By Dr. James M. Dahle, WCI Founder
I keep running into people who want to know how to lower their tax bill. This is seriously an important financial goal for them. I suspect many of them are just tax illiterate, but I bet some just haven't really thought through this goal. The problem with this goal is it leads people to do stupid stuff and be vulnerable to people selling bad financial products. To be honest, I WANT TO PAY MORE TAXES because it usually means I made more money and in the end, I'm still coming out ahead even after paying those taxes.
8 Ways to Lower Your Tax Bill
So today, I'm going to rant a bit and actually answer their question. Then, at the end of the post, I'll answer the questions they should have asked.
#1 – Vote
If your tax bill is a very important issue for you, then I would suggest you make it very important when you vote for local, state, and federal politicians. In nearly every general election, one candidate supports lowering your tax bill and the other supports raising it. You will probably also notice differences in primary elections. If lowering your taxes is your most important political issue, then I would suggest voting for the candidate most likely to lower your bill. If it is not an important political issue for you, and perhaps isn't even in the top 10 most important issues for you, then quit whining about your tax bill.
#2 – Work Less
Want to instantaneously lower your tax bill? Work less. Yup, that'll do it. In fact, thanks to our progressive tax code, if you stop working, your tax bill will go down by a larger percentage than your income went down. Let me demonstrate a simple tax situation:
- Gross income: $400K
- MFJ Standard deduction: $25,100 (2021)
- Taxable income: $374,900
- Marginal tax rate: 32%
- Tax due: =$19,900*10%+($81,050-$19,900)*12%+($172,750-$81,050)*22%+($329,850-$172,750)*24%+($374,900-$329,850)*32%+0.9%($400,000-$250,000)* = $82,972 (2021)
- Effective tax rate: =$82,972/$400,000= 21%
Note that I am ignoring state and local income taxes, payroll taxes, property taxes, and sales taxes for the sake of simplicity.
*PPACA tax on income over $200K ($250K MFJ)
Now, what if you worked half as much and made half the money?
- Gross income: $200K
- MFJ Standard deduction: $25,100 (2021)
- Taxable income: $174,900
- Marginal tax rate: 24%
- Tax due: =$19,900*10%+($81,050-$19,900)*12%+($172,750-$81,050)*22%+($174,900-$172,750)*24% = $30,018 (2021)
- Effective tax rate: =$30,018/$200,000= 15%
As you can see, your gross income went down by 50%, but your taxes went down by 63%.
#3 – Give Your Money Away to Charity
You know what else lowers your tax bill? Charitable deductions. You can donate up to 50% of your adjusted gross income and take a tax deduction for it. No, giving away $1,000 in order to lower your tax bill by $320 is not a winning strategy if your goal is to have more money after taxes. But if your goal is to lower your tax bill, it works great.
#4 – Spend Money in IRS Approved Ways
Want an even lower tax bill? Spend your money on stuff the IRS approves of like child care, college education, mortgage interest, and health care expenses. Again, at best you're spending $1,000 in order to get $320 off your tax bill so you won't have more money after tax, but you will lower your tax bill.
#5 – Get Married (to a Non-Earner) and Have Kids
When you get married, you get to use the married filing jointly tax brackets, which are much better than the single tax brackets. Of course, if you marry a radiologist you may find that the overall tax bill goes up, not down! Having kids may also qualify you for a lower tax bill. The child tax deduction doesn't start phasing out until $200,000 ($400,000 married). It isn't indexed to inflation, unfortunately.
#6 – Save for Retirement
If you aren't maxing out your tax-deferred accounts such as the 403(b), 457(b), and 401(a) at your regular job, doing so will lower your tax bill (and you even get to keep the money this time). If you have a 1099 side gig, add on an individual 401(k). You might even want to look into a defined benefit/cash balance plan for your employer or partnership (or yourself if an independent contractor).
#7 – Save for Health Care
If you are using a High Deductible Health Plan, then fund a Health Savings Account (HSA) each year. For a family, that's a $7,200 (2021) tax deduction and like a retirement account, you get to keep the money!
#8 – Stop Being Tax Illiterate
Most people think they're leaving a lot of money on the table due to filling out their tax returns improperly. The truth is they probably aren't leaving all that much. But if you're making dumb tax decisions like not deducting all of the business expenses you are eligible for, choosing high-turnover tax-inefficient mutual funds for your non-qualified (taxable) investing account, or not tax-loss harvesting investment losses, then stop doing that. Besides retirement accounts and an HSA, that's really the only free lunch.
The Questions You Should Have Asked Instead of “How Can I Lower My Taxes?”
Now that I'm done ranting, let's talk a bit about the questions you should have asked instead of “How can I lower my tax bill?” Here are a few good ones:
Q. “Are there any tax deductions I should be claiming but am not?”
A. Read through the instructions for Schedule A and Schedule C and have your return looked over by a tax accountant or two with many clients like you.
Q. “How can I rearrange my financial affairs such that I am not dramatically inconvenienced and have more money to spend after paying taxes?”
A. If you are a business owner, consider becoming an S Corp to save on Medicare taxes and figure out if there is a way you can qualify for or increase the 199A (pass-thru business) deduction. Make sure you know about and use all of the tax-protected accounts available to you. If you give to charity, make sure you are doing so in the most tax-advantaged way.
Q. “How can I end up with more money after-tax?”
A. The answer here is usually to invest for the long-term. All of your investment income will at a minimum be free of payroll taxes, but when investing in a non-qualified (taxable) account, you may also wish to consider municipal bonds (the yield is usually federal and sometimes state tax-free), total market index funds (minimal distributed capital gains, dividends mostly qualified, possibly a foreign tax credit), and equity real estate (where depreciation shelters some or all of the income).
The answer is not to buy whole life insurance, because the returns are so low (and likely to get lower given regulatory changes in early 2021) that you would have ended up with more money after-tax if you had used a more traditional investment and just paid any taxes due. Nor is the answer some other complex, high-fee, tax-sheltering investment. You can't give up a lot of return for additional tax benefits and expect to still come out ahead when there are options like muni bonds, index funds, and real estate out there.
Don't be tax illiterate. Know enough about our tax system that you can at least make sure you're asking the right questions. It's hard to find the right answers until you know how to ask the right questions.
What do you think? What have you done to increase the amount of money you have left after paying taxes? Comment below!
