future, whatever you want. So in other words, let’s say you give $10,000 a year to charity. Whatever the number is, doesn’t matter, and you’re an extra high tax year, and you can afford it. So you put $50,000 into a donor advised fund for future charities. You get the $50,000 deduction this year, the year you put the money into the donor advised fund, then you can decide next year, alright, I’m going to give the $10,000 to the charities of my choice, and it can be it can be any charity you want.

JA: Right. And it can vary, you can say all right I’m going to give $20,000 this year, zero next year. $5,000 the following year. It doesn’t matter, you’ve got that the tax deduction when you put the funds in the overall account.

AC: Correct. And so, understand it’s a one way street, you can’t take the money back, it’s a charitable donation, but it applies to a lot of folks, when they’re in a high tax year, and we see that particularly those individuals that are in their 50s and 60s, maybe they’re making more salary, maybe they had a big bonus year, or maybe they sold a bunch of company stock, stock options, who knows. And any number of things that can happen to where, temporarily, you’re in a higher bracket and wouldn’t it be nice if you could create an extra deduction in those years. And the truth is you can.

JA: Right. Yeah, it’s a great strategy. Donor advised fund.

AC: Yeah that’s a good one. The fourth one, Joe, is tax loss harvesting, which we talk about all the time. So that can be pretty effective too for reducing tax.

JA: Yes but I think, still, people get so confused on the concept. They don’t understand the long term effects of why you would want to do it. And it’s almost counterintuitive to what people hear in regards to when to buy and sell stocks. Because here’s the concept of tax loss harvesting and this is only applicable if you have money in a non-retirement account. So if you have dollars in a brokerage account that are outside of a retirement account, and stocks go up and stocks go down and let’s say you have a loss in a particular stock, stock mutual fund, exchange traded fund, index fund, doesn’t matter. So you bought it at $10 a share. Now it’s worth $7 a share. So you have a $3 loss. What we would suggest that you do is, to sell that security. People are saying, “well no, I’m at a loss, because it’s anchoring.” People anchored their investments on whatever they purchased it for. “No, I bought it at $10 a share. I’m not going to sell it until it at least gets back to $10 a share.” We’ll say, no, now it’s at $7 a share, you can sell those, invest that investment, and buy something similar.” Let’s say it’s a mutual fund, large company mutual fund. You sell that, you buy something similar. You buy an all U.S. stock market index fund.

AC: Yeah. And then 30 days later, you can go back into the original fund if you want to.

JA: And why would you want to do that is what you’re doing, yes, you’re lowering your basis to $7 you share, but you’re also taking that $3 loss,  and then that sits on your tax return. And then that loss will offset any gain that you have in any other investment, dollar for dollar. So if you harvest enough losses, as stocks are volatile, and you have gained in other areas, and as you rebalance your portfolio, or you try to create income from your portfolio, that income or distribution that you’re taking from that account would be offset by those losses. So you could create another tax-free way of income in retirement.

AC: Yes so your Roth IRA plus your non-qualified non-retirement accounts can be taxed at zero if you do enough tax loss harvesting.

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34:01 – More on Tax Loss Harvesting

JA: We’re talking tax loss harvesting, and I want to get into this just a little bit more because you could get a globally diversified portfolio that will perform quite well with three funds. You could say, I want to do the total stock market index. I’m going to do the total international emerging market index and a short term bond fund. And then I could pick my allocation, maybe I want 60% of my equity component in U.S., 40% is going to be international emerging markets, and then the rest is going to be bonds and depends on my split of 60/40, 70/30 of bonds and stocks. So you can do it with three funds. The returns on that – it could be similar, let’s say if you had 10 different funds. If you break it out a little bit differently. If you say I want a small company fund, I want a large company fund, I want a growth fund, I want a value fund, I want an emerging market fund, an international fund, and so on.

AC: So you kind of have similar investments, but they’re in additional wrappers if you will.

JA: Yeah right. Instead of having three apples, I might have nine apples, but the three apples that I have, they’re really big apples.

AC: Yeah. Same amount of good eatin’. (laughs)

JA: Yeah right. It’ll fill you up if you eat those three apples versus the nine. (laughs)

AC: Gotta eat all nine to get filled up. (laughs)

JA: Yes, right. OK. But here’s the problem with that, is that what happens is, trying to rebalance and tax loss harvest is a little bit more challenging, or not nearly as efficient in my opinion.

