Pay Today or Put Away? – Episode 046

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[00:01] Welcome to the Prosperity Podcast, fresh alternative personal finance talk for independent thinkers who prosper outside of Wall Street. Here’s your host, bestselling author, Kim D.H. Butler, and No BS Money Guy, Todd Strobel. Hey, everybody. Welcome to another edition of the Prosperity Podcast. This is No BS Money Guy, Todd Strobel. Once again, we have my co-host and bestselling financial author, Kim Butler, with us. Welcome, Kim. Thank you, Todd. Looking forward to our discussion today, I think we’re going to be talking about pre-tax versus post-tax dollars. This came from a client that emailed in a question about the information that he finally figured out on his Truth Concepts calculator.

[00:47] So, yes, we do have some clients that buy the Truth Concepts calculators at truthconcepts.com. The idea was that the actual dollars available after tax on a pre-tax account are the exact same actual dollars that are available after tax on a post-tax account. Did I make that clear? Well, I think it takes a little bit more explanation. And maybe an example would help. But the two things that we’re comparing is should we pay the taxes today and move money into either a Roth type environment or a investment into, say, a whole life insurance policy that, again, would not be taxed again. So we’re trying to create a tax-free situation by paying tax today versus putting money into a tax-deferred account, which the money’s going to be higher because we’re not paying

[01:55] those taxes. So there’s a higher amount to start with and to build with. But then when we access the funds, we have to pay the taxes. So am I kind of setting that up a little better? Yes. And I don’t know that I’ve got an example quick at hand. I agree that’d be handy. We’ll have that for next go around unless you have one. But it is interesting. This pre versus post discussion happens often. And it is always easy on the front end because we’re such a today’s society that people are going to turn towards the pre-tax environment, which would be like a 401k or an IRA or something that you’re getting a deduction for your contribution. But it is so funny to hear those same clients or, in often cases, other people

[02:47] but that are on the other end of the spectrum. In other words, they’re in their 60s and 70s, and now they’re looking at their accounts and thinking about how they’re going to take it out. And as is often the case when we think short-term versus long-term or when we have the benefit of hindsight, here we have somebody in their 60s or 70s looking at all these pre-tax accounts that they funded and being very disappointed, mad even, that they have to pay taxes on all these dollars. I cannot tell you how many times I have talked to somebody in their 60s or 70s, especially people bumping up against the 70 and a half, where it is actually required by the government that you start to take money out of your accounts

[03:36] in the required minimum distribution arena or RMD. And they’re mad that they have to do that because maybe they’re still working or they don’t want to spend that money or they don’t want to be forced to take it in any event. And nevertheless, because they got the deduction on the front end and they agreed to go into business with the government, essentially that’s what 401Ks and IRAs are, then it’s becoming fully taxable on the back end. So that can be a challenge. Now, tell me a little bit more what our goal is here. Well, one thing I would like to point out, and our client did a great job of illustrating that, is you have to go through a mental shift of when you’re looking at a tax-devert account of netting that down in your mind so you

[04:25] don’t have the tendency to say, wow, I have $100,000 in this account. I’ve saved $100,000 because it’s really not the true net. So I think that’s a great point that he made. Absolutely. I make that mistake all the time. I look at a particular leftover 401K that’s stuck in a place that I can’t do anything about, and I always look at that gross value when in actuality I should be cutting that number in half. And it’s further problematic these days because of all the conversations that are going around about the 401K fees. You’ve got Congress involved. There’s huge discussions because of Tony Robbins’ book, Money Master the Game. John Wogel, the head of Vanguard, is out there with his thoughts on the

[05:17] fees and all the things that he’s been trumpeting for years. So these are interesting discussions to follow, and yet I don’t really think they’re getting at the heart of the matter. And that’s what our client brought up is, okay, 401K fees, yes, they’re high. Yes, they create massive lost opportunity because once the fee is taken, then that money is no longer in the account to earn. And that’s something that most people are not even addressing when they’re having this conversation. But then furthermore, you have this issue of what do you do with the account when you’re done with it, when you die and you either haven’t spent it all or you didn’t want to spend it all. And there are many, many people that have a desire to leave portions of those

[06:08] accounts to children and grandchildren. And yet, in our opinion, the 401K plan and the IRA plan money are the worst asset to leave to children and grandchildren. This would be known as the stretch IRA, I believe is the concept. And maybe you could just kind of just briefly tell our listeners what that is. Well, a stretch IRA is often recommended to families that have either 401Ks that they’re going to roll over into IRAs or regular IRAs or self-directed IRAs, doesn’t really matter. And what the accountants often recommend is stretching that IRA out through subsequent generations, whereby in essence, it’s a 100% tax to the person that saved the money. Now, of course, the accountants aren’t telling it that way.