Under the Tax Cuts and Jobs Act passed in December 2017, depending on the type of gift and type of charity, it is now possible to deduct up to 60% of your AGI in charitable donations. Under previous law it was limited to 50%.
Great point!
There is an exception, though, for people like me who like to donate appreciated assets (mutual funds) to a donor advised fund as an intermediary. I’m limited to 30% of AGI for those donations.
I’ve made my first donation of appreciated mutual funds directly to a charity to have some giving outside of that model, but the DAF sure makes it a lot easier. Note that you can donate up to 60% of AGI to a DAF if donating cash (writing a check).
Cheers!
-PoF
Thank you!
This fear of paying taxes is something the whole life insurance salesperson capitalizes on. We need to learn to see through this smokescreen and realize it is the wrong approach. I know one real estate investor who lowered all his tenants’ rent so he had a lower income and paid less tax. He was happy paying less tax and never noticed how much less money he had. He just didn’t get it. Less taxes shouldn’t be the driving force.
Dr. Cory S. Fawcett
Prescription for Financial Success
I think this site was where I first came across the phrase don’t let the tax tail wag the dog. The loss of mortgage interest deduction is a perfect example of people who carry mortgages to capitalize on this tax deduction when financially you are paying more in interest to recoup that amount.
I took advantage of the progressive tax code for a change when I decided to take a day off each week (and pay someone for that coverage). The 20% of less clinical time did not result in a 20% drop in take home and turned out to be far less.
I have said: “I can’t wait to pay less in taxes.” All taxes, not just income tax.
It’s because I am getting ready to retire from full time work AND have been paying so much in taxes. Taxes are my biggest expense and have been for decades. They exceed retirement funding from 401A, 457, HSA, SEP-IRA, and Roth money for my working college kids. Now, I know this marks me as fortunate, especially being so well off that I can make matching Roth contributions for my teenager on her meager minimum wage earnings.
One year recently I added up my federal, state, social security, Medicare, and property taxes and it was over $125,000, about what my entire salary was in 1994 before production bonuses.
I use every method you mention including the pass through on 1099 income (saves about 20% of moonlighting income from taxes) and use a CPA.
Fast forward three years and I really begin to use the “work less” option. I drop from full time plus moonlighting to just call and locum vacation coverage.
My work drops from 60 hours a week to just a few weeks of work a year, my income drops by two thirds and my total taxes drop by an amount greater than the % drop in income. At that point, with no mortgage and only using the standard deduction, I’ll get my wish to pay even “less taxes”…but I’ll also be living on a smaller budget, but I won’t be paying $10,000 a month in taxes, more like $2000, an 80% drop.
If I don’t like my new lower income and being “semi-retired” , I’ll just work more…and Uncle Sam will love me again and welcome me back.
I purchased single premium whole life insurance from Northwestern Mutual in 2013 at age 50. I paid $341,000 for a policy with a guaranteed death benefit of $1,000,000. I intend to use it as a legacy for my children and never use the cash value. With payment of dividends, the actual death benefit will almost certainly be higher than the guarantee of $1,000,000; likely in the range of 1.3-1.7 million based on historical dividend payments by NW Mutual for over 100 years.
My life expectancy at purchase was approximately 32 years.
Using only the guaranteed death benefit amount, my rate of return (assuming I live to my life expectancy) will be 3.36%. The likely rate factoring in dividends will very likely be 4-5%.
But assuming the guaranteed 3.36% –
Such amount is
1. Guaranteed for over 30 years
2. TAX FREE (not tax deferred if left to my children as life insurance benefits are not taxable).
3. Completely IMMUNE from attack by judgment creditors in my state.
4. Provides peace of mind should I not reach my life expectancy (with correspondingly much higher rate of return).
5. Peace of mind knowing I can spend the remainder of my retirement savings knowing that a nice legacy is already taken care of, guaranteed.
6. Yet I can still access guaranteed growing cash value (in an unforeseen emergency) that equaled my premium payment within 3 years, and has been growing steadily since.
How is this not an excellent investment?
I have been more than happy with the decision. I actually purchased a similar policy for my wife concurrently.
I don’t understand the drumbeat of criticism of whole life insurance, at least as it pertains to my situation.
I would by it again today.
You need to learn more about this investment. when you die you get face value of 1 million only to your family. You lose the savings.
Imagine if you put 341,000 into good s and p index for 30 or so years at historically 8-10% rates. Calculate that.
Well said, agree 100%.
With respect, gentlemen, it is comparing apples and oranges to compare a guaranteed tax free return with historically projected potential returns in the stock market.
And you do not “lose the savings”. The return I calculated is based on the guaranteed death benefit. I have no intention of using the cash value, as I stated.
The asset protection is highly valuable, as are the other benefits I enumerated.
One can always project the highest potential return using equity investments, but these are certainly not guaranteed. While I have other assets invested in low cost market index funds, I recognize that the post -WWII returns on stocks in the USA represent a historically unique period, and I do not personally expect similar results in the future. No one can know, and this is a critical point in comparing returns here.
Finally, many physician specialists are in a very unique situation. Their income is so high that if they simply live below their means and invest the large remainder in very conservative investments they will certainly achieve wealth and financial independence. Equity type growth and its associated risk is not necessary for this. Vanishingly few other wage-earners have this potential.
Apples and oranges comparison
You don’t “lose the savings”. The returns I calculated were based on the death benefit. As I stated, I have no intention of ever using the cash value. The death benefit, as a rate of return, is around 4% and this is TAX FREE, no other investment offers this unheard of benefit.
Assuming 8-10% returns for 30 years is certainly an option, but this is not comparable to a guaranteed rate of return. I have other funds invested for growth, though for high income specialists growth and associated risk is not at all necessary to achieve financial independence and wealth (though that is a whole other discussion).
Finally, the unknown capital gain tax rates to be attributed to the growth fund 30 years from now are unknown, and given our demographics, likely to be much higher than current capital gains rates.
In the end, I’ll take the guarantee of tax free 4%, with the potential for higher but not lower returns coupled with asset protection and life insurance to boot.
One must think about their own situation. The low cost index fund approach is fantastic, and should be utilized by the great majority of investors. I’ve taught it to my children. I’ve also given them JL Collins great little book “The Simple Path to Wealth” as an excellent primer.
However, many physicians’ incomes put them in a unique category where those rules may not always apply. Personally, I believe this is one of them.