AC: When you have just three. Because you have kind of winners and losers all blending together in the same investment. That’s a good point.

JA: In that same fund. And then when you look at target date funds, those are extremely popular. If you have a target date in, let’s say a Freedom Fund, I’m retiring in 2030. So you picked that in your 401(k) plan it doesn’t matter because there’s no tax loss harvesting. But if it’s in a non-qualified account if it’s in a brokerage account, I think it’s very inefficient from a tax perspective because you might have all those asset classes in one fund or two funds, but how are your tax managing it? Because let’s say I have a total U.S. stock market fund. Well, I’ve got small companies in there, I got mid-sized companies in there, I got growth companies in there, and I got value, and I got growth. But it’s all in one fund. And we just went through the numbers. Sometimes value significantly outperforms growth, well you might want to rebalance that to get it right, or sometimes value underperforms. You might want to tax loss harvest that.

AC: Yeah, there’s no question this can be a big deal. And these losses, you can net dollar for dollar, against any capital gain. So for example, your stock losses, you can net against real estate gains, because it’s still a capital asset. And the IRS says that every single year, whatever your accumulated losses are, you compare it against your gains. Dollar for dollar. And so you can, year after year, have no capital gains. If you still have extra losses, the IRS says, “well, we’ll even let you deduct $3,000 more against ordinary income. And then the difference will carry over to the next year.” And it carries over for your entire life. So you never lose it. So there’s really no downside to doing this, other than there are some trading costs. And so if you have a $6 loss, you might not want to do that trade, because the trade might cost you $6.

JA: Right. Sometimes you just gotta bite the bullet with some of this, because you might have a position that is a significant gain from when you purchased it, but that now is getting crushed. You still can’t tax loss harvest it, because it’s still higher than the basis that you purchased it. So that’s kind of where I’m falling into. I have two different portfolios. One is just a simple three fund jobbie that I put together, I don’t know, 15 years ago. And now there’s a lot of gains over the last 15 years in that portfolio. And I was like, “OK, I need to get into my other well-diversified tax efficient portfolio, but I can’t. I’m just going to blow myself up and tax!” So I’m not even following my own advice! I’m like a fat doctor. (laughs)

AC: Well that’s because you get smarter over time. You’re better now. Hey, Joe, we’re talking about the top 25 tax saving strategies in the last 25 years in Worth Magazine. Their next one is maximizing retirement plans and a lot of people don’t do that. I mean basic stuff. If your employer has a 401(k), you at least want to contribute to the match. And what a match is, is, if you put money in, your employer puts money in. So why wouldn’t you do that? You put in a dollar, your employer puts in a dollar. It’s like you put in two, but it only costs you one.

JA: Because I can’t afford it, Al.

AC: I know that’s what we hear. People don’t realize though that a 401(k) or 403(b), it’s a tax deduction. So that dollar that you put in is something you don’t pay tax on. So it’s actually, out of your pocket, it’s gonna cost you less than a dollar because you save taxes on that buck. So anyway, and I understand, especially when you’re younger, and you’ve got credit card debt, you’ve got a car loan, you’ve got student loans, and you’re being told by Dave Ramsey to get that thing paid off as fast as possible. And I don’t disagree with that, but I also don’t want you to leave money on the table when it comes to a 401(k) with a match.

JA: Well here’s on the other side of this, Al, because let’s say that I’m self-employed. I ran into an individual, hypothetically, that builds very high-end homes in Southern California. Makes a great living, he’s got lawyers, he’s got CPA’s, he’s got a broker, and he’s been putting his retirement savings solely in an IRA. $5,500, $6,500. That’s it. And I’m like, “Well, why don’t you have a solo 401(k) plan? You’re a sole proprietor, you don’t have any employees, you make a great income, you know that you can shelter a lot more money than the $6,500. And if he would have done that, because he’s in his 60s. How about if he started that 20 years ago? And had the income, do you think you would probably max it out? The answer is yes. So he’s maxing out an IRA, which he thought that was the max, was $6,500, and he doesn’t have a ton of retirement saving, because of that fact. Because of human nature again. I’m going to start with my retirement account, well it’s $6,500, well then I got an extra cash flow. Instead of saving it into a non-qualified or brokerage account, sometimes we tend to spend.

AC: Well and I think a lot of professionals and business owners, they spend time thinking about their business, not about retirement planning.

