Complete Wealth Management With Dave Alison

Optimizing Retirement and Tax-Advantaged Investing

• Dave Alison, CFP®, EA, BPC • Season 1 • Episode 16

Share episode

Dive headfirst into the world of taxes and chuckle along as we explore the comedic side of CPAs' March Madness—a frenzy of number crunching that rivals any basketball tournament. Our latest episode offers a spirited look at the humorous anecdotes that pepper tax season, from deductions so wild they border on mythical to the truth behind splurging for tax breaks. We also unravel the concept of tax-efficient funnels, providing savvy insights into how smart planning with 401(k)s and other financial strategies can bolster your savings and ease the burden come tax time.

When it comes to the future, it's about making choices today that secure a comfortable tomorrow. This episode, featuring Dave Alison, Conrad Levesque, & David Roth, lays out a map for navigating the complex terrain of retirement accounts—from the dependable traditional IRA to the modern appeal of the Roth IRA—tailored for high-income earners seeking to optimize their golden years. We debate the merits of pre-tax contributions versus Roth's after-tax appeal, and even crack the code on backdoor conversions and the power of Solo-K plans for the entrepreneurial spirits tuning in.

Don't miss out as we pivot to the more strategic aspects of financial planning, examining tax-advantaged savings vehicles that do more than just shelter your money from the taxman—they serve as pillars in a robust financial framework. Learn how HSAs can be more than mere savings accounts, but rather investment opportunities with tax-free growth potential. And for those looking to diversify, we delve into the intricacies of real estate and cryptocurrency investments, assuring you that starting with maximizing your 401(k) is just the tip of the iceberg. Whether you're looking for a laugh or a lesson in finance, this episode strikes the perfect balance between entertainment and education.

Advisory services are provided through Prosperity Capital Advisors LLC (“PCA”) an investment advisor registered with the United States Securities and Exchange Commission (SEC). Views expressed herein represent the opinions of PCA and are not intended to predict or depict performance of any particular investment.

All data provided, including any reference to specific securities or sectors, is provided for informational purposes and should not be construed as investment advice. It does not constitute an offer, solicitation, or recommendation to purchase any security. Consider your investment objectives, risks, charges and expenses before investing. These views are as of the date of this publication and are subject to change. Past performance is no guarantee of future performance.

Speaker 1:

Mr Conrad, you're looking all dressed up for a Friday afternoon of doing taxes.

Speaker 2:

Oh, don't remind me about the tax work.

Speaker 1:

You guys are pretty busy.

Speaker 2:

Oh my gosh. Yeah, let's just say ready for tax season. We'll be over with already and we're just getting you into the meat and potatoes of it.

Speaker 1:

I was going to say it's March 1st. People are just starting to upload their documents.

Speaker 2:

Oh, so everybody thinks the NCAA is about March Madness, but really it's the CPA that goes through March Madness. Right, we're just and it's like we'll get 30 returns in a day just pummeled. It's going to be an interesting rest of the tax season.

Speaker 1:

Nice. Well, when I'm in Vegas in two weeks, I can see if I can bet on your taxes, like we can bet on the NCAA.

Speaker 2:

Wait. So I'm stuck in the rainy weather doing taxes and you get to go to.

Speaker 1:

Vegas. I'm going with a client, conrad, it's work. No, no, here we go. These are. Isn't this a tax write off, like you teach?

Speaker 2:

Oh my gosh, put us on TikTok, let's make the video, just write it off, throw it in an entity.

Speaker 1:

Let's write it off Exactly. There's going to be a lot of financial advising and budgeting conversations.

Speaker 2:

Should you take some money off the table after you want it, or do you just double down, put it all on red?

Speaker 1:

Not gambling your financial future away. I mean, if anyone else is listening. If you need your financial advisor to go to Vegas with you, I am open and ready to do that. Yes.

Speaker 2:

I'm available. If anybody has a beach house that they want confirmed as a rental, I am available for that. That's right. I'm trying a very reasonable fee to do that.

Speaker 1:

Any clients that need us to travel and go on vacation around. Just make sure they're getting all the deductions they can. We are here and ready to go.

Speaker 2:

Yeah, Listen. You did a podcast with one of your clients from their boat, right?

Speaker 1:

I know, but I made the crucial mistake that I should have flown out to Trinidad and Tobago and been on the boat with them to record that Stupid me sitting here in Charleston doing it on a Zoom meeting instead.

Speaker 2:

Listen there's always part two.

Speaker 1:

Well, here's the thing that I've always learned about taxes. I've heard you say this over and over At the end of the day, there's nothing that really gets a 100% credit. If I have to spend $1,000 to travel somewhere and I get that as a deduction and I'm in a 40% tax rate, it still costs me 60% to go do that thing. I always love Conrad. I'm sure you've experienced this with business owners. They're like hey, I saw on YouTube, I should buy a car at the end of the year, in December, to get a big tax write off. It's like, yes, you could do that, but if you spend $150,000 buying your Mercedes G-Wagon to be able to depreciate it, you still spent 60% of the money that you would have otherwise Now. If you were going to go buy a G-Wagon in the first place, maybe it makes sense to. But again.

Speaker 2:

The best one I heard was and it was some lady talking about realtors right, oh, just go buy a new Range Rover every year and write it off, and you don't have to pay taxes on that money.