[07:03] The accountants are saying, oh, my gosh, this is so great. If you stretch this into the next generation, then they can pay tax at their lower tax bracket. But the problem is that then, as I indicated, turns into a 100% tax for you, the person that saved and invested the money, because there is no use of the money. You, as the saver slash investor, don’t get to use the money at all. It’s passed on to the next generation in a taxable environment. But 100% tax to you because you didn’t get to use any of it. So if people are really wanting to benefit the next generation, it’s so much more effective to split up your IRA and do two things with it. The first thing should be to pay it out. Take a 10 or a 20-year period of time and get it paid out on purpose to yourself.

[08:00] Pay the taxes and then reinvest in after-tax environments where you can get solid double-digit returns and not lose your principal and not be taxed on the entire amount. Again, of course, you’re going to be taxed on the income, or maybe you can even convert that into capital gains, but get it out of the IRA 401K box for a portion of the money and use it, spend it, even give it away, but make use of it during your lifetime. And then take the other portion of the IRA, and it’s going to depend on every family, what percentages or what, but take that other portion of the IRA and buy life insurance with it so that your beneficiaries get a truly tax-free asset. The life insurance death benefit is income tax-free.

[08:52] It can be paid to children or grandchildren, ideally somebody over 18, or in trust for somebody under 18, and it’s a so much more efficient structure if you really, really want to leave something to children and grandchildren to leave them a life insurance policy. There’s no probate, it goes immediately, it’s cash, it’s income tax-free, there aren’t any questions about it. In fact, it even supersedes any type of will or trust work that you did get done. In other words, if you leave $100,000 to your daughter, but your son, the will says that your son gets all of your assets, then that $100,000 is still going to go to the daughter and the son will get everything else. And so sometimes for families, this is a much cleaner way to leave an asset

[09:41] base where you specify maybe a percentage or a dollar figure that you want to leave to each child, fund that desire with life insurance, and then be done. You don’t have to worry, you don’t have to try to figure out, well, how much of this money am I going to spend because I want a little leftover? You already know that the leftover portion is handled, so that means you get to spend all of the rest. I think the thing that bothers me the most about the IRA strategy for heirs is that it relies on us hoping that our children are poor. Otherwise they could be as in this high of tax bracket. I would hope that my kids would earn more than I did, not less. Yes, that’s a fabulous statement. And you’re making that statement, assuming that tax rates stay the

[10:30] same. If tax rates go up, our children may be paying higher taxes, even if they’re not earning more income. And I agree with you. I hope my kids do earn more. So this is, and as you said, it was said so well by our clients that emailed in, it’s a shift in thought. It’s a paradigm shift. It’s a shift in your thinking. That’s why think is the number one principle of the seven principles of prosperity, and it enables you to really hone in on, okay, I know that this is what the government is saying. I know that this is what all the media is saying, but this is what I think, and to be clear that maybe investing when your partner is the government is not the best way, which would be a 401k plan. Maybe you are actually better paying the tax today and doing after

[11:25] tax, both saving and investing. So again, after tax saving to us would be the life insurance after tax investing would be the bridge loans or the life settlements. And then you get to keep the control and control is the fifth principle of the seven principles of prosperity that we always want to be paying attention to because control and keeping control of our money and control over who gets to use it and when and for what purpose are very important things in having the financial independence that we’re all seeking. Now, the second part of our listeners question was looking at that same tax deferred versus tax free environment for leaving money to a charity. Fair enough. So that’s an awesome goal and certainly something that we support and yet we

[12:20] support it in the exact same way that you would want to leave money for children. Because again, if you have life insurance that’s slated for a charity, then you can spend all the rest of your money now. And if you have life insurance, then of course that can go tax free. The charity, that’s not going to matter so much, but you may want to actually do some of that gifting now. Why wait to benefit the charity until you have passed on and you don’t get to see any other results? Why not go ahead and do some of that gifting now? So that’s actually another strategy that you could employ is to have the income, go ahead and come off taxable income from that 401k or IRA and then turn around and give that to a charity, which of course will create a

