A Tax Hater’s Guide to Investing: 5 Tax Free Investment Options Outside of the Roth IRA

Good investing includes minimizing taxes wherever possible. If you’ve followed me or the blog for long you’ve probably picked up on the fact that I’m a big fan of the Roth IRA for this exact reason. You pay income tax on the dollars you contribute to the account, but you never pay them afterward.

I’ve written about Roth IRAs quite a bit. Musings here on the blog have covered how to execute a back door Roth IRA conversion, a mega back door Roth IRA conversion, and when & how to convert your tax deferred savings during your retirement gap years.

Roth IRAs aren’t perfect though, and they’re not for everyone. So what other options are out there for investors trying to avoid taxes? This post will cover five.

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How to Evaluate a Real Estate Investment

The concept of acquiring rental properties as a means to build passive income has become exceptionally popular recently. In fact, it’s difficult to peruse the internet for content on personal finance without bumping into videos/podcasts/blogs/courses on how to build passive income through real estate investing.

My take on real estate investing is that it can indeed be a wonderful complement to your investment portfolio. But the conditions need to be just right. And given how quickly housing prices have risen since the depths of the financial crisis in 2009, the circumstances today are rarely compelling.

As you can imagine, this is a conversation I have with clients frequently. Some have an existing property we need to evaluate. Others fall in love with the idea of putting in sweat equity now & building an empire of properties that kick off income over time. This sounds nice in theory, but in my experience rarely pencils out. (At least of the opportunities I’ve seen recently in California & Oregon).

This post will explore how to evaluate real estate investing opportunities. We’ll cover cash flow, return on investment, and go through a real life scenario of a property I pulled from Zillow.com.

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72t Distributions: The Ultimate Guide to Early Retirement

What’s the most common piece of retirement advice you’ve ever heard? I bet it has something to do with tax advantaged retirement savings. Most people are inundated with voices telling them to start saving early and take advantage of tax deferrals. It’s solid advice. Saving tax deferred money through IRAs, 401(k) plans, and other retirement vehicles is a wonderful way to grow your wealth over time.

The downside? Those pesky withdrawal penalties. The IRS will typically ding you 10% if you withdraw from these accounts before turning 59 1/2. This can pose a problem if you’re considering an early retirement. Fortunately there are a few loopholes. eight of them, in fact:

Roll withdrawals into another IRA or qualified account within 60 days
Use withdrawals to pay qualified higher education expenses
Take withdrawals due to disability
Take withdrawals due to death
Use withdrawals for a qualified first-time home purchase up to a lifetime max of $10,000
Use withdrawals to pay medical expenses in excess of 7.5% of adjusted gross income
As an unemployed person, take withdrawals for the payment of health insurance premiums
Take substantially equal periodic payments pursuant to rule 72t

For those of you interested in an early retirement, the final loophole is likely the most interesting to you.

According to rule 72t, you may take withdrawals from your qualified retirement accounts and IRAs free of penalty, IF you take them in “substantially equal period payments”.

This post explores how.

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A Beginner’s Guide to Cash Balance Plans

In my financial planning practice I work with a good number of business owners who want to make aggressive contributions to their tax deferred retirement accounts. This helps put them on strong footing for retirement, but also provides a generous tax deduction. While the 401k plan is the primary retirement plan most business owners are familiar with, a cash balance plans is one I often recommend in addition. In fact, cash balance plans can actually allow for far greater contributions & tax advantages.

A cash balance plan could be a good fit if you’d like to contribute over $50,000 per year to a tax advantaged retirement plan. They don’t come without their nuances though. This guide will explain how cash balance plans work and whether they might be a good fit for you.

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What You Should Know About the SECURE Act Retirement Bill

Every now and then, lawmakers in Washington make noise about changing various sections of the tax advantaged retirement accounts I’m so fond of recommending to my clients. Now that we’re living substantially longer, and a greater portion of our lives is actually spent in retirement, there’s a good argument that we should increase age limits, mandatory distributions, and other rules governing IRAs, 401(k)s and other types of accounts.

I usually don’t pay much attention to this speculation until there’s a bill on the floor that has a strong chance of becoming law. The majority of the legislation drafted in this area doesn’t get far, and often doesn’t even get out of committee.

Nevertheless, the house and senate have both recently introduced bills that would change how retirement accounts work. I’m no political expert, and don’t have the foggiest idea what the chances are of one of these bills passing. But from what I’m reading there’s more momentum for retirement reform now than there’s been in the last several years. Plus, more than one client asked my thoughts on the subject recently so I felt a summary post would be appropriate. This post will cover what happened & why it might be important to you.