Speaker 2:

I was thinking to myself all right, let's just say that somebody could afford to do that Number one the depreciation recapture rules, which she never talked about, because this lady was not an accountant, she was not a CPA, she had no background in tax. She just read an article and threw out some advice like we were in a zoo, right. And so, ultimately, who can afford to keep five Range Rovers? Do you have a big enough garage to keep those? Where do you store all these Range Rovers? The questions that were never asked, and the fact is I had multiple clients send me that video and I finally told them and I'm going to steal this term, we're going to call it tax porn. Right, you're watching these videos and they sound too good to be true, because they are Tax porn.

Speaker 1:

That's all you should trademark that. That could be your stick as a CPA. So I guess right now, if any of our clients need their financial advisor to go to Vegas, I'm open to it. If any need them to go to a beach house, they can bring Conrad, and if any of them want to go buy a new Range Rover and don't have a place to park it, they can give it to you, david. And yeah, we have six spaces in our driveway.

Speaker 3:

We got to fill them up there you go.

Speaker 1:

So if anyone wants to send David three Range Rovers so you get the tax deduction, that would be great.

Speaker 2:

Well, let's see. I think you hit the nail on the head, though, talking about it. By and large taxes, you get to avoid part of what you spend, right? You got to ask the question of would I rather keep 60 cents in my pocket and pay the 40 cents, or would I spend 100 or that whole dollar, and what do I get in return? So you better be getting more value than that 40 cents that you would have paid anyway.

Speaker 1:

Well, it brings us right into what we're going to talk about today. So, by vote, you guys chose to dive into our tax-efficient funnels. You know, just by way of background before we kind of kick this podcast episode off, this is actually something that has kind of evolved over time. Just the backstory of this and I'll show the image when we kind of get into it is I used to go through this concept with clients called the order of money, and I had so many clients that would come to me confused at how they should structure their savings when they're in the accumulation years, like should I be participating in my 401k?

Speaker 1:

If I should, should it be the pre-tax side or the Roth account side? Should I be participating in my 403B? Should I be doing an IRA? Should I be investing in brokerage accounts to invest in stocks, bonds, mutual funds and ETFs? Should I open a cryptocurrency wallet and buy Bitcoin and Ethereum and all these other things that are out there? How much should I have in the bank account? Should I be buying real estate? Should I put money in an HSA or an FSA or a 529 planner by life insurance?

Speaker 1:

And the reality of it is is. The answer is yes. The answer is yes to all of those things If you have enough money and enough savings to be able to afford to do all of that. But the reality of it is most people don't have enough discretionary savings to go buy every one of those investments, and so what I was doing with clients is mapping out an order to money. Here's what you should do with your first dollar of savings. Once you max that out, here's where you should go next. Once you max that out, here's what you should go to next. And then vice versa, on the flip side, our retirement planning clients were like okay, I've now accumulated this money, I have money in a 401k, I have money in a brokerage account, I have real estate, I have a health savings account and maybe I have a Roth account. How should I think about taking money out of these accounts to be able to supplement my retirement income needs, above and beyond what my social security or maybe pension is? And so there's an order of money to how you should take out of those accounts so that you could maximize your income and minimize your taxes.

Speaker 1:

And I was teaching this to our clients. I was teaching this to financial advisors all across the country through my national organization, c2p, and I remember I was teaching this to my business partner at C2P and at Prosperity Capital Advisors, jason Smith, and he was like we could take this into a visual because I was just writing out the order of money step one, 401k, up to match step two, roth. You know all these things and you know he's great at kind of taking a concept and simplifying it into a visual. I mean, he did it with the bucket plan that we all use three simple buckets now, soon and later. Of course, we wrote the bestselling book on the bucket plan.

Speaker 1:

You could go to our website, allison Wealth, and request a copy of this book. We'll send it out to you as a complimentary gift. It's all on our retirement planning process, our holistic wealth management process, but what we came out with was this kind of tax efficient funnels. There's these funnels that you can utilize to fill your buckets of money over time, and then there's these funnels of money to take your distributions when it's time to go take withdrawals. And so I'm excited to jump into this episode with you guys today.

Speaker 2:

Yeah, absolutely. This is a topic that I can't even begin to explain. How many times I talk to clients about diversification of tax. Location right and not take allocation out of the picture. Where are your assets located and how do you look at taxes as a net, after tax wealth and I think this is a topic that you know.

Speaker 2:

I don't know, you probably have encountered the same thing, but most of my clients have never gone through this exercise and every single one of them that does says man, I wish I would have done this 20 years ago.

Speaker 1:

It's the time machine. All my retired clients are like I wish I would have met you 20 years ago. So let's go ahead and let's jump right on in and talk about the tax efficient funnels. Don't forget, subscribe to our channel here. If you're listening to this through podcast on Spotify or Apple or any of the other players, make sure you go back and check out our YouTube page, alison Wealth. Subscribe to that.

Speaker 1:

We have a ton of additional videos. Some of those videos are going to be directly related to things that we're talking about today. So here we go, all right, here we are talking about the tax efficient funnels and in this video I'm gonna actually throw up guys. I'm gonna throw. I'm not gonna throw up guys. That sounds sick. I don't know why that came out. What I'm gonna put up on the screen here is a visual. Again, I mentioned in our opening that my partner created this visual around the tax efficient funnels and, you know, really, as a way to help us leverage the order of money to ultimately increase cash flow.