You do not “lose the savings”. The return I calculated was based on the guaranteed death benefit. As I stated, I have no intention of ever using the cash value.
Comparing projected returns from equities, which are far from guaranteed, is not appropriate. Risk and reward are always tethered. I personally do not believe future returns in USA equities will match the prior returns in the unique post-WWII environment for the US. Future returns in equities are likely to be more modest in my opinion, and they will likely be taxed at higher rates given our demographics and social situation.
In the end, I’ll take the guarantee of a tax-free, asset protected 4% rate of return for this portion of my net worth. In fact, it is the most satisfying part of my portfolio.
fwillison is correct that with most whole life policies the death benefit will likely be more than $1M if he uses the dividends to buy more insurance. It’ll still be much less than an investment that made 8-10%, but it is unlikely to be only $1M unless he dies this year.
“TAX FREE (not tax deferred if left to my children as life insurance benefits are not taxable).”
If you invested the premium in a taxable account in VTI or VTI plus VTEB, and left it to your kids:
You would expect the value to be much higher at your death
And
The proceeds would be completely tax free to them at your death.
And
Returns would not have been reduced by expenses of the life insurance policy.
Life insurance dividends have been decreasing for years. Although your company is likely to continue to pay something, don’t be surprised if the dividends are much lower than illustrated. Ask your salesperson to show you the dividends that were illustrated on a policy like yours 30 years ago and compare then to what was paid over that time.
Remember that the dividends are not paid on the total amount of your initial investment. As you saw a year after you paid the premium, your cash value was not
1.0335 x $341,000. It was very much less than that. The dividends apply to money in your CV, the expenses come off the top.
Your hypothetical portfolio of VTI and VTEB would have thrown off taxable dividends of about 2% of the amount in VTI with no federal tax on the muni bond income. So you would have paid 15, 20, or 23.9% tax on that 2% of part of your investment. That investment would have had gains considerably larger than 3.36% and the tax cost would have been less than the insurance expenses.
This is not an “investment” I would want. On the other hand, I am sure your salesperson was thrilled with the purchase. The commission would have been to die for.
“The proceeds would be completely tax free to them at your death.”
This is incorrect. The return on VTI, VTEB or any other stock mutual fund is certainly taxable to your heirs. This is a fundamental issue.
Sorry I didn’t realize VTEB was a muni fund. Yes this is tax free federally and is a good option. I have substantial positions in Munis.
However, VTI returns would certainly be taxable.
Taxable as they grow, but not taxable to heirs upon inheriting them as the basis is reset as of the date of your death.
FWILLISON,
“The proceeds would be completely tax free to them at your death.” is actually correct.
If you die before you realize your capital gains, your heirs receive a step up in basis upon your death.
It is correct. The heirs would inherit the VTI and VTEB with no taxes. Not deferred taxation. Tax free.
Any subsequent income would be taxable, exactly the same as a life insurance death benefit. No tax on the benefit but taxes on income from subsequent earnings.
Life insurance is no better than a taxable account in this regard.
No, it isn’t. Look up “step-up in basis at death.” I’m really sad you didn’t know about that prior to being sold this policy. I wish the agents who sell them were required to tell you that everything is tax-free to heirs when you die, so long as your estate isn’t so large that inheritance/estate tax comes into play.
Please understand, there are no “insurance expenses” or any cost of insurance or other expenses when a return is calculated based solely on the guaranteed death benefit.
Similarly the discussion about dividends is not applicable. I assumed no dividends in my calculation of the guaranteed death benefit. Any dividends applied and added to the death benefit (extremely likely but not included in the calculation) would only add to the return.
The costs of insurance are what drives the return. If you put $341,000 into a taxable portfolio then you have the entire amount invested. If you put it into an insurance policy then you pay these expenses. The company might not break them out for you but who else would be paying them?
The rate of return, guaranteed, at life expectancy is not very appealing compared to a taxable balanced portfolio. The reason the return is so low is the costs of the insurance company. You can invest in the same things in which they invest without paying those costs. You get to keep the difference.
Returns to financial assets do not have to be as good as they have been to be better than the guaranteed return on the life insurance policy.
Did you ask your salesperson for a comparison of dividends illustrated 30 years ago to actual dividends paid over the last 30 years?
Taxes:
If you own the policy then the death benefit becomes part of your taxable estate for estate tax purposes. If your total estate is large enough to be taxable based on the threshold at the time you die, then your estate will pay taxes on that amount. This is exactly the same as for a taxable account. Life insurance is no better.
What drives the rate of return is not relevant. Sure that is what drives the return, but only the return matters, not what drives it.
Now, you may view a 4% Tax Free Guaranteed rate of return unappealing, and that’s fine. I find it appealing, and I greatly value the asset protection aspect given my malpractice risk climate.
Regarding dividends – these are ignored in my calculation of guaranteed returns. With no dividends at all, I would still consider the return to be excellent given the tax free nature of the investment, the guarantee, the insurance benefit, asset protection, and access to a cash value if emergency occurred (unlikely given my other assets). Some dividend will almost certainly be credited to the death benefit, but this would only be gravy and not considered in my calculation or decision.
Of course estate tax would apply equally to life insurance death benefit or a taxable account balance. The point is that there is NO INCOME TAX applied to the life insurance return if kept as a death benefit. Very different than mutual fund or other investments (passed to heirs or not) that you compare, which ARE subject to income tax. Moreover, a life insurance death benefit can easily be excluded from estate tax using an ILIT, if that should ever become necessary.
It simply comes down to whether one considers a 3.5-4% tax free guaranteed return (with the other benefits enumerated) appealing. The proper comparison is not equity investments, but guaranteed return investments such as bonds. While I own significant positions in bonds, munis in particular, I find the SPLI policy to be better in most aspects.
Many high income specialists do not need to equities’ historical (though far from guaranteed) returns with associated risks. They can save and invest very large sums by living comfortable lifestyles well below their means and saving and investing the rest in conservative low risk investments. This virtually guarantees significant wealth and financial independence at a young age with little risk. This has worked very well for me, and I was able to retire at 55 in this way, with guaranteed returns and interest that total higher than my lifestyle costs such that my net worth grows without the need for work. Perhaps with more risk I could have a somewhat larger net worth, but to me the risk isn’t worth it. Many physicians are in a very unique situation in this regard.