JA: Exactly. Where’s the next job going to come from? Let’s finish this one…

AC: Right. And then it’s like retirement, you’re 40, it’s like, well, I’ll think about that tomorrow. I got to get the next client. I got to do this job. They’re expecting it tomorrow. And I understand that. But sometimes if you would just plan your retirement as much as you planned your vacation, you would be in so much better shape, and when it comes to retirement plans, if you’re a business owner, there’s that solo 401(k), which is a good one, if you have employees, safe harbor a 401(k) is a great one. If you make a lot of profit and you’re older, let’s say you’re in your late 50s, 60s, defined benefit plans still make a lot of sense. Joe, you and I have seen business owners put away $200,000 or $300,000 in a single year, and get a tax deduction in a defined benefit plan.

JA: So 300 grand deduction. We’ve given advice to some business owners where, because of that large deduction, has put them in such a low tax bracket, then it makes sense to take their other retirement accounts and convert those into Roth IRAs while they’re in a low bracket. They’re like, “I’ve never been in a low bracket, I’ve never been able to qualify for a Roth IRA.” I was like, here, watch this. Here, shelter 300 grand. Now you’re in a 10% bracket. There’s room for another, I don’t know, maybe $100,000. You’re still paying half of the tax that you would have if you didn’t do the planning.

Your Money, Your Wealth isn’t just a podcast, it’s also a TV show! Check out Your Money, Your Wealth on YouTube to see Joe and Big Al talking about planning for retirement over your entire lifespan, investing biases you may not realize you have, Social Security claiming strategies, and… Pure Financial Feud! Watch clips of the Your Money, Your Wealth TV Show – just search YouTube for Pure Financial Advisors and Your Money, Your Wealth.

43:16 – Choice of Business Entity 

AC: You know what’s weird about doing the TV show is you get recognized, albeit very, very occasionally. (laughs)

JA: (laughs) Once you go to the nursing home.

AC: (laughs) I get recognized in the office with our clients. “Oh! You’re on the TV show!”

JA: Yeah, in the elevator.

AC: But I went to the San Diego Fair. I think it was over the Fourth of July weekend, and right in the middle of thousands of people, this lady: “Oh you’re the Pure Financial TV guy!”

JA: Did you sign some autographs, Big Al?

AC: (laughs) I said, “Well, yes I am. Thanks for watching.”

JA: “Call me Big Al!”

AC: It happens occasionally, and I’m here to tell you, I enjoy that.

JA: Oh! So if you see Big Al  on the street… (laughs)

AC: Just say hi. I’m not one of those celebrities that get inundated. (laughs)

JA: (laughs) Celebrity is a very large word there, buddy. Wow. I’d say you’re an infomercial king.

AC: (laughs) I’m an accountant/financial planner that gets an opportunity to talk in front of a microphone and a camera.

JA: There’s nothing better than getting a microphone, project your voice a little bit.

AC: Oh it’s great because people will tell me sometimes, “wow, you got a great voice for radio.” I’m thinking “really.” (laughs)

JA: You should see his face. (laughs)

AC: (laughs) Well they always follow up with that: “And I can see why you don’t do TV,” but they don’t say that anymore since I do TV. But they put dark lights on me so you can’t really see – just see the silhouette.

JA: We’re in the presence of something special here folks. (laughs)

AC: Well, we are talking about the top 10 tax saving strategies of the last 25 years. This is Worth Magazine.

JA: We’re not finished with that yet?

AC: We’re only halfway. How many segments do we have? (laughs) I’m only at number six. Next one is the choice of business entity.

JA: Oh, now this is interesting.

AC: So like, here’s your basic choices. If you don’t do anything, you’re by default a sole proprietorship, but you might want to be an LLC. You might want to be a partnership. And partnerships, general partnership, and limited partnership. You might want to be an S-Corp. You might want to be a C-corporation. And it’s very confusing for new business owners as to what’s best. And there’s there’s a lot you could say, but I’m going to try to boil it down pretty simply. And that is if you’re just starting out a company and you’re not even sure if you’re going to make a go of it, just stay sole proprietorship. It’s simpler.

JA: What’s the difference if I’m a single… why do Subchapter S versus just a single member LLC?

AC: Well, that’s a good question, because that would be kind of the next level that you would go to.

JA: Is it based on employees, is it based on profits, is it based on revenue, is it based on liability?