Speaker 1:

I think any one of our clients would want the ability to increase their cash flow, increase their income, minimize their taxes, and this is really, you know, what I would say is the foundation of what we call the tax management journey. It's our proven process that we take our clients through to help them maximize their income and minimize their taxes. And the reason that I say this is the foundation is that, as we build wealth, these are the areas that we could accumulate that wealth in outside of an operating business. Right? I know most of us realize like maybe I can be self employed, I can have an S corporation or an LLC or a C corporation and you know, I know we do a lot of education, conrad, on that stuff and the right entity set up. If you're a small business owner, if you're a large business owner, if you have a side hustle, but as you're accumulating that wealth and you're either generating savings via your W2 job or you have business income that you want to continue to start to build passive wealth, the way to do it is really in these three tax efficient funnels that we have here the pre tax funnel, the post tax funnel and the tax advantaged funnel. So, david, give us a little bit of education on the pre tax funnel.

Speaker 1:

Like what type of vehicles? And I want to stress the word vehicles, because these are not investments, that's what people need to realize these are not investments, they're just vehicles. Think about, on the highway there's a lot of different vehicles. Those vehicles all do a different thing. You know there's an RV, there's a truck, there's a sedan, there's a minivan, the people inside of those. That's what you can think of as the investments. But, david, just give us kind of a high level on the vehicles that are available for generating pre tax savings and wealth.

Speaker 3:

Yeah, and Dave, as you said, the pre tax funnel it's contributions made with pre tax dollars, and so those are going to be things like your 401ks, your 403Bs, your IRAs and pensions, and the unique part about that is these come from pre tax dollars, but distributions from this account are taxed as income. So, again, you get this funnel where you have pre tax money that you're putting in and then when it comes out it's going to be taxed as income.

Speaker 1:

So kind of an easy way or an analogy to think about this is if we were farming farmer would plant a seed. They're going to then have a harvest at some point and the decision would be like do you pay tax on the seed or do you pay tax on the harvest? With pre tax, you're making a decision to pay tax on the harvest. You're kicking that tax liability down the road, so you're getting a deduction to put money in. It's going to grow tax deferred over time. If I go buy a bunch of stocks, bonds, mutual funds or ETFs in my 401k or IRA and I sell some of those that have realized to gain and then I buy others, I'm not paying a tax on that, right guys.

Speaker 3:

No, absolutely not.

Speaker 1:

No, it's all tax deferred, but then at some point in my life I'm going to want to take money out of that pre tax funnel. And David, what you're saying is that's when you pay tax right?

Speaker 3:

Yeah, exactly so. And, dave, I think there's a key point in that for these 401ks, 401k three Bs IRAs, they're tax deferred, so you're not paying taxes on them every year as they accumulate and grow. And that's one of the really big advantages to this funnel is that you get that tax deferred growth so that the taxes that you're paying each year aren't eating into the growth of the account.

Speaker 1:

Absolutely. Now, david, you mentioned when we take the money out, we're going to be taxed and so is there a specific age that we can start taking the money out, and what happens if I'm almost 40, I'll be 40 this June and if I have some money in these 401ks, 403 Bs or IRAs and I wanted to take that money out right now because I'm going to go do a construction project on the house kind of tell me about what happens if I take money out right now as a 40 year old and then kind of some of the rules around these accounts Generally speaking, if you take them out before your age 59 and a half, you're going to have to pay the tax, but you're also going to have to pay an additional 10% penalty for the federal level.

Speaker 3:

There might be state penalties as well, so it's kind of incentive to hold them for the longer term, so you couldn't just go out and take funds out of them right away. There are some exceptions to those, and one of them I'll give you is if you are a first time home buyer, there's a $10,000 exception for taking them out, where you still have to pay the tax but you don't need to pay the penalty. So there are a couple around there. But generally speaking, you really want to hold these until 59 and a half. So a couple exceptions.

Speaker 1:

I know even in like a 401k sometimes there's like some hardship provisions or maybe you could take a loan from those in an IRA. There are no loans. But what you mentioned is a key word Even if there is an exception to the penalty, you're still going to have to pay tax at whatever your highest marginal rate is. And is that just a tax on the investment gain or is that a tax on everything that comes?

Speaker 3:

out. That's a tax on pretty much everything that comes out, so really with these accounts.

Speaker 1:

If we're putting money in, we want to make sure that we can leave that money in kind of cooking in the oven until we're at least 59 and a half. You know, I will say, because we work with a lot of what I would call kind of early retirees people who have been fortunate enough to be able to retire well before 59 and a half. There are some really advanced ways to get money out of these accounts without paying the penalty, such as a 72t distribution. Or if you have a 401k and it's your last job and you follow some of the right rules, you might be able to take withdrawals at age 55 instead of 59 and a half. But none of those things reduce the tax of the money coming out. It's just the penalty, and so really again thinking of optimizing this.

Speaker 1:

This is long term money. This is in the bucket plan later, bucket money Now. Conrad, being a CPA and also I know you have a crystal ball that tells us the future. David mentioned earlier that when you take money out of these accounts you're going to pay the tax at that time. Do we know what that tax rate is?

Speaker 2:

I do, actually, and I can guarantee you that your tax rate will be somewhere between zero and 100%, and that is the crystal ball. The real answer. They're down for us. I like it.

Speaker 1:

Zero, so you might not pay anything, or you might pay everything. That's right.

Speaker 2:

That's right or somewhere in between, right? So, everybody, that's my crystal ball. I can give you that same answer, and I'll see you on the boat here soon, right? The real answer, though, is absolutely not right. If I had that crystal ball, I wouldn't be here, honestly. But if we knew exactly what taxes we would pay at retirement, then we could design a perfect plan and never have any issues. The fact of the matter is, I don't know about you guys. I don't trust Congress to even act on things that will help us in one year, much less 20 or 30 years down the road, and so we just can't predict what those will be. Taxes likely in the short run likely go up and this is a whole nother episode about where the economy is, where the debt limit is and how Congress has continued to spend. But, ultimately, the answer is no. We don't have a crystal ball. I can't tell you what tax rate you'll pay at the time of distribution, but we know what you'll pay today.