If you really thought you needed life insurance from age 50 did you consider term? Get the cost of 30 year level term. Put away enough money to pay those premiums. Invest the fund in a 60/40 taxable account. Also put away the difference between the whole life premium and the term premium. Put that in the same fund.
At your death any money left in the account would go to your heirs TAX FREE.
At your death, the heirs would ALSO get the $1M life insurance death benefit.
If you lived more than 30 years after buying the policy and wanted to continue the insurance, then pay on an annual basis. The policy would get expensive, but you would have the returns on the taxable account to pay the premiums.
If at any point you wanted to take money out, you just do so, no need for a loan from the life insurance company and no obligation to keep paying premiums. If you wanted to take out more than the annual income from the taxable account you could pay capital gains taxes on the stock, liquidate some of the bond holdings, which might not generate any taxable gains, or borrow from your broker in a margin loan. Again, no obligation to keep paying premiums.
This whole life policy is not a good deal.
Please re-read my initial post where I specify the goals and purposes of this investment.
The policy was purchased for the purpose of providing a known legacy to my children, allowing me to spend the remaining retirement assets on myself and my wife without worrying about leaving something to our children (both teachers, and unlikely to have the financial success I have been fortunate enough to attain as a physician). Term insurance does not accomplish this goal (though it is superior for providing protection against loss of income for a younger family, a more common goal of life insurance – just not mine). .
You are right that if I live beyond 82, the guaranteed returns will be less, but if I die early they will be more. This is not consequential to my goals.
Unless I am not understanding something, you seem to be making an error in what can pass tax free to heirs. Estate tax is not the issue, that only applies to very large estates, over 22 million for a couple and I’m not quite there. The issue is income and/or capital gains tax. Life insurance is unique in allowing the gain (between the $341,000 premium and the $1,000,000 death benefit) to be tax free if left to heirs. A 60/40 taxable account, or any other type of account, taxable or not, would ultimately be taxable as to the gain in the investment, whether left to heirs or not.
The bottom line is that for me, this single premium policy with a guaranteed rate of tax free gain that is completely protected as to creditor attack in a lawsuit has been an excellent investment for me.
I am certainly not the typical investor, but the policy fits my needs exceedingly well, and it was flat out simple to boot. One payment, done for life. Kids get a minimum of a million each (more with probable dividends) no matter what. I live it up on the rest. If I can’t be hedonistic enough to spend the remainder, and I may not, the girls will get that too. Makes me happy.
“A 60/40 taxable account, or any other type of account, taxable or not, would ultimately be taxable as to the gain in the investment, whether left to heirs or not.”
You keep saying this, but it simply isn’t true. Google the term “stepped up basis”. It sounds like you’ve made a costly mistake due to your failure to understand this simple concept.
“A 60/40 taxable account, or any other type of account, taxable or not, would ultimately be taxable as to the gain in the investment, whether left to heirs or not.”
The taxable account would pass to your heirs with NO tax. NONE.
There would be no capital gains tax due at your death.
Your heirs would get the account with a stepped up basis. They could then sell the assets with a cost basis equal to the sale price. There would be ZERO capital gains tax.
An extreme example.
You invest $1 in some super stock. You die decades later and that holding is now worth $1,000,001. You have a gain of exactly $1,000,000. NO tax would be due at your death. Zero.
Your heirs could then sell the stock with a cost basis of $1,000,001. There would be NO tax. No tax deferred. NO TAX due at all.
Thus, it would be the same as a life insurance death benefit. NO tax due at your death.
As with a death benefit, if your heirs then invested the money and earned dividends or realized capital gains on the investment then they would owe tax on that. The tax treatment would be identical if the money came from a death benefit or a taxable account.
I can see why a life insurance salesperson may have wanted you to think that you got some special tax treatment at death, but you do not.
“The policy was purchased for the purpose of providing a known legacy to my children, allowing me to spend the remaining retirement assets on myself and my wife without worrying about leaving something to our children (both teachers, and unlikely to have the financial success I have been fortunate enough to attain as a physician). Term insurance does not accomplish this goal”
Term insurance would pay the same death benefit as whole life insurance. That is how life insurance works. Because it is cheaper, there would be money left over.
The only question is whether your kids would have more money at your death if you bought life insurance vs investing the money. The combination of enough term to get the total to $1M, plus invest the rest would protect you against a premature death with less time for the assets to accumulate. Of course, the assets will continue to accumulate once your kids receive them, so it is not clear in this situation that it matters whether the assets accumulate during your life or after you pass.
A common strategy would be to buy several smaller term policies and cancel them as the value of the investment account grew. The total would then be over $1M, with less of if dependent on a death benefit. By the time you reach life expectancy, probably, your total investment account would be far more than $1M and you could assure your heirs that amount of money without the cost of the whole life insurance.
Insurance companies are not charities. They do not provide insurance for free. When you buy insurance, you are paying for their costs and profit.
As for the tax question- you should really look this up or consult a tax adviser. But you are mistaken. There are NO income taxes on your capital gains at your death. NONE.
Oh, I see, yes the step up in basis for capital gains is an excellent point. I apologize for missing that. That would apply to capital gains that were never distributed, but not capital gains distributions or dividends.
However, the stepped up basis rule is under serious threat of repeal. Personally, I see this as pretty likely given our government’s debt problems. Certainly more likely than repealing the concept of life insurance benefits being passed without tax.
Nevertheless, its a fine point.
But again, I think it is an apples and oranges comparison between “potential” equity returns and guaranteed fixed returns not to mention all the other benefits including asset protection.
One can always argue that the potential returns of a higher risk investment may outperform the returns on a guaranteed investment, but that is simply fundamental.
Equity returns are far from guaranteed. The USA is a declining global economic power in the sense that in the future it will not have financial hegemony with the rise of China and Asia. Future returns may not look anything like past returns over 30 years. Thus a guaranteed tax free return of 4% or so with asset protection fits my needs better for this portion of my portfolio.
” That would apply to capital gains that were never distributed, but not capital gains distributions or dividends.”
But as noted above, the capital gains distributions will be very close to zero. I am not sure that VTI has paid such a distribution in the history of the fund. As noted above, the taxable dividends will be quite low and the tax rate on the dividends will be low.
“The USA is a declining global economic power in the sense that in the future it will not have financial hegemony with the rise of China and Asia.”
Then invest in China and Asia. Total international stock market fund.