AC: No, a lot of confusion here, but most business owners pick S-Corporation over LLC for a couple of reasons. One is, with an S corporation, you pay yourself a salary and you only pay payroll taxes on that salary. When you’re an LLC, everything is considered earned income. You don’t pay yourself a salary, but it’s all earned income. So let’s say you make $100,000 of profit. If it’s an LLC, that whole $100,000 is subject to payroll taxes. If you’re an S corporation, you pay yourself $50,000 and the other $50,000 is just profit from the business. You only pay payroll taxes on the $50,000.

JA: OK, so tell me the distinction because there’s some practice here that the IRS doesn’t necessarily care about.

AC: True. Well yeah, when I go over that you can start to see the abuse, here.

JA: I still don’t understand. So I’m making $200,000 of profit. And so I’m going to pay myself a $30,000 salary.

AC: Yeah, or a dollar. (laughs) If you want to go extreme.

JA: (laughs) Yeah. So I’m paying myself a salary, I’m paying some self-employment tax on the 30 grand, and then 270 is coming through the flow through as a dividend. I’m not paying Social Security tax on that.

AC: No you’re not.

JA: I’m not paying self-employment tax but I’m still paying FICA on the employer side, or no?

AC: No, nothin’. No payroll tax at all on the 270.

JA: 14%.

AC: Yeah you save 15.3% on the first $127,000. And then above that, you save 2.9%. Now, I will say in California, you do have to pay 1.5% for S-Corporation profits, so there’s a little offset there. But it works out a lot better. And so the IRS is very savvy to this because people are trying to pay themselves a really low salary with an S corporation. And here’s what they say. IRS says that you have to pay yourself a reasonable salary based upon the job that you’re doing. So, for example, let’s say…

JA: I dig ditches. If I’m digging in every ditch, everything is salary.

AC: If you’re the only employee, it’s hard to justify anything other than 100% of the profits being your own efforts.

JA: But If I have reoccurring revenue, then that would qualify as a dividend, maybe?

AC: It could, I’ll give you a couple of extreme examples. You’re an attorney. You make $300,000 a year, you got no employees. At all. That would be pretty hard to argue your salary shouldn’t be $300,000 because it’s all based upon your own efforts and energy. Now on the other hand, as an attorney, what if you work on contingency and get a big settlement? Maybe you could show that this million dollar settlement that you got, only $300,000 was based upon your salary and efforts, and the other $700,000 is potentially a dividend. That could be. Another situation is, you’ve got employees, and your employees are all getting paid $50,000, and you’re the CEO, owner, the person getting the clients, blah blah blah, and you only pay yourself $20,000. Well, it’s not going to fly. You’re CEO. CEOs make more, generally than the other employees.

JA: How about this. Let’s say if I create an app. And I put in a lot of time and effort upfront. Now the app is just killing it. So I’m not doing any work.

AC: Yeah I’m OK with that.

JA: I haven’t even looked at the app in years and it’s bringing in $500,000 of revenue.

AC: So probably all you’re doing is going to your mailbox and putting your money in the bank. You have to pay yourself for that. Keeping the company open, whatever it may be. But that would be rather minimal.

JA: So I could justify maybe a $10,000, $20,000 salary and have everything flow through.

AC: Potentially.

JA: Guarantee I’ll get audited though.

AC: Yeah, the IRS may look at that, (laughs) but that’s really what it comes down to is. What’s a reasonable salary for the services that you’re providing? And so there’s no hard and fast rule. I mean, it’s not like you can say, “if I pay myself $75,000 and I’ll be ok, right?” Well, it may be, depending upon what you’re doing for that salary. And so, consequently, this is abused a lot. But I will say this, just based on my own experience in the past. So who knows whether this will still hold true. I have never seen the IRS come after somebody that paid themselves some salary. I’ve only seen them come after ones that pay zero salary.

JA: Oh, awesome.

AC: So far. So far. So maybe I shouldn’t have even said that.

JA: But still, people are not even paying themselves a salary. They’re saying everything’s a flow through.

AC: Right, exactly. And sometimes in a scenario, they don’t even know they’re supposed to pay themselves a salary.

JA: Sure. Yeah. Hand writing their tax return. Alright, well, lessons learned from Big Al.