Speaker 1:

So there's an unknown right. We know what the deduction is, which is why, as tax planners, we can calculate how much savings our clients will get to put money into these vehicles today, but we have no idea what the taxes will be when they come out. And if we do a good job at investing… Will the balances in these accounts be higher or lower in the future than they are today? Higher? I just ran into a client that I was meeting with that was in their early 70s and they had amassed 14 million dollars in their IRA 14 million dollars. They deferred tax their whole lifetime. But guess what? Somebody needs to pay it. The government wants their cut of that money. It's either. This client is going to pay it when he's alive.

Speaker 1:

He was married. His spouse was about seven years younger than he was, so if he passes away, that money is going to go to his spouse. His spouse is going to have to pay the tax, and if neither of them do, their children are going to have to pay the tax. He had two children. His goal was that each of the children gets a 50-50 inheritance. And if you inherit an IRA or a 401K or a 403B as a beneficiary a non-spouse beneficiary. How quickly do I have to take that money out of the account and pay tax on it?

Speaker 2:

Ten years, Right. The current rule requires those funds to be distributed. Now there is no annual requirement, but there is a total 10-year requirement. So in your client's situation, their kids would have 10 years to withdraw $7 million from an IRA. And so we've got that simple math.

Speaker 1:

That's at least 700 grand a year, putting them in the top bracket, and that's an extreme example. But here's the gist of the pre-tax money. Right, it has a time and a place and I think everybody, as they approach retirement, should have a certain amount of money in a pre-tax account, because as we go to build a retirement distribution plan, we have a standard deduction in retirement. It's a certain amount of money that the government gives all of us that we could take out tax-free. I think the biggest mistake that we see people make is they actually over-accumulate in the pre-tax bucket. Like you should never have a 10 or $15 million pre-tax IRA because, as my good buddy Ed Slott would say, ed's a CPA. What's the title of his book?

Speaker 3:

The Retirement Savings Time Bomb and how to Diffuse it.

Speaker 1:

The Retirement Savings Time Bomb. Ed is known by the Wall Street Journal as America's IRA expert. Right, you're building a time bomb. It's either going to go off on you, your spouse or your family amongst your passing. And so again, this is not saying don't participate in the 401k, the IRA or the pension plans you need to. You should Absolutely All day long. Just don't over-accumulate in those vehicles, because you could have a tax time bomb on your hands in the future. Now let's talk about the opposite of that. Conrad, give us a little bit of a rundown on this other funnel on the opposite side that we call a tax-advantaged funnel.

Speaker 2:

Yeah, this is going to be. You know, specific accounts are listed here your Roth plans and ROTH. Much like David Roth Royalties will be coming soon. Not going to be, david? Can we share also what your?

Speaker 1:

middle name is oh yeah, absolutely Go ahead.

Speaker 3:

Yeah, it's a middle name IRA, ira. So David Ira Roth Come on.

Speaker 2:

you can't make that up.

Speaker 3:

You can't make it up I always have to recommend the Roth IRA to everyone just by virtue of birthright.

Speaker 2:

Well, I better explain this properly then, because if I don't, then there will be a hell of a problem. I'd say too.

Speaker 1:

like you know, David, you're a musician, you know music degree, and so you know. When I always joke with people and say guess what his middle name is, what does everyone say? Of course, yeah, david Lee Roth, david Lee Roth. But like I was like, this is a clear-cut reason that, david, you were made to be a tax and financial advisor and maybe not a musician. Roth, ira, come on.

Speaker 4:

This is like this is.

Speaker 1:

This was your career calling from birth.

Speaker 3:

It was, and I just accepted it.

Speaker 1:

So I knew I don't even think you knew that, Conrad, Whoa, I did that was my honest reaction.

Speaker 2:

I'm still a little like whoa.

Speaker 1:

that's pretty cool you need us to take over the rest of the episode. Do you need to?

Speaker 2:

go. I think I can give you some. How's that All right? So tell us about.

Speaker 1:

Let's start with the Roth account, Conrad, because that's the most common one. I think every listener is probably heard of a Roth account. You know, talk about the characteristics of a Roth account.

Speaker 2:

Yeah, so the Roth account operates. If you think about an IRA, how it operates, it's very similar, right? Dollars go in, they build tax deferred and I'm going to say deferred in quotations and the difference comes on the front end of the back end, right? So the IRA, as David mentioned, you get a deduction for those contributions in. It builds up and then when it comes out it's taxed at ordinary income rates. The Roth fits that equation. So you pay tax on the dollars before you put them into the Roth IRA. Once you put them in, the Roth IRA builds tax deferred. But at distribution the Roth account is actually tax-free, right? And so the equation there.

Speaker 2:

Think about that $14 million IRA. If we just say it's 40% tax, you're looking at $5 million, right? $5, $6 million of tax potential that could come out of that. Flip that around and make it a Roth IRA and there's zero and that's a massive difference. So, but you are paying tax on those dollars up front. So if you're in the 37, 40% tax bracket or let's go back to World War II rates you're in the 80% tax bracket, right? Do you want to pay that tax or do you want to defer it? If tax rates are low, let's say you're in the 12% bracket right now. Maybe it makes sense to pay 12% on those dollars one time in order to have lifetime accumulation and tax-free distribution.