What do you mean serious threat of repeal? I have heard no talk whatsoever of repealing this law and I pay a lot of attention to stuff like this. Please provide a citation for your statement.
I agree that would make life insurance a more attractive proposition, but if one were going to change this law, why not also tax the life insurance death benefit?
If one is buying life insurance at 50 because they need it until age 80, whole life might not be all that bad of a way to get it. The reason term life works so well is because it is so cheap. But a 30 year term policy bought at 50 isn’t particularly cheap. Even if you are completely healthy (perhaps not so likely at 50) a $1M policy costs at least $2900/year. Hardly the peanuts it costs at 30 ($645/year).
Whether it is a good deal or not depends on what fwillison wants. If his goal is a guaranteed death benefit no matter when he dies and he does not wish to take any sort of investment risk with that money, then whole life insurance works perfectly well for that goal. The problem is most people who buy it are buying it for some other reason for which they should be using term life insurance, a retirement account, or a 529 account.
There absolutely are insurance expenses. They are simply baked in to the returns already. That’s one reason they are so low.
Better read the illustration again. It likely includes reinvesting the dividends. If you spent those, the guaranteed death benefit would remain $1M.
Yes, life insurance provides a guaranteed death benefit. If you want a guaranteed death benefit, life insurance is a great way to get it. It’s not necessarily the best way to maximize the probable amount of money left tax-free to heirs, but it does provide a guaranteed death benefit. So I’m happy that you’re happy with your purchase.
But at the end, you’re wondering “how is this not an excellent investment” and the way it is not an excellent investment is if you live to your life expectancy or beyond your heirs would have been better off if you had used more traditional, but still tax-efficient, investments. Just run the numbers on how much money you would have left behind if you made say 8% instead of 4-5% and you’ll see what the guarantee cost you.
Many of the comments here reflect a lack of reading of my specific rationale for purchasing the SPWL policy. Just to clarify, I first researched my options to achieve my goals, determined that the single premium whole life policy met my needs, then determined that NW Mutual provided the best product based on price, value and security. I then contacted their home office who referred me to a local agent to purchase.
The references to dividends and illustrations reflects a lack of reading of my rationale to purchase – a legacy to the kids with protection against potential malpractice claims, which increasingly are being awarded over-limits. The 3.6% tax free return is GUARANTEED and NOT dependent on no guaranteed dividends (which will only increase the return over the guarantee , and is disregarded in my analysis)
I have large assets outside of this policy that are invested differently for my own benefit.
Finally, comparing non guaranteed equity returns is highly improper.- apples and oranges.
Glad you’re happy with your policy. It sounds like it is meeting YOUR goals and that’s the important thing.
“One year recently I added up my federal, state, social security, Medicare, and property taxes and it was over $125,000,”
LOL. Now imagine if you were actually in a high tax bracket…
ZZZ – Is your point that 32% is not a high bracket, and I am fortunate to pay only 32% plus state, self-employment tax and more Medicare tax on my second job income?
The 35% bracket starts at AGI $408,000 and the 37% bracket starts at > $612,000 for 2019…that’s as high as they currently go. Is that your point, that historically they have been higher at times? For the hard working top earners 35% (now) is the same as the 35% (in 2017 and prior).
If I made a bit more (> $400,000 AGI) I guess I could pay 3% more on the bit above $400,000, but I already have two jobs…
Re: tax brackets.
This is WCI. There are a lot of hihly compensated physicians and dual professional income families. They are in the 37% bracket, NIIT and looking to cut their tax bills.
Years ago there were lots of tax shelters, some of which actually worked. Higher income people who got into them stood to save a lot of money.
Nowadays, those are gone and docs have far fewer tax saving opportunities. Very few for the growing share of docs who are W2 employees.
Yes, I know. That was partly the point of my answer. I’m at 32% marginal rate and the superstar earners and double income top 1% are at 37% marginal, and these are so close as to be roughly equal, and both groups (the $400K folks, and the $600-800K folks) should both want to do everything legal to reduce taxes.
My other point is that making a lot more money is simply not my goal anymore. I am going to downsize and quit the treadmill. One of the five biggest regrets of the dying are “I wish I hadn’t worked as much”.
When I make $125,000 (semi-retired) and drop our taxes from > $10,000 a month to $2000-$2500 a month, and drop out of college funding, and no longer put away $80,000 a year in retirement funds, and live on a LOT less, I’ll finally be free.
I have no interest in accumulating things anymore. I don’t buy much anymore. We will go to restaurants, travel, and take care of ourselves. I budgeted $20,000 a year for entertainment and travel. That’s plenty.
I want time, not money. WCI seems to do a good job of balancing things even making more than a million a year, but he got smart at 30…not 50 like me.
As I said, if I want to become a consumer again, I can always just work a bit more…and pay more taxes.
Yes, there are certainly many readers of this blog paying a multiple of that tax bill (including me), but it isn’t an unusual tax bill among physician and other high income professional families. It’s about 1/3 of $400K and 1/4 of $500K.
# 5 Get Married (to a non-earner) and Have Kids
It would be a little more tax efficient to get married to a low earner ($5000). That opens up a tax break for a childcare FSA. Just sayin!
Or being married to a real estate professional.
Wow. That’s really letting the tax tail wag the earning dog! What would the hourly rate for that earner be after paying for child care!
WCI,
You talk about Whole Life all the time…But I don’t remember you ever doing a post on Captive Insurance. It seems to be all the rage the past few years for business owners. Obviously this is another device to try and lower tax bill’s….but can you discuss here briefly you opinions on it, or maybe do a post on it?
Thanks,
Ok…So I found the article…https://www.whitecoatinvestor.com/captive-insurance-companies-for-physicians/
but wondering what your feelings are on it since 2014?
I don’t know that I’ve spent very much of the last 5 years thinking about it. Has something changed about it in the last 5 years that would make that article out of date?
See
https://www.irs.gov/publications/p551
For basis of inherited property. The basis is the value at the date of death. It does matter how much of this may have been capital gain during life.
“I have no interest in accumulating things anymore. I don’t buy much anymore. ”
I am with you on that. Having tried a small amount of the expensive things people buy, I know that I don’t want them at all. Not if they were free. Not unless someone paid me to take them and then disposed of them for free.
“We will go to restaurants, travel, and take care of ourselves. I budgeted $20,000 a year for entertainment and travel. That’s plenty.”