Visit YourMoneyYourWealth.com and sign up for free financial assessment with a Certified Financial Planner. Find out if you’re on track for retirement. How much money will you need? What Social Security strategies are available to you? How much income can you get from your portfolio? Which of the tax strategies we’re discussing today work best for your situation? Make sure your retirement strategy is aligned with your retirement goals. Sign up for a free two-meeting assessment with a Certified Financial Planner at YourMoneyYourWealth.com

51:42 – 529 Education Savings Plan

AC: Joe, I am going over, if you just tuned in, what have been the top 10 tax saving strategies in the last 25 years, according to Worth Magazine. You already missed the first six. If you missed them, go to our podcast on iTunes. Type in Your Money, Your Wealth and you can hear the other six, but I’m on to seven. The seventh one is a Section 529 education plan. What’s the big deal about that?

JA: I don’t know. (laughs)

AC: (laughs) Why is that a good idea? Or is it?  (laughs)

JA: I don’t know.  (laughs)

AC: Agree or disagree?  (laughs)

JA: Yeah, right. Exactly.  (laughs) Well, here’s what a 529 plan is, is that it’s a college savings plan, they’re sponsored by states, there are several states that have them, most states I believe. You don’t necessarily have to pick the state that you live in, or that you reside in. You might want to look to see if there’s a tax benefit by putting money into it. Some states do. They might give you a little bit of a tax credit.

AC: California does not, by the way.

JA: California does not. So you put money in. $10,000. Put that in, per year. Grows to $200,000. Because you started this when your child was 5 years old.

AC: And you bought Apple. (laughs)

JA: Yeah whatever. (laughs) So now you have this money in a 529 plan. The benefit is that if you use that for qualified education expenses, then the distributions are going to be 100% tax-free.

529 plan. The benefit is that if you use that for qualified educational expenses then the distributions are going to be 100% tax-free.

AC: So in your example, that whole $190,000 of gain, tax-free. Never pay tax on it.

JA: Tax-free, as long as you use it for college. So if I use it for higher education, trade schools….

AC: But you’ve got to designate a beneficiary, what if that beneficiary, your first grandchild doesn’t go to college?

JA: Well then you can name another beneficiary.

AC: So you can switch it.

JA: Yeah that’s pretty cool. So instead of, like, “oh man, I’m stuck,” because if you don’t use it for higher education, well then it’s going to be taxed and penalized.

AC: Yes so none of my grand kids go to college and I want the money. So I pull the $200,000 out, I got to pay taxes on $190,000 and penalty on it.

JA: You got it. So you want to make sure that – I guess the pro to those, is that, well you get a tax deferred, tax-free vehicle, which is phenomenal. The downside is that what we’ve found is that some of you may have overfunded it. That’s very few of you. Most people are ill prepared for retirement and college savings and things like that. But if you were one of those 5 out of two million people (laughs) that are overfunded, then it’s like, “OK, well now what do I do here? The kid’s not going to school.” Even if you have like 10 grand in it, you’re still going to have to pay taxes and penalties. So you look at it like this, to say, who are my beneficiaries that I want to save for? So is it my children, is it my grandchild? So then you look at how many beneficiaries do I have. You just have one, my advice – not to say, here, let’s put four years of college in this thing.” Maybe you fund two years of college into it.

AC: Yeah that’s a good point. So let’s, just in simple numbers, I know college is more expensive than this, but let’s say four years is $100,000. Maybe you end up with where you have 50 or 60 grand in a 529 plan, because if you put the whole hundred in, it may not be used, and then you kind of stuck, now what? Now you can, if your kids don’t go, you could give it to your grandkids, or your great grandchildren. So you could do that.

JA: Yeah you could keep switching beneficiaries, but let’s say that the child goes to the Armed Forces and they get a full scholarship like they’re brilliant.

AC: You got one that goes in the military and one is brilliant. So you didn’t need the 529 plan.

JA: Or you’re short on your retirement. And the kids don’t know that the money’s in the 529 plan. And you’re like, “honey, see this 100 grand?” (laughs)

AC: “Let’s pull this out, we thought we were OK.” (laughs)

JA: “He could get a loan. I need to fund our retirement!” (laughs)

AC: “We never listen to Your Money, Your Wealth. We’re behind a little bit.” (laughs)

JA: So yeah. So there’s pros and cons that you can pick any state that you want. California has a decent plan I think, you just kind of take a look at the custodian and make sure that you’re comfortable with the investments. It’s a state sponsored plan.

AC: So you can pick, like for example, I picked Nevada, because at the time they had Vanguard funds that I wanted to do, and my two kids, one went to college in California, and one went to Colorado. So it makes no difference what state the 529 plan is in.

