financial advisor looks at taxes my lattice wealth

A Financial Advisor looks at Taxes

Tax Preparation usually doesn't mean tax planning.

Preface: My experience is that most tax-preparing CPAs and EAs look backwards, at the previous year’s tax experience.  It takes overt client requests to have them do forward tax planning.  As such, the more advanced financial advisor with a good understanding of the US and their respective state’s tax code might be a better source of advice.  Even them, these tax-savvy financial advisors ought to and do disclaim their knowledge and defer to tax professionals.  I know I do.

Now, to the topic at hand. Never forget step four of financial planning: Pay attention to taxes.

Looking for Tax Strategies in your 40's

Buying real estate.  I live in the southern part of the San Francisco Bay area in San Jose.  Home affordability is a challenge for those in their 30s and 40s.  I will offer you two approaches that likely require help from a well trained financial advisor, but these approached get you to that real estate purchase.

The first idea is to use your concentrated stock position as collateral for the rather huge down payment.  Many lenders, in lieu of cash down payment will allow you to pledge liquidatable assets for that mortgage purchase.  This requires finding the right lender and accepting change of custody of those assets, but it is possible.  Well trained financial advisors can help you out on this. 

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Another approach is doing rental real estate first.  A very seasoned mortgage lender who owns multiple homes confided to me that had she had it to do over again, she would have bought her rentals first.  This gets you into the real estate markets while having renters pay the mortgage service.  Both of these have tax advantages that are not to be ignored and can cancel out other taxability you must deal with.  Neither are simple transactions though and require some professional help.

Private equity, placed properly, give you excellent returns but is illiquid.  Private equity demand attending to cash calls, and the holding period might extend to years beyond projects, but again the returns might justify the long holding periods.  But here’s the tax twist.  Private equity reports taxes annually on a K-1.  Depreciation and other tax advantages flow to you, the investor.

The presumed tax benefit I want you to ignore though are so-called 529 plans.  I strongly recommend the investor not to cede ownership of college funds to their kids.  Just build the wealth yourself and deal with post high school expenses when they come along.

Looking for tax strategies in your 50's

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Continue to buy rental real estate with that income you are not spending.  Continue buying private equity with that income you are not spending.  Now, if you have the desire and time, start a one-off business put it in an entity like a Subchapter S corporation or an LLC.  What you will find is that the expenses of starting one business might cancel the income from another.

In today’s world, if you are in fact earning more that you spend you will undoubtedly be using a company retirement plan.  Even retiring in your mid 60s, there is a great temptation to delay taking money out of that tax-deferred advice until you are required to take those taxable distributions.  In many, many cases the account grows to over $2 million which then demands distributions over $80,000 delaying the distributions! 

How do you reduce this burden?  One way is changing your contributions to a Roth 401k or IRA.  Some will counsel you against this because you aren’t getting that IRA tax benefit.  This is a legitimate objection if you are looking at current year taxes.  But having higher taxable income in your 70s, dealing with MediCare Part B and D costs as well as potentially higher tax rates must be part of the discussion in your 50s.

While this suggestion contradicts the previous one, every tax-payer is different.  Defined Benefit or Cash Balance Plans allow you as an employer to defer a max amount of money from taxes.  The amount you can defer is far in excess of 401ks.  While every situation is in fact different and this ought to be part of the discussion.

“Forward Gifting” is a term for used to describe giving a low cost basis asset to an aging parent with the agreement that upon their death the asset will come back to you.  Why do this?  If properly titles, at death the cost basis of an asset is stepped up to that death’s date.  If you at age 50 have an asset with extremely low basis, you have enormous tax consequences upon sale—so you simply don’t sell it.  If, however, you put it in your parents’ name and one passes, the basis gets stepped up and it gets returned to you at the market price.

Looking for Tax Strategies in your 60's

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Buying rental real estate

Buying private equity.

Starting a one-off business.

Roth 401k or IRA

HECMs for tax and Medicare Planning.  Once you hit 65, regardless of whether you are still working or not, you will participate in Medicare part A.  Some will also participate in Medicare part B.  In 2014, the George W Bush Administration added Medicare Part D and with it came the “Income-Related Monthly Adjustment Amount,”  better known by the acronym IRMAA, or “Irma.”  IRMAA is a tax on your Medicare to provide these benefits for the less fortunate.  It is very progressive, meaning that if your income is high two years ago, your IRMAA contributions will be high.  This will last until you engage with Medicare to reduce it.  This is technically not a tax, so your tax preparer will likely not discuss ways to address it.  But, I will.

IRMAA is based on your MAGI, or modified adjusted gross income.  MAGI is typically higher for the accredited investor because in all likelihood they own some tax free bonds or such other things that modify their adjusted gross income.  Meaning, it goes up. 

How can you manage the insidious progressiveness of IRMAA?

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Oddly enough, by using home equity through a Home Equity Conversion Mortgage or HECM.  Remember how distasteful the thought of doing a “Reverse Mortgage” has been throughout your adult life?  Not so fast, given that Americans have a whole lot of their net worth tied up in their residence, and many will need to rely on that equity during their retirement, Reverse Mortgage Stabilization Act of 2013 made tapping your home’s equity far more palatable, and then rules were even improved more in 2017.  Since what you pull out of your home’s equity is technically a loan, it isn’t MAGI.  This is useful.

In years where you anticipate your taxable income spiking, manage that income down by not taking IRA distributions or deferring your Social Security.  This also allows you to convert traditional IRA assets to Roth assets—and taking a taxable distribution.  You simply establish a HECM.  Analyze the situation though.  HECMs come with some up-front costs that need to be considered before you create the instrument.

Seemingly contrary to doing a Roth Conversion is the idea of using your business to establish a Defined Benefit Plan, or the newer terminology, a “Cash Balance” plan.  These plans allow you to defer meaningful chunks of money annually from your business, in many cases more than you can defer with either a one-person 401k or the more traditional 401k.

Strategically use Charitable Giving.  The first thing to note here is that if you are not charitably minded, stop right there.  However if you are there are several tools you can use to make large enough contributions to move the needle on tax deductions.

As I have repeatedly said, I am not a licensed tax professional.  Take all of the above concepts with a grain of salt and review them with someone in that profession before you take any advice.

Looking for Tax Strategies in your 70's

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All of the previous term’s periods apply in your 70s, but my experience is that those with wealth in their 70s are more concerned with providing for heirs than working the tax angle.

Give money away using Donor Advised Funds. A Donor Advised Fund is a simple, inexpensive way to take highly appreciated assets and provide them to charity.

Give money way using Qualified Charitable Distributions. This is yet another way that you might receive advantageous tax treatment with your charitable contribution.  In many cases today, this is a better approach that a Donor Advised fund because ordinary income taxes as so much higher than capital gains tax.

Aggressively Use HECMs to do Roth Conversions.

About Michael Ross

Michael Ross, is 30+ year veteran as a financial advisor. After 30 years with Morgan Stanley, he is now an independent financial advisor who excels in helping business owners exit their businesses and move to the next phase of their lives. 

Advisory services are offered through Integrated Advisors Network LLC, a registered investment advisor. 

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