Speaker 1:

Well, and I think the difference is, I always say, if you look at the left funnel, the pre-tax funnel, you're in the government plan. There You're in a partnership with the federal government because you're deferring taxes. I mean, think about it, guys, if we were to go into a business together and here's how I would outline that business it's going to be a partnership and today we're each going to own a third of the business, but I have the ability, solely at my discretion, to change the rules of the ownership at any time in the future. Where I could decide one morning that, hey, you know what. Dave gets 70% of the business and you two get 15%, would you two come into business with me? No, probably not, right. And that's really what a pre-tax account is, a 401k, right? We know what the rules are today. Conrad, you mentioned it earlier. We know the tax rates today. You're either in the 12% or the 22% or the 24, or the 32, or the 35, or the 37% bracket, but we don't know what those are going to be in the future. And so you know, we opened the episode with me going to Vegas in a couple of weeks. That's a little bit of a gamble right Now with the Roth plan I always share.

Speaker 1:

Like this is for the person that hates the government. Like you don't want the government to be able to dip their hand into your money ever again into the future, and so you're making a decision to say I'm going to pay that tax. Today we have clients that are ultra-high income earners. They're in the 37% marginal bracket and they still decide that for them, they want to participate in the Roth account because they don't want the government to be able to take a piece of their money later on into the future. And so there's a mathematical part of the decision-making process like what's your deduction? What's the tax-deferred growth? What tax rates will you be at in the future, potentially? But then there's also a very personal decision of how much faith and trust do you have in the federal government and what future tax rates could be. Because, again, in a pre-tax account, you are trusting that you're going to be in a lower tax rate later on in life. Versus the Roth account, you're eliminating that public policy risk of increasing taxes later on in life. Now, conrad, I just did a video on this on our YouTube channel. In my opinion, it is the single biggest myth that I hear of over and over for clients, but it's that well, I can barely get any money into a Roth account Right now.

Speaker 1:

The contribution limits for 2024 for a Roth IRA are $7,000 if you're under age 50, $8,000 if you're over age 50. And that's the same for an IRA as well. The Roth IRA on the tax advantage side and the IRA on the pre-tax side it's 7,000 or 8,000. But with the Roth account there's a phase out if you make too much income. And so, for example, if you're single in 2024, that phase out starts at $146,000. And if you make over $161,000, you could not directly contribute into a Roth account. If you're married and file a joint return, that phase out starts at about $230,000. And if you earn over $240,000 of modified adjusted gross income, you could not make a direct contribution into the Roth IRA account. But, david, how do we get around that for our high income earning clients?

Speaker 3:

Yeah, I mean, there's a couple ways to get around with it. One is the backdoor Roth IRA, and I'll give you another one as we go. A lot of 401Ks, they also have a Roth contribution option, and then there's also in 401Ks the mega backdoor Roth option. So there's actually many ways to get around that.

Speaker 1:

And what about business owners, Conrad? I know that's where you focus most of your time. Can we set up Roths for business owners?

Speaker 2:

We certainly can, and a lot of times the Roth 401Ks. If you have employees, the setup of your 401K could include the Roth component. Otherwise, we can set up what's known as a Roth Solo-K, which is really just a 401K for an individual that doesn't have employees in their business In those because of that plan. A lot of 401K plans require testing or what's called the safe harbor design, which really limits what the owner can get in as a solo-K. We can do what's called a discretionary plan and really match $100 for dollar into that plan up to the contributions and even potentially additional over and above that.

Speaker 1:

Here's the thing you might have a W2 job where your employer has a 401K plan maybe they even do a match for you and you're participating in that but you might also have a side hustle. I love when clients have side hustles, being entrepreneurial minded, building some business, betting on themselves and their abilities, doing something that they're passionate about. If you have that side hustle again, conrad, how many times have we set up additional retirement plans for the side hustle, where then we could coordinate the benefits of what they're getting from maybe their W2 job with additional benefits stacked on top through their side hustle business?

Speaker 2:

I think 100% of the time we make that recommendation to clients. I think the challenging part you mentioned coordination that the way the law is written today is that contributions to 401Ks are limited, meaning you can only put in so much per year across all 401Ks. If you have five jobs where you get a 401K, you manually have to do that math right by putting 5,000 in here and 2,000 here. It can become a challenge If it's one job in a side hustle. It allows us to really target more of we know what percentage you're putting in.

Speaker 1:

This is where you really need to work with our team, because you can't do your stuff on your own. There's control group issues with the IRS if you have a certain amount of ownership in one company and another company, but the savings are massive. Again, in my YouTube video that I just did on Roths and the biggest myth around Roths, I show a plan where you could get cumulatively 77 or 78,000 dollars per year into a Roth account. Now, if you're married, times that by two. I mean Conrad. If we were able to put 140,000 dollars a year in a Roth account and let's say it's invested in the stock market, averaging a 7.2% rate of return over a 10-year time period, that one year of contribution 140 grand would double to 280 grand at the end of a decade of completely tax-free money. Imagine if we did 140 grand a year every year for 10 years. You would have a $3, $4, $5 million Roth account by that point for completely tax-free money for you, for your spouse, for your family, upon your passing. That's a huge way to build tax-efficient wealth long-term. Again, we have so many advanced strategies for business owners, but that's one of the biggest ones for even a W-2 income earner that most people aren't taking advantage of.