JA: Or what state the child goes to school. So if I live in California,  my kid goes to the University of Florida. That’s my alma mater. If I have a kid, first I’ve got to find a spouse. But anyway. (laughs)

AC: You know, I got contacted by my alma mater…

JA: Cuyamaca College? (laughs)

AC: (laughs) Chapman’s.

JA: University of Phoenix? (laughs)

AC: No, I went to University California in San Diego.

JA: UCSD. The Fighting Toreros.

AC: I got contacted by Louis and had coffee with him yesterday morning, and he wants me to get a little bit involved with the alumni association a little bit so, maybe will.

JA: Have you ever met the guy before?

AC: No.

JA: What’s his name?

AC: Louis.

JA: Oh. You said it as though I should know the guy.

AC: You don’t know him? (laughs)

JA: No. You’re like, “Louis,” I’m like “who the hell is Louis?” (laughs)

AC: Well I don’t have his last name memorized. Nice guy though.

JA: Got it. So you guys are pretty tight. How much money does he want from you? Because he heard big wallet on Big Al.

AC: Tight. We had coffee together. No money. Well, he did watch our TV shows. So he kind of stalked me a little but.

JA: Got it. UCSD, that’s the Toreros, isn’t it?

AC: No it’s the Titans, isn’t it?

JA: You don’t even know.

AC: It’s the Titans.

JA: Yes I knew it was T.

AC: But he gave me a special pin. It’s the Sun-God because that’s kind of the mascot, I guess, if you will. Because no one knows what a Titan is, myself included. And I went there 4 years. (laughs) Anyway, we’ve also on this list, Joe, we’ve got the estate planning. And estate planning is tricky. I should say estate tax planning. Let me rephrase – estate tax planning because there’s a difference. Estate planning is making sure your wills, trust, powers of attorney, are all in order. Estate tax planning is trying to figure out the assets going to the kids in the most efficient manner and a few years ago, the limits were increased substantially. So now, as it stands right now, if you were to pass away this year, the first about $5.5 million goes to the kids tax-free. And if you’re married, you double up on it. So it’s the first roughly $11 million goes to the kids tax-free. So for most people, that’s enough. They don’t have to do what’s called advanced estate tax planning. But if you’re over that, then you may want to look at some strategies, like family limited partnerships, like charitable remainder trusts, like charitable lead trusts. There are all kinds of things you can do. But interestingly enough, it’s not…

JA: QPRT? (laughs)

AC: Oh, you’re going deep. Qualified personal residence trust? Yeah, that can be a good one. (laughs) We know somebody that really likes QPRT.

JA: Oh yeah. Intentionally defective grantor trusts.

AC: Yes. Wow, look at you. Pulled that out of the hat.

JA Keep going.

AC: (laughs) Yeah, GRAT.

JA: Yeah. Yeah, grantor retained annuity trust.


JA: Well that’s an intentionally defective grantor trust. (laughs)

AC: OK. This one’s too good, I’ll come back to that next segment. The last one, number 10 is life insurance. Is that a good tax planning strategy?

JA: Well it’s 100% tax-free, so if you take a look at the tax code, the death benefit is 100% tax-free to the heirs. So not a lot of things pass to the heirs tax-free. Well, I guess a lot more nowadays than it did before, such as assets have a step up in tax basis if you pass. And what that means is, let’s say if you purchased an asset such as your primary home for $500,000 20 years ago and it’s worth $1.5 million today and you die. Then the basis, the tax basis gets stepped up at the date of death. So now the basis is 1.5, the heirs could sell the house, and not pay any tax at all. So that’s pretty cool. If you have a life insurance contract when you die with that, well then the proceeds will go to the heirs 100% tax-free. They would not have to pay any tax at all on those life insurance proceeds. So I think that is key. I think if it wasn’t tax-free, I don’t know, how many more… Well, I still believe that people should have life insurance. But it wouldn’t be as beneficial.

AC: Yeah, I mean, to me one of the main purposes of life insurance is your premature death. You have a family, they’re depending upon your income. So that would be a time to have it. But, some wealthy people actually use life insurance to reduce taxes.

JA: Is that what it’s saying, is that just the death benefit, or are they using the BS fund a life insurance contract and take income out with loans and FIFO?

AC: Well, yeah. With tax-free growth, investment flexibility, yeah.