Plenty? An unbelievable figure. Depending on how long I live, $20,000 might cover all the travel I will ever do for the rest of my life. It will exceed any annual travel budget by many fold.
We spend a lot at restaurants every month and a family vacation for my crew of six usually costs me several thousand.
Example: Cape Cod this summer for five of us.
Gas for the van and a hotel day on either side for the 16 hour drive, plus bike tuneups before we left: $500
Cabin Rental was $1300 (as a friend came along and kicked in $500). Ferry price for day trip to Nantucket $500, restaurants and groceries ran about $150 a day or $1000 for the week. So that’s over $3000 for one family trip.
We go to our retirement cabin in NC twice a year for a week and that’s just gas, food, and restaurants, but I have 4 kids. We eat at a lot of nice places and the meal is usually $100 to $125 with drinks.
So when I say $20,000 a year for restaurants, plays, movies, hiking trips, family vacations, and another vacation a year for just my wife and I…we can spend it.
If I were alone and had no kids, I’d spend a lot less, but I chose to have a bunch. We are no longer flying and haven’t flown for a decade, but food and entertainment can add in some $$$. More often these days, we eat breakfast and dinner at home and only lunch out.
Different strokes for different folks. Price out a trip to Europe or a cruise for you and all your kids, in-laws, and grandkids some time and you can see why someone might spend more.
“Q. “How can I end up with more money after-tax?””
The problem with this question is that even if we had a theoretical 99% marginal tax bracket, you can still end up with MORE money after tax by continuing to work. By that logic, you should try to earn an extra $100,000 a year even if you only keep $1,000 of it.
The real question that SHOULD be asked, that this pretty much article ignores, is “what is the marginal value of my time, and how does that compare to my marginal after-tax earnings?” The first only becomes more scarce and valuable, but with the second you get less and less juice with each squeeze thanks to our progressive tax code.
Excellent point. While not addressed in this article (can’t address everything in every post and still expect people to read them) it has been addressed elsewhere on this blog many times. For example, here:
https://www.whitecoatinvestor.com/the-hidden-costs-of-a-dual-income-household/
https://www.whitecoatinvestor.com/marginal-utility-of-money-progressive-tax-rates-and-fixed-overhead-expenses/
Agree with the principle but the tax system is not that progressive. Tax rates top out at 37% for federal. Yes, there is NIIT but that also tops out. Once a family reaches the top bracket their tax rates do not further increase with higher incomes. That means the share of incremental income they pay in taxes stays constant, rather than continuing to increase.
Yes, constant at 37%, plus the uncapped Medicare “you are rich” surcharge, plus state tax (let’s say 6%) plus self employment tax on 1099 money (15.3%)…
At some point these marginal dollars not only seem worth less…they seem worthless. They are associated with the “extra” work required to make them: extr weekends, holidays, tougher jobs with more responsibilities (Medical Director), etc.
If your marginal dollars don’t carry this extra effort that affects your health and family time, great. Most of the time they have more sweat, more hours, more stress, and simply aren’t worth it with 50% of the amount going to taxes.
Yes. You’re right. It all tops out. In California, 37% federal + 3.8% NIIT + 12.3% state. 53.1%.
However, I disagree with your assertion that the system is “not that progressive” when one person pays 53.1% of her next dollar in income taxes while someone else, and in fact something like 43-47% of taxpayers literally pay nothing in income taxes. I think that’s pretty progressive. But most of politics is basically people disagreeing on how progressive the tax system ought to be. I think everyone ought to pay something and no one should pay more than 33%, but reasonable people could disagree.
To be more progressive, the tax rate would continue to increase as income increases. It does not.
Once a Californian hits the 53.1% combined tax rate her marginal rate will stay the same, even if her income increases by 20 fold. A more progressive system would continue to increase the tax rate.
The system is progressive up to a point, then there are no further increases with higher income.
Pointing this out is not a political comment. Just describing the way the tax system works.
Yes, I agree a system with even higher marginal tax rates than 53.1% would be more progressive than our current system.
The “Vote” section is politically biased and erroneously slanted. Your Vote Counts; however, in the long-term, voting does not eliminate one’s taxes, regardless of the individuals party given the way our two-system political party works. The government is designed to leverage the tax system to drive policy change, on both sides. For example, the Democrats like the solar and wind tax benefits while the Republicans like the oil & gas tax benefits. Democrats want to cut taxes on the poor and middle class while taxing the rich more. The Republicans and the 2016 Trump Tax law increased taxes for 10M middle-class Americans while significantly decreasing taxes on businesses and the rich. Just because there are right wing fanatics trying to destroy our country, we should not be advancing their radical agenda of fully eliminating taxes at all costs.
I live in the most expensive taxed state in the country, and I’m fine with paying my fair share to get the best roads, schools, parks, etc… However, I’m doing everything my government wants me to do to work towards eliminating my taxes. The politicians who are all about eliminating all taxes are out to destroy our great nation. This post should really be about physicians decreasing their tax liability and there are many ways to do this. Given the shift, today physicians are mostly employees with a W-2, so that is a very different tax strategy then someone who owns their practice as a business. I have a very nice W-2 salary, and I’m trying to develop my strategic tax plan to pay NO taxes this year because I’m trying to align my personal financial efforts with what the government wants me – a person with money – to do. Simply invest appropriately in equity positions in these industries: real estate, solar/wind, and oil & gas. Your vote will determine whether we have a dysfunctional country for many years to come. To vote simply for tax reasons will be a short lived blip that will only change incrementally year over year as shift from blue to red and then back again.
We are far from the tax highs of the early part of twentieth century when federal taxes were upwards of the 60% range – with significant instability in the world with world wars and a Great Depression. So yes, appointing politicians who will bring instability to our world, will increase taxes in the end; for the mere reason that tax policy is designed to bring order and stability. Think about the long-term strategy, for a stable and well functioning government with rational tax policies will lend to lower taxes for all and/or a higher currency value.
During “the early part of twentieth century” there was no federal income tax. The 16th amendment wasn’t ratified until 1913.
The “early part of the twentieth century.” Please google taxes in the 1930s.