Speaker 1:

With the Roth IRA, the Roth 401k or the pre-tax IRA or 401k, these are not investments. Sometimes I hear clients say, oh, my 401k has been such a great investment, or my 401k I've heard they're horrible investments. They're not investments, they're just vehicles. Inside of these vehicles, you can pick investments. You could buy individual stocks, mutual funds, etfs. You could buy real estate. You could buy cryptocurrency. You could buy cryptocurrency ETFs. Now you could really invest in almost everything. Not everything, though the word almost everything. There are very specific prohibited transactions that are all those the death sentence for an IRA. It makes it fully taxable if you invest in things Like if I were to buy my primary house in my IRA and live in the house. That's a no-no. But again, there's a lot of really unique things that you can do with these accounts. I want to move the conversation in the tax-advantaged funnel over to actually my favorite account, my favorite. Can you guys guess which one it is? I know, you know, because you hear me talk about it all the time with clients.

Speaker 3:

Yeah, it's going to be the HSA.

Speaker 1:

Yeah, the HSA account, David. Why is this one the most unique one out of all the solutions here?

Speaker 3:

A lot of these have advantages on one side, where you make contributions with after-tax money and then the distributions are tax-free. This is one scenario where you get a triple tax benefit. So you get three benefits when you put the money in, you get a deduction. The second benefit is when it grows, it grows tax-deferred. And the third is that if you use it for qualified expenses, it comes out tax-free. So it's the one scenario where you really get these three benefits where you really don't see pretty much anywhere else. So that's kind of the magic of the HSA.

Speaker 1:

My business one of my businesses we didn't have an HSA plan. I was so excited by adding a high deductible plan. 2023 was my first year being able to max out my HSA. Of course, in January I contributed the maximum that I could into that HSA. I invested it in an all equity fund. That fund has gone up between last year and so far this year like 30% in value and that's all tax-free money and I got a deduction to put the money into that HSA.

Speaker 1:

I was just talking with a client of ours in California about this and this client is super, super high income. They're in a 50% tax bracket. That's 37% on the federal side and 13.3% California income tax, so over 50%. That means every dollar that they earn over that. You know, 600,000, which they're a lot, a lot, a lot over $600,000, is essentially taxed. 51 cents on the dollar goes to the government and they keep 49 cents.

Speaker 1:

I asked them if their company has added a high deductible health plan and they actually looked in. They did add it. And so by adding or going to a high deductible health plan, a couple of things happen. Number one is his monthly premiums have gone down now because a high deductible plan is less expensive than a low deductible plan. So let's use easy math and say he is saving about $500 a month on his family health insurance plan because they've gone to a high deductible. Now their deductible is around $6,500. Their max out-of-pocket is $6,500. So if they have catastrophic health events, the most they're going to pay is $6,500 out-of-pocket. But how much savings did that client have by moving to that high deductible plan? $500 a month times 12 months is $6,000. So really they're only out-of-pocket $500 for that expense. But what else can we do then, conrad, if we now have a high deductible health plan at work, what can we set up for that client?

Speaker 2:

You set up the HSA right the health savings account and let's take those $500 and put them into the HSA, which also gets the deduction going in right. So it saved them $500 of cash. But those same dollars now ended up saving them 50% of that going into that HSA Absolutely, and this is one right. So that specific client probably has the cash flow to pay the $6,500 of deductible right. But I love the HSA. For this reason, I'd utilize it and I don't actually take money out unless it's a really big year. I try to pay for those expenses and my goal is to have about $150,000 at retirement of HSA funds and right now I'm just going to keep my receipts in my pocket and hold them for the next 30 years and in 30 years, when I want some tax-free money, I can reimburse myself for those expenses.

Speaker 1:

Now in 2024, if you're self-only coverage, you can put $4,150 into an HSA. If you're under family coverage, you can put $8,300 in the HSA. So, Conrad, going back to that example, he takes $8,300, and he puts it in his HSA. That's tax-deductible money At a 50% tax rate. How much did we just save in income taxes?

Speaker 2:

$4,000.

Speaker 1:

A little over that right $4,000 of savings right out of the gate. Now let's say that $8,300 doubles twice in the next 20 years because it's invested in the market, so that $8,000 turns to $16,000. The $16,000 turns to $32,000. And now he withdraws that money because maybe he's going to retire early and have to cover health care expense before Medicare kicks on. Or maybe he's now past 65 and he's on Medicare but he's got some out-of-pocket medical expenses. Or, even worse, when he's in his 80s or 90s he has an extended care or long-term care event that's going to require substantial health care costs. He's got a big old funnel of tax-free money to be able to tap into. That's an incredible account. We're going to do a whole podcast episode just on that, but again I want to distress the importance of that. The other two in the tax advantage funnel are the 529 plan. If you have educational funding needs, talk to our team about that.

Speaker 1:

The FSA account is a flexible spending account. You can either structure this if your employer allows it for medical expenses, but you got to be careful not to overfund it because if you don't use it in a current year you lose it. We share with our clients what's your average out-of-pocket expense for health care. If it's $1,000, put $1,000 in your medical FSA, but don't go put $3,000 in your medical FSA if your average expenses are only $1,000. There's also a dependent care FSA. If you're working and you have children under the age of 13, you can use some pre-tax money to help childcare again if your company allows that.

Speaker 1:

And then, last but not least, is permanent cash value life insurance. I'm not talking about term life insurance. I love term life insurance. I think everybody who has anything to protect needs to have term life insurance. It's the lowest cost way to protect the ones you care about and love. When I had my first kid, I bought my first term policy. When I had my second kid, I bought another term policy. When I had my third kid, I bought another term policy. I know both of you guys did the same thing as well. It's the lowest cost way to protect the human value of Dave Allison.