JA: Super Roth.

AC: Yeah, we don’t necessarily buy all that stuff. But I will say if you are high net worth, and we just talked about, if your assets are more than $5.5 million, or you’re married and over an $11 million, it’s a way to get assets to the kids avoiding estate taxes. But you have to set up an irrevocable life insurance trust, and a lot of people don’t know what that is, or how it even works.

JA: Right. It’s got to be outside of your taxable estate, because life insurance is included in your taxable estate, with respect to estate taxes.

AC: So I’ve got a policy on myself, I pass away, Ann gets the money, she passes away at the same time. But it’s part of our estate. And that means it’s going to be subject to estate tax unless we put it in an irrevocable life insurance trust. But we can’t pay for the premiums. So we have to gift them out. It gets kind of complicated.

JA: Crummey letters.

AC: Exactly right.

JA: So let’s make this simple. I’m single, and the estate tax exemption is 5 million bucks. And let’s just assume I have a house that’s worth a million. I got my IRA that’s worth a couple of million bucks. I got a brokerage account that’s worth whatever, million. So you add all of that. That’s $5 million.

AC: OK, so without the life insurance, you’re fine.

AC: And then I got another $2 million life insurance policy. So just in case if I pass away, then I can make sure Ruthie, my mother, and my family members are all right. So then they’ll add up my taxable estate, and they’ll say, Anderson, you’re worth $7 million.

AC: And you’re thinking – you’re dead – but you’re thinking, “Wait, I only have five.”

JA: Right I only have five. Where do you get the other two? No, that life insurance, that’s included in the taxable estate. So then they’ll say, “OK well you can pass $5 million estate tax-free. But the other two is going to be subject to estate tax at 40%.” So that’s why if you have a larger net worth, you want to still have the life insurance to create liquidity. So let’s say we had a small business, you didn’t want to fire sale the business. You have a farm, you have – I say farm because I’m from Minnesota, but – a winery, or whatever. You don’t necessarily want to have the kids or the grandkids sell it, just to pay the estate tax. So you set up a separate trust that has a life insurance contract into it, and then you have to gift the premiums out to the beneficiaries of it with Crummey letters and then they have to fund it because it has to be totally outside of your control.

AC: Yeah, you basically gift it through your kids, and kids spouses, grandkids, whatever, and then they have to sign this letter saying they’re foregoing their gift, and it puts it into this trust. And so you don’t have complete control over it – they could say no. But then you could say, “then I’m going to take you out the will or the trust.” So they’ll probably say yes.

JA: In most cases. (laughs)

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1:04:13 – After Tax Investing: Asset Location

JA: It’s a triton, Alan. It’s a merman.

AC: I don’t even know my own mascot. Merman?

JA: I don’t even know what the hell a merman is.

AC: Well I knew what the triton looked like. I said, Titan. So Triton.

JA: You got a gold pin. Well, you should give that back.

AC: Well, if it was a triton, I would have said correctly, but it was a sun god. (laughs) It’s been a while, Joe, since I’ve been in college and…

JA: Well me too, but I still follow my team.

AC: But we were not a Division 1 school, so there are no sports, like yours. Although here’s what Louis told me, they are likely to become a Division 1 school. Not for football, but for everything else – basketball, baseball. So anyway, we’ll see. The Tritons. UCSD Tritons.

Well, Joe, I usually do these lists in a segment, this is taken six segments.

JA: Yeah, my whole email bag is blown out.

AC: I know, gonna have to wait till next week. But if you just tuned in, we’ve been talking about the top 10 tax saving strategies of the last 25 years, according to Worth Magazine, and the very last one is a pretty good one, which is after tax investing, otherwise known as asset location. So what’s what is that?

JA: Well, you want to put certain assets in certain areas of how those areas are taxed, for instance.

AC: Clear as mud. (laughs)

JA: I know. That was really poor. You have assets, such as real estate, or you might have assets such as stock. You might have assets such as bonds, commodities, whatever. And each of those different asset classes has different tax characteristics within themselves. If I have a stock, it produces capital gains or dividends. If I have a bond, it’s going to create income. If I have real estate, let’s say a real estate investment trust, a publicly traded one, that’s going to create income, potentially. And so then you look at the growth of that particular investment. Can I put that in a certain account to get the best tax efficiency?

AC: So you’re looking at after tax return again.