I respectfully disagree. It makes a big difference who gets into power regarding taxes. I am a high earner and Trumps tax cut didn’t lower my effective tax rate. This is an example of fake news that the rich made out like bandits with the tax plan. The middle class did very well with the tax cut. I still support the plan even though my taxes didn’t do down due to the incredible boon to business in our country directly as a result of the tax plan. Tax and regulation cuts for businesses benefit all of us. I sure hope we get many more years of “right wing fanatics trying to destroy our country”!
There was a small percentage of high earners whose taxes were raised by the TCJA. They primarily live in states with previously deductible high income and property taxes the loss of which outweighed the decrease in tax brackets.
Not sure what “2016 Trump Tax Law” you’re referring to, but the most recent significant tax law was the TCJA, passed in 2017 and enacted for the 2018 tax year. In that law, the vast majority of people, including those in the middle class, had their taxes reduced. You are entitled to your own opinions but not your own facts. Stop listening to biased news sources if that is what they are telling you and the facts.
https://www.taxpolicycenter.org/feature/analysis-tax-cuts-and-jobs-act
I’m glad you’re okay with paying high state taxes. You might notice that many of your fellow Americans are not, so we don’t live there. Isn’t that wonderful? Everyone gets what they want. You get more services and higher taxes. I get fewer services and lower taxes. Win-win.
I have no idea why you think you should get to decide what the posts I write are about. Seems kind of egomaniacal no?
I disagree that anyone interested in lowering taxes wants to destroy the country. Kind of a black and white way to view the world, no?
Absolutely tax law does change at the will of voters. It tends to be cyclical though. We get sick of paying so much in taxes so we elect conservatives and taxes are lowered. Then we get sick of government doing less, elect a liberal, and taxes go back up. Does one vote matter much? Maybe not but a million do.
Once more on the “tax highs of the early part of the twentieth century”, you are entitled to your own opinions, but not your own facts.
https://www.savantcapital.com/blog/tax-rates-yesterday-today-and-tomorrow/
https://bradfordtaxinstitute.com/Free_Resources/Federal-Income-Tax-Rates.aspx
As you can see in the charts there, even the maximum MARGINAL tax rate has only been above 60% from 1935 to 1981. It was 0-10% in the “early part of the twentieth century.” But more importantly, check out the effective tax rates. Those high marginal tax rates applied to very few people in mid century.
As you can see here:
https://www.taxpolicycenter.org/statistics/historical-average-federal-tax-rates-all-households
The tax rate on the middle quintile of tax payers has been 14-19% over the last 40 years. The tax system has clearly become more progressive over that time period.
Get the facts, then form your opinions.
WCI, you are correct in that the Trump Tax Law was in 2017 and my comments were in-line with your cyclical perspective of our democracy. However, with great respect – the rest of your comment is erroneous and quite misleading. I find it interesting that you shared a somewhat slanted conservative organization’s article posted PRIOR to the TCJA bills passage in the Congress to bolster your argument. My comment was simply stating that not all middle class Americans had their taxes decreased via the TCJA and some even had it increased. In December of 2018, the Tax Foundation stated that only 80% of taxpayers benefitted from the TCJA. https://taxfoundation.org/tcja-one-year-later/
There are many good aspects of the TCJA, but there are many bad ones as well. For example, many of us who live in wealthier states like CA with more expensive houses have lost a significant portion of our tax benefits due to the decreased mortgage interest deduction and this obviously has implications on the appreciation of our house prices as well. I follow the tax code and will likely pay no taxes for 2020. If that tax code is amended with the next election, then I will strive to find ways to meet the new governments policies which are again driven by the tax code. All of what the government wants us to do is mostly driven by taxes and fees. If you simply focused your side hustles on aligning with government policy, regardless of whose in power, you will decrease your taxes.
I see you modified your prior comment WCI. Again, you are entitled to your right wing opinions; however, I merely stated facts. I guess I should not be surprised. We all should want and strive to pay as little tax as possible within the law; however, there are “right wing fanatics” out there who think they should not pay anything and let our roads and government crumble. I realize the majority of conservatives are more rational on this subject; however, there is a fringe of them that wishes to eliminate their taxes at the expense of maintaining our great country – which I find abhorrent.
The one comment here that I can agree with you on is that our tax system is a progressive model, since most Americans do not understand this concept. If your in the 35th tax bracket, that does not mean that you are paying 35% on all of your income. It is a progressive model and I’d encourage your followers to watch this simple video on the subject: https://www.vox.com/2019/1/18/18187056/tax-bracket-marginal-video
I agree there are political fanatics on both ends of the political spectrum.
I agree that most Americans do not understand the basics of the tax code. That is also true for physicians.
I linked to the first sites that pulled up with a simple google search.
“Only 80% benefitted” seems an odd use of an adjective. Would you say “only 90%” or “only 99%”? I mean, what does it take before you stop using “only” to describe it? I love that you think I’m a right wing fanatic. From your apparent location on the political spectrum, it would seem that almost every one looks like a right wing fanatic so I’m probably in pretty good company.
I think we can agree that we will disagree on this. Interestingly, I’m a firm moderate on this topic, so we all should reflect on where we stand in this unique political climate. I agree and disagree with many liberal and conservative financial perspectives. Since our country has roots in both socialistic and capitalistic philosophies, i see them as pillars of what has made US great, and acknowledge the importance of finding that right amount of each of them in this unique recipe – this Great American Experiment – to ensure our countries long term prosperity. I try to focus on what makes sense for our country and my family for the long term regardless of party. I’m grateful to you for continuing to share your financial wisdom with us.
All the Best.
Anthony, if you feel you aren’t paying enough in taxes to the federal government, you are more than welcome to write a check for however much extra to the general fund of the U.S. treasury. I guarantee you they’ll cash the check.
What marginal rate do you think would be appropriate and necessary at your level of income?
#9. Earn more money in IRS approved ways.
Taxes are high because it’s primarily earned income for high income households. I’m sure many of you have seen this bit from Warren Buffet about paying proportionally less in taxes than his secretary. That’s true for all the uber wealthy people I know ($10M+ net worth) . Taxes do keep the government chugging along though.
https://money.cnn.com/2013/03/04/news/economy/buffett-secretary-taxes/index.html
Warren Buffet’s comments have never made much sense to me, mainly because there is a lack of clarity about the numbers. Discussing taxes is often confusing because people can throw in Social Security, Medicare, etc into a discussion about Federal Income tax.