Pending Legislation

In February the senate introduced a bill called the “Retirement Enhancement and Savings Act” (or RESA), aimed at fixing America’s retirement savings problems – both in the public and private sectors. This isn’t the first bill on retirement reform that’s been introduced recently. Multiple versions containing similar provisions have been introduced since 2016, which speaks to the growing interest in helping Americans save for retirement.

Meanwhile, the house passed the SECURE Retirement bill (Setting Every Community Up for Retirement Enhancement Act) about a week and a half ago in a 417-3 vote. This bill contains many of the same provisions as RESA, and the bipartisan support on both sides of congress could mean one of the bills may actually make it into law sometime soon.

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Maximizing Your 199a QBI Deduction as a Specialized Service Business

As you’re probably aware, we’re working with some new tax laws as of January 1st, 2018. The tax change that will have the most impact for many business owners out there – particularly owners of pass-through businesses – lies in section 199a.

Section 199a specifies that qualified business income is eligible for a 20% across the board deduction on the owners’ personal tax returns. 20%! This is a big deduction, and falls in line with all the political rhetoric about making the country a more business friendly environment.

Unfortunately, not every business owner will be able to claim it. One of the more controversial aspects of section 199a is that the deduction phases out at certain levels of taxable income, if your business is considered a “specialized service business” (SSTB). In 2019, this phaseout range is $315,000 to $415,000 of taxable income for married people filing jointly, and $157,500 to $207,500 for everyone else.

What exactly is a specialized service business, you ask? It’s one whose principle asset is the skills or experience of one or more professionals. This includes medicine, law, accounting, financial services, athletics, and several others.

With the introduction of section 199a & the QBI deduction, there are a number of tax planning opportunities for business owners. Qualifying for the deduction and maximizing its benefit could easily have a significant impact on business owner’s total tax liabilities. This post will explore three different types of tax planning strategies owners of specialized service businesses may consider to maximize the benefit of the 199a deduction.

Income Reduction Strategies

The first, most logical way to maximize the QBI deduction is to find ways to reduce your taxable income. The lower you are in the phaseout range, the greater portion of the deduction you’ll qualify for. Note here that the phase out isn’t based on your adjusted gross income or modified adjusted gross income (which is common for most other phaseouts, like IRA/Roth IRA contributions). The QBI deduction phases out based on your taxable income, which is after you take itemized or standard deductions. Here are a couple ideas to consider.

Qualified Retirement Plan Contributions

Establishing & funding a qualified retirement plan is usually the low hanging fruit for owners of specialized service businesses. The best plan structure and form for your situation will depend on a number of factors, of course. And if you have employees, chances are you’ll need to make contributions on their behalf as well.

The usual suspects here are SEP-IRAs & solo 401(k) plans for those without employees, and 401(k) & profit sharing plans for those with employees. You can also tack on a cash balance plan or defined benefit plan if you want to be aggressive (and are comfortable with mandatory contributions each year). In either case, every dollar you contribute to a qualified retirement plan, both as an employee deferral or employer contribution, will be deductible. And, of course, every dollar you deduct gets you one dollar closer to the beginning of the phaseout range.

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Year-End Capital Gains Distributions: How to Avoid Getting Slammed

With tax season now in the rear view mirror, many of us are licking our wounds after a shellacking from Uncle Sam. I heard from a lot of people this year that they owed far more to the IRS than they expected to. Come to find out, the IRS changed the withholding tables with the new tax bill. Rather than overwithholding throughout the year and getting a refund in April, thousands across the country underwitheld & had to pay out of pocket.

Another item factoring into last year’s fat tax bills was capital gains. Mutual funds and ETFs distribute capital gains back to shareholders, which are taxable based on the amount of time the fund owned the holding. As an investor, receiving an unwanted taxable distribution can be inconvenient.

As a reader recently put it: “For the second year in a row I’ve gotten killed with large capital gains from my mutual funds, resulting in a large tax bill. Aside from owning stocks on my own, how can I eliminate or minimize these capital gains?”

Today’s post will answer this exact question. For those of you who’ve seen the adverse tax consequences of capital gains distributions, read on to learn a few strategies you could use to minimize the bite.

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What’s an Appropriate Cash Reserve in Retirement?

Cash flow is one of the first topics I like to cover when working with new financial planning clients. Cash flow is so fundamental to the rest of your household finances that it’s really helpful to understand how much money is coming in every month and how much is going out. With this in place we can begin to wrap our heads around concepts like your capacity to take risk, disability insurance needs, and other components of a typical financial plan.

We can also use this information to determine how big your cash reserve should be. There are many different names for a cash reserve: cash buffer, cash safety net, emergency fund, and so on. Regardless of what you might call it, the objective is to keep enough cash on hand so that no matter what happens in your life, you don’t need to sell investments at an inconvenient time (i.e. during corrections or market crashes).