JA: You got it. And so, ideally, you want to put assets that have a higher expected rate of return in accounts that are more tax favored, such as a Roth IRA, or a brokerage account, versus a retirement account. Your retirement account, no matter what the growth is of that thing, it’s going to be taxed at ordinary income rates. So if I have some high flying stocks inside my IRA, versus my Roth IRA, well you might want to switch them, because if I get all this great growth in my retirement IRA account, well all the growth is going to be, well I’m partners with the IRS. If it’s in a Roth, well I don’t have a partner. 100% tax-free. If I’m in a brokerage account, well I’m going to be subject to a lower tax, capital gains. If I lose money in that account, I can tax loss harvest it. So, there are all sorts of different benefits on asset location. But people get so confused. We do asset location and we can asset locate, let’s say, a lot of our clients might have five or six different accounts. You’ve got a married couple. Both of them have Roth IRAs. Then there’s a brokerage account. Both of them have IRAs, and then we might have done a double Roth IRA conversion.

AC: Yeah, so there’s at least five, if not more.

JA: Right. So you want to asset locate across all of the accounts in a household. But here’s what happens sometimes, is that one spouse IRA might be filled with bonds. Then the other spouse’s IRA might be filled with 40% bonds. But then the rest stocks, because of the overall allocation of their group.

Ac: So what you’re saying is, you want to make sure they have the right allocation, where you put investments makes a difference. But sometimes when you do that, husband or wife might have different assets in their individual IRA.

JA: Right. And so they’ll say well why is one spouse’s retirement account performing better than mine.

AC: Yeah, I want Roy’s account.

JA: Right, or I want Brenda’s.

AC: You put bad investments in mine.

JA: Yeah, what the hell are you doing? No, it’s not that. We look at the total household so we have to have conversations. That’s the best, most efficient way to manage your money, bar none. If you look at all the academic studies that are what we follow. But then there’s emotion, there are personalities, there’s… “Well no, I want to kind of keep it separate.” So then you’ve got to blow up the efficiencies that way, but it makes you feel better.

AC: Yeah, you put your highest performing asset class – when I say highest I mean over the long term – in the Roth IRA because that’s where you want your highest growth. Well, the highest asset classes tend to be a little bit more volatile, and sometimes your emerging markets, your small company stocks, your value stocks, which over the long term tend to outperform other ones. In the short term, they may be down. People say, “we did this Roth IRA and the account’s down. You guys don’t know what you’re doing.”

JA: Well, I don’t think they’ve ever said that. They might have said that to you. (laughs)

AC: They’ve thought that. (laughs)

JA: They’ve never said that to me.

AC: But the point though is, they wonder. They wonder, “Is this really the best strategy?”

JA: Yeah, well why this Roth IRA stinks? It’s down 10%.” Because you’re in an asset class that has a higher expected return long term. To get that higher expected return you have to take on more risk. And where you measure risk within volatility.

AC: Yeah and then how many times have you seen, they don’t have a Roth. They’ve got IRA and they got a trust account, and they got all their stocks in their IRA, and they got all their bonds in their trust account. Which basically means 100% of their retirement is taxed at ordinary income rates, the highest rates. If they flipped it, then they would have half of their portfolio potentially as capital gains.

JA: Because here’s what happens. They’re used to saving into stocks or stock mutual funds in their 401(k) accounts. But then they get an inheritance, or they sell a business, or they sell a property, and then they have all this cash. It’s like, “well why don’t you invest? They say, “well I don’t know where to put it.” I’m like, “Well you’ve got all this money already invested in your retirement account, I don’t understand.” “Well, it’s different. It’s outside of my retirement account.” No, money is money. You have to understand that and you have to understand the tax consequences of the money that you have in regards to what account that it sits in. Whoo! What a list today. Man, that’s a heavy duty one. Thank you so much for joining us. Hopefully, you enjoyed the show. That’s it for us today. We’ll be back again next week. For Big Al Clopine, I’m Joe Anderson. You just listened to another great episode of Your Money, Your Wealth.


So, to recap today’s show: Muni bonds, harvesting your losses, choosing the right business entity, life insurance, and asset location are just some of the ways you can save on your taxes. In Q2, growth beat value, large beat small, emerging markets were strong. and volatility was high – but every quarter is different, so stick to your long term strategy. And Titans were members of the second generation of divine beings in Greek mythology, while Triton was the mythological Greek god who was the merman messenger of the sea. Glad we straightened THAT out.

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