Speaker 1:

But at some point you might have maxed out a lot of these other saving sources like the 401k or the Roth IRA or the HSA, and there is a life insurance policy available out there again of vehicle that you could accumulate savings in. It does provide a death benefit if you were to pass away. But this is more structured to build tax-free savings like a Roth account, but it has no contribution limits. And again, I say, the cash value life insurance, just like the Roth account, just like the health savings account, just like the IRA, is just a vehicle. It's not an investment.

Speaker 1:

And when I say that there's many different types of permanent cash value life insurance, there's the old traditional whole life insurance Works really well. There's indexed universal life insurance. There's variable life insurance, where we could actually go buy stocks, bonds, mutual funds and ETFs in a life insurance policy. So there's a lot of different options. But at the end of the day, what we're doing here is we're building a big pile of money for the future and we're telling Uncle Sam and the federal government hey guys, you can't dip your hands in any of this. This is all tax-free for the future.

Speaker 2:

Yeah.

Speaker 1:

Now let's talk about the middle funnel. The middle funnel is the post-tax funnel. I say this is kind of where you have a double tax because you don't get any deductions to put the money in per se. Hopefully that money grows in value over time and then when you sell the investment, you're going to realize a capital gain and if you've held that investment for at least 12 months, that is preferentially taxed, but you are taxed a second time. You're taxed on the gain and that could be at a tax rate of potentially zero if you don't have a lot of other income.

Speaker 1:

But for most of our clients it's somewhere between 15%, 18.8% or 23.8% at the federal level. These are like our brokerage accounts, our trust accounts, your cryptocurrency accounts that aren't held in a retirement plan account, things that maybe you're buying real estate, right. You're buying rental properties or commercial real estate. If you've got money at the bank, that's post tax money, and so there's some enormous tax planning opportunities here, but you're not really getting a deduction on the front end and you're not getting a tax benefit on the back end. Conrad, for example real estate right. Huge tax benefits to invest in real estate for some people, right?

Speaker 2:

Yeah, I mean. Ultimately, real estate under the IRS code is considered for most people a passive activity which is subject to what are called passive activity loss limitations. And for a married couple, the long and short, if you make more than $150,000, your passive income the losses associated with it, will be limited in that year. Now the limitation is up to $25,000 per property. So it's pretty high, but you ultimately will phase out at about $180,000 of income. So there's a lot of moving parts to that. However, we like real estate because of the cash flow generation. If you're able to put money into a vehicle and realize, let's call it a $5,000 profit, but because of depreciation you show zero taxable profit, it means you've got positive cash flow. Now that doesn't mean it's forever right. The IRS actually calls depreciation. You borrow from the asset, not actually reduce the value. So there is a much like the IRA. There's a borrowing component or a partnership component, but in those years that you have positive cash flow, it allows you to deploy it somewhere else without having to take some money for taxes.

Speaker 1:

Yeah, and we'll do another episode just on real estate. With real estate, I always share with clients like is it a good investment on paper? A lot of times it is. And actually, david, you help build this calculator where we help evaluate properties and what their cash flow is and what their internal rate of return and what their tax benefits are. We've helped a lot of our clients acquire rental properties over time. I get the misconception from clients all the time that they think it's a great tax write-off. But, conrad, what they don't realize is that it's a passive activity. It's not like you can write off the losses of your rental property against your ordinary income or your W2 income in most cases. Now there are some exceptions, right, david? We just helped a client buy a short-term rental. That's classified as an active activity. So there's some things we can help you think through there.

Speaker 1:

The thing I always stress with real estate is you have to have the desire to want to manage a lot of this. Like I know fundamentally as an investor, real estate is a great investment. I've owned rental property before. I've had that property manager calling me saying, hey, my tenants toilet broke. What should we do? Can we get a plumber out Blah, blah, blah, like for me.

Speaker 1:

I'm at a point in my life today where I've got too many other competing priorities. I've got young kids, I've got multiple other companies. I want nothing to do with adding rentals into the mix. That doesn't mean like in five or 10 years my objectives might change and now I'll say, hey, maybe we could take on, maybe my wife could help manage these properties because she's not so busy with young kids. So again, matching up the dynamic of that investment with the phase you are at in life is really, really important. But these could be a tremendous way to build assets. And there's some tax benefits, brokerage accounts also, because with after-tax money and brokerage accounts, david, what can we do here from like a tax deduction creation if there's a lot of volatility or maybe some of the investments have losses while others have substantial gains in them?

Speaker 3:

Yeah, like you said, dave, we could create tax deductions if there are some positions that are showing losses and essentially use that to offset your other capital gains, or up to $3,000 of ordinary income. So there's stuff to do there.

Speaker 1:

We have a great platform for our clients where we invest their after-tax money and we have this algorithmic trading that looks for daily deduction creation opportunities. And just a couple examples of that in action is we had a client in end of 2021 that moved their money over to us to manage. It was a couple million dollars of after-tax money. We deployed this strategy where we essentially built their family, their own mutual fund or ETF, so we acquired about 1,200 individual stocks. Of course, any given day, some of those stocks are going to be up, some are going to be down, but the algorithm searches for tax deduction opportunities and we were able to secure in 2022, obviously not a great year for the market, but a very volatile year meaning we were able to get these tax deductions harvested and they ended up selling a property that year that had a bunch of capital gain. Well, guess what? We were able to use the losses that we harvested from the portfolio to offset the gains that came from selling the property. So net net, they didn't have any tax exposure. We've done that many times for our clients that have company stock, like RSUs, that vest, and again, we can use a portfolio of post-tax money to create deductions to then offset a lot of capital gains that are realized on your company stock position. So this is where we look at the integration of tax management with investment management and, again, having brokerage accounts, trust accounts that post-tax money can be a great opportunity to do so and so just landing the airplane here of these tax-efficient funnels you know, for me, if I'm starting off my journey of savings and you're listening to this podcast right now, number one place to go is your 401k up to the company. Match right Up to the company. Match. That's free money. Conrad, if my company will match $5,000 and I put $5,000 in and they give me $5,000, what rate of return is that on my money? 100%? It's 100% rate of return. Like go get the 100% return. I can't give you 100% return on any reliability and any investments we choose. So that's the first place to go. The second place to go is the Roth account. Start funding your Roth account because with a Roth account, if you need to access the money, if you have a financial emergency, you could take your contributions out income tax-free and penalty free. It's just the earnings that need to stay in there. From there, start funding your health savings account. Right, get those deductions to put the money in. Build up a nice reserve in case you have a medical emergency. Start building that tax-free money From there.

Speaker 1:

Maybe you want to go back to your 401k and contribute up to the maximum the IRS allows. That could be either the Roth 401k or the pre-tax, depending on some of the things that we spoke about earlier. From there you can look at additional things like maybe a 529, if educational funding is important. You want the kids to go to Harvard or MIT. I just had a colleague their child's probably going to get into Notre Dame 80 grand a year. It's crazy. I was like whoa, that's insane. You better have a big fat 529 plan for that and Roth accounts in the names of the children, which again a whole nother episode. Had to set up Roth IRAs in the names of the child. Or you just call Conrad and he'll or David, they'll take care of that for you.

Speaker 1:

But then from there, brokerage accounts, real estate, and then the cherry on top is if you're in a fortunate enough position to have enough discretionary savings. You've maxed out the 401k, you've maxed out the Roth account. Maybe you maxed out a side hustle retirement plan like a Sep IRA or solo 401k, you're contributing to your HSA and maxing it out. You're putting money in a 529, if that's important. You're saving money in a post-tax brokerage account. You're buying real estate, if that's your cup of tea I mentioned. It's not mine for now. The last thing, but not least, is cash value life insurance, being able to stuff some additional savings in there, to have tax deferred, growth tax free, income tax free inheritance to your beneficiaries, and so what we could do is help you structure your own order of money. If you're in the accumulation phase and if you're approaching retirement, maybe you only have one of these funnels.

Speaker 1:

We just met with a client who hired us. We're taking them through our financial planning process and they have about 90% of their money in the pre-tax funnel. They've accumulated about $5 million. About 90% of it is pre-tax and about 10% of it is post-tax. They've got plenty of money to last them for as long as they're in retirement.

Speaker 1:

But the one thing that we showed them is if one of the two spouses passes away early, then they go from having a 100% probability of success in their retirement plan down to a 70% probability of success, and that's just because of the impact of having all of their money in the pre-tax funnel that's taxed all as ordinary income and then later on in life when one spouse passes away, going from a married filing jointly tax status to a single filer, where your deductions get cut in half and all the brackets compress, causing a lot more tax on the same amount of income.

Speaker 1:

So what we were able to do is show them that, even though they're retiring now, if we live off of a little bit of the post-tax money for the first few years and we start strategically shifting money from the pre-tax funnel to the tax-advantaged funnel, we basically take them from a 70% probability of success if one of the two spouses passes away back up to 100% probability of success. And, conrad, what am I talking about when I talk about moving money from the pre-tax funnel to the tax-advantaged?

Speaker 2:

It's really what's called a Roth conversion Right, and we're converting funds intentionally from the pre-tax to the tax-advantaged funnel. But how we do it is huge right. Again, you mentioned how we're going to help this client and say we're going to use after-tax dollars to live on right and really keep their income as low as possible. We'll use up first the exemption that they have $30,000 plus thousand dollars and then ultimately move up in the tax brackets where we know we're going to pay the lowest amount of tax possible in order to do that conversion and by doing that we really get what you're going to call discounted rates.

Speaker 2:

all right, comparatively to what we know is likely to happen in 2026 in terms of making that conversion.

Speaker 1:

Awesome. Well, guys, this was fantastic. We covered a ton. I know we went long in this episode, but there's going to be so many great components that people can go and zero in on and so appreciate you, guys, and let's go out there and help some more clients. Awesome that's good Thanks.

Speaker 2:

As a reminder, I'm available for the Beach House audit.

Speaker 1:

That's right. Vegas or fishing I'll throw myself in If anyone wants to go fishing. I'm in Conrad's got the beach and send all your Range Rovers and G-Wagons to David. He needs them. That's right. All right, guys, it was awesome. Thanks, I'll see you soon.

Speaker 4:

Financial planning and advisory services are offered through Prespair, the Capital Advisor, PCA, an SEC registered investment advisor with its principal place of business in the state of Ohio. Allyson wealth management and PCA are separate, non-affiliated entities. Pca does not provide tax or legal advice. Insurance and tax services offered through Allyson wealth management are not affiliated with PCA. Information received from this video should not be viewed as individual investment advice. Contact may have been created by a third party and was not written or created by a PCA affiliated advisor and does not represent the views and opinions of PCA or its subsidiary. For information pertaining to the registration status of PCA, please contact the firm or refer to the investment advisor public disclosure website For additional information about PCA, including fees and services. Send for our disclosure statement as set forth on Form AB from PCA using the contact information here. Please read the disclosure statement carefully before you invest or send money.

People on this episode

Head Shot

Dave Alison, CFP®, EA, BPC

Host