The easiest way to view your cash reserve is as a function of monthly living expenses. Simply multiply your monthly living expenses by the number of months you feel comfortable with and voila! That’s how big your cash reserve should be.

During your “accumulation” or working years, most financial planners recommend a cash reserve of somewhere between 6 and 24 months’ worth of living expenses. Where you fall on that spectrum depends on a several different factors:

Your capacity and willingness to take risk
How many incomes you have in your household
How consistent your income is
How many dependents rely on your income
What your disability insurance situation looks like

In retirement the situation is quite a bit different. You’ve already amassed the amount you need to quit working, and are obviously not concerned with the possibility of being laid off. Instead, the biggest issue is avoiding having to sell assets at an inconvenient time.

It’s a challenging line to walk. You want to keep enough cash on hand to cover unexpected expenses and avoid selling stocks in periods of market turmoil. But you also don’t want to keep more in cash than you need to. Keeping too much is a drag on your portfolio, and inflation will slowly eat it away over time. The right amount of cash for you in retirement depends on a different set of factors, which I’ll cover in this post.

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How to Take Advantage of Your Retirement “Gap Years”

Often when I bring up the idea of retirement “gap years” in meetings, my clients’ minds wander toward a family member who’s decided to take a year off between high school and college. Then they shake their head in disbelief about how millenials are often encouraged to backpack around for a year to mature and “find themselves”. Another moment of reflection about how the world’s changed, and that’s about when their attention snaps back to refocus on our meeting.

No, retirement gap years don’t have anything do with finding yourself or maturing. They have to do with the years between retirement and age 70. Many people will see their taxable income fall to lower levels once they stop working, and spike once they turn 70. Thus, the retirement income “gap”.

Here’s why. For those of us with assets in qualified retirement accounts like 401(k) plans or IRAs, 70.5 is the age when the IRS begins imposing mandatory distributions, which will be added to your taxable income. Once you begin collecting Social Security you’ll also be taxed on either 50% or 85% of the benefits, depending on where that taxable income falls. If you’re one of the many people waiting until age 70 to collect, that’s two extra sources of taxable income added simultaneously, and recurring every year thereafter.

Thanks to our progressive tax system, the years you find yourself in a lower tax bracket can be a great opportunity to reduce taxes over the rest of your life. This post will explore how.

The Opportunity

As you know, we have a progressive tax system here in the U.S. The higher your taxable income, the higher the rate you pay. As I write this, the tax brackets for single & married people filing jointly are:

Notice the big jumps here – our marginal tax rates don’t increase evenly. 10% & 12%, 22% & 24%, and then 32% and higher. The increases from 12% to 22%, and again from 24% to 32% are significant, and present a convenient opportunity when planning for retirement.

Think of a typical retirement timeline. If you plan to stop working at 65 years of age, chances are your taxable income will be higher at age 64 than it will be at age 66. Then a few years later at age 70.5, you’ll enter RMD territory. The IRS will force you to take a certain amount of money out of your tax deferred retirement accounts every year, or face a stiff 50% penalty.

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Backdoor Roth IRA Conversion: How to Contribute to a Roth IRA When You Make Too Much Money

If you asked me to choose my FAVORITE type of account to invest in, it would definitely be the Roth IRA. Roth IRAs allow you to save money tax free for the rest of your life. They’re not subject to mandatory withdrawals in your 70’s, and your kids won’t even owe taxes on their withdrawals if they inherit the account from you down the road. In my opinion the Roth IRA is just about the best deal out there.

Problem is, they’re not accessible to everyone. The IRS considers Roth IRAs such a good deal that they won’t let you contribute to one if you make too much money. Fortunately, there’s a work around: the backdoor Roth IRA conversion. The backdoor Roth conversion allows you to get money into the Roth IRA by making non-deductible contributions to a traditional IRA. Don’t worry if this sounds complicated. We’ll go over the strategy step by step in this post. Read on to learn more.

The Backdoor Roth IRA Conversion Strategy

So here’s how it works. I’ll break it down into two-distinct steps. But to start, let’s review the income limitations for direct contributions to a Roth IRA. If your modified adjusted gross income on the year (MAGI) falls below the “Full Contribution” threshold, you can contribute to a Roth IRA directly. If your MAGI falls into the phaseout region your contribution limit for the year begins to fall. When it reaches the “Ineligible” threshold, you’ll be prevented from contributing to a Roth IRA altogether (at least in 2018). If this is you, the backdoor Roth conversion might be a good fit. (Here’s a review of how to calculate modified adjusted gross income).

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