To be taxed at an effective rate above 20% (marginal rates really aren’t comparable, paying 39% on your marginal dollar is not the same as paying 20% on all long-term capital gains) takes household income of about $200K. Buffet suggested that his secretary was paying 8 to 9% above him, which would put the Secretary’s household income in the neighborhood of $380K.
Overall, I think the media took this message and equated “Buffet’s Secretary” with a “typical secretary.” The reality is that the secretary for a high net worth person needs far more skill than the person answering the phone at a typical business. But the media never clarified that Buffet’s secretary likely makes salary north of $250K and shouldn’t be compared to a secretary making $35K.
But ultimately, my biggest question was “Why isn’t Buffet giving his secretary some compensation, profit sharing, 401k match etc using BRK stock? ” I suspect he is, and the Secretary has a net worth of several million dollars from a long career of receiving stock and it appreciating.
All of the nuance of reality would complicate the message that, in Buffets opinion, he should pay more tax. The tax differences between a millionaire and a billionaire wouldn’t be relatable and would lose the messaging value.
Edit: Found confirmation that Buffet’s secretary earns far more than the phrase “secretary” could imply. https://www.forbes.com/sites/paulroderickgregory/2012/01/25/warren-buffetts-secretary-likely-makes-between-200000-and-500000year/#4ade87487e83
That’s just an effect of lower capital gains/qualified dividend rates. There are good reasons to have those (primarily to encourage investment but also because it isn’t really fair to tax inflation at full freight). It makes a good political soundbite though for sure.
Sure, that’s kind of the point. W2 income is taxed at the highest rates. It’s been that way since the tax code went into effect. Regrettably, most of you don’t have the flexibility of earning a high income along with the tax advantages that come with generating non-W2 income. Buffet isn’t an outlier by any means when it comes to wealthy people paying far lower taxes than the average Joe.
For entertainment value, here’s how $500K of income would be taxed in different categories:
1. W2 earnings @ 40% taxes (my guesstimate)
2. Business @ 15 – 25% (contribute $200K+ to tax deferred retirement accounts)
3. Capital Gains @ 15% (endless possibilities)
4. Sell primary residence @ 0% ($500K capital gains exemption w/married couple)
5. Asset Appreciation @ 0% (refinance out cash as needed)
6. Puerto Rico @ 0% (Act 20, Act 22, etc)
2. Depends on business structure.
3. Could be up to 23.8%.
The article is about:“I Want To Lower My Taxes” Is a Stupid Goal. I don’t think it is a stupid goal, but I would agree that some of the ways to accomplish this goal as stated in the article are stupid.
It is surprising to me that no one is talking about DB plans. If your self employed, max out your W 2 earnings with the salary cap of $280,000. Then fund your IRA $6,000, (nothing), your 401(k) $24,000 (a little more than nothing) and your cash balance plan 370,000.00 (ok now were getting somewhere).
For every 100,000 that I put into my plan I save $40,000 in taxes, so putting $394,000 away pretax saved me about $160,000.00 I still had to pay tax on the $6,000 IRA (over the salary threshold). I’ll be taxed on the money upon withdrawal, just like my IRA. But I’m saving pretax.
Ill take my chances that Ill be in a lower tax bracket between the ages of 60 to 70 not working for a salary, converting 150,000 IRA accounts to Roth accounts. Then the 1.5 million that is converted will grow tax free with no MRD.
Yes there are administration cost, yes you need an actuary, yes you need an age weighted cross tested 401k profit share plan, but that is minimum compared to the taxes you will save.
My actuary tell me I about to hit my max funding of my DB plan of 2.8 million. Can anyone tell me where I should be looking to park my next dollars to maximize tax efficiency?
Limit the king from taking your sheep.
I’ve been writing about DBPs for 8 years, so not sure why you think no one is talking about it. Here are a few examples:
https://www.whitecoatinvestor.com/cash-balance-plans-another-retirement-plan-for-professionals/
https://www.whitecoatinvestor.com/cash-balance-plans-for-solo-and-group-practices/
https://www.whitecoatinvestor.com/cash-balance-plans-podcast-78/
Great information in the three posts. The only other time I’ve seen CB plans mentioned is briefly in the forums. For a tightly held small business, the biggest risk seems simply not being able to fund it consistently every year. At some point, the plan eventually ends with maxing out the cash value, business closes, gets sold, owner retires, etc.
If you want to stop sooner, does the company just revoke the plan? What happens to the accrued cash?
It’s great to stop sooner. I’ve stopped two plans. You just roll the assets into your 401(k). It’s basically an extra 401(k) masquerading as a pension.
I’ve been doing the same, going on year 3. I am also interested in shutting it down early. Apparently the IRS can retroactively deny the plan if it isn’t continued for some minimum period of time (3-5 years). Also apparently not likely if there is a legitimate reason to terminate it early (which there would be for me). There seems to be a lack of hard and fast rules on this so I suppose it is up to the IRS to decide.
Also, my DB plan is not a “cash balance” plan, and I don’t think there is an advantage to the CB type for a solo practitioner like myself. However, I’m not entirely clear on the benefit, if any, of a cash value type of DB plan vs a regular DB plan.
The key is the legitimate reason, but there’s a fairly liberal set of reasons out there.
Curious about your DB plan. Whenever I’ve looked, it’s way too expensive as you have to fund the front office, hygienist and assistants. Even a small practice will have 5 or 6 other people to fund besides the doctor so it’s not a straight up 100k in and 40k tax savings right?
You are correct, there are costs associated with the plan. I have a age weighted cross tested plan, and I am mandated to put in 6 % for my employees into the 401k and profit sharing. I think I’m coming up to 10 years of funding. I’ve ranged in between 180,000 to 370,000 into the plan, pending what the accuracy and cpa agree. 93% benefit to owners. If there is a more efficient way to save taxes of larger amounts of money, I’m not talking about $6,000 into a HSA (although there is a lot of power in that beauty) I’m all ears. You should walk away with 91 to 93 percent of whatever you fund. If you are not max funding the I guess the costs associated would be relatively high.
Any tax savings is theoretical depending on the withdrawal tax rate, right? Same as with a 401K?
I’m not saying deferring taxes on hundreds of thousands of dollars isn’t worthwhile, just clarifying whether that’s how the DB plan works in practice. One of my companies is a single owner / employee corporation which eliminates the employee means testing and shared contributions. Retirement funding is one of the big reasons I kept it and the huge annual DB plan contributions are really interesting. Thanks!