[13:12] deduction, thereby netting you, in essence, a very, very low, if not even possibly zero, tax on that particular transaction. You take the income in, turn around, give it as a deduction. So that’s one strategy, again, to benefit charities while you’re living and then go back to the life insurance strategy if you want to benefit charities when you pass on so that you know that particular amount is set for that charity and you can spend all the rest. It’s so much more valuable to have that kind of control and flexibility and freedom on your dollars, rather than just hoping that there’s a certain amount left in some account somewhere that can go to charity. Super. So we’ve talked about tax deferred versus tax free.

[14:01] The second part that I want to just kind of address here briefly is that there, we’re talking again about two amounts. We’re talking about the amount that you contribute monthly, and we’re also talking about if you have a bulk amount of money in a tax deferred account, would you automatically say that anybody with money in a tax deferred account, which would be a 401k IRA, should try to take that money out, pay the taxes and penalties, or are there any strategies where you could create a tax free account from a tax deferred account without paying the penalties? Well, yes, there are definitely strategies to avoid the penalties. So there’s something called a 72 T that that’s a tax code that is available.

[14:49] If you are in your fifties, it can work. If you’re younger, it’s maybe not as effective because what it says is if you take out that tax deferred money over your life expectancy, then you can avoid the 10% penalty. So that’s a helpful thing for people to be aware of 72 T can work with a 401 K that’s rolled over to an IRA or a regular IRA. And it is a 72 T strategy whereby you are taking that amount of money out over your life expectancy, which probably for 50 year olds, 40 years or so, and thereby not paying the 10% penalty. But you said something else that I wanted to comment on, and that is that we do have one investment whereby you can take a tax deferred account like an IRA or a 401 K roll over and actually convert it to a Roth IRA.

[15:46] Now, a lot of people don’t think this is possible because they think their income is too high, but contributing to a Roth has an income requirement converting to a Roth does not. And so there is a situation where somebody could take an IRA convert portions of it. We probably would do this over time. No need to do it all in one year to a Roth, pay the income tax so that that account would never be taxed again. So Roth IRA, as we know, is after tax money going in and then never be taxed again. Now it is still heavily subject to government control, which may be a problem, but setting that issue aside for a moment, if you want to make that conversion, please reach out to us for help, because one of the

[16:38] investments that we work with will actually enable you to get a discount for that conversion due to lack of marketability and lack of liquidity of this investment. So those two things, lack of marketability and lack of liquidity cause this investment to get a reduced appraised value. So as an example, you have $100,000 IRA, you want to convert it to a Roth. We can get an appraisal on this asset for $70,000 and thereby, when you pay taxes for that conversion, you’re only paying taxes on 70 grand instead of on a hundred grand because of the lack of marketability and lack of liquidity of the investment. So that’s a specialized environment. But if that’s something that you have an interest in, please reach out to

[17:30] us either on email at partners, number four, prosperity.com or by calling the office at eight seven seven eight eight nine three nine eight one extension one 20 that’ll get you to Jill and she can schedule you with either me or Todd and we can walk you through that Roth conversion capability. And this is absolutely something that you don’t want to rush into. You know, there are situations, particularly if you have kids in college and things like that, where where this is not the applicable strategy, there’s no one strategy that’s right for everybody. So take your time, get your information, get your ducks in a row. You know, we certainly spend a lot of time talking to accountants and attorneys to before we advise you that this is a great strategy for you.

[18:23] So again, your situation may be somewhat different. Anything else you want to share before we wrap up? Well, just always happy to help if people have questions or welcome to email them in again. The website is partners, number four, prosperity.com. And if you haven’t grabbed our ebook called financial planning has failed, you can get that at partners, number four, prosperity.com slash ebook. And we do these 15 minute snippets and sometimes they can be a little bit intimidating, especially the subjects we’ve been talking with today. There’s no required minimum education required. No one will ever make you feel silly or anything like that to call it and ask questions, do we? Absolutely. We love Q&A.

[19:10] It’s our favorite game to play. Super. Well, I’m going to wrap this up. This is No BS Money Guy Todd Strobel for the Prosperity Podcast. Take care, everybody. Thank you for listening to the Prosperity Podcast to take control of your money and have it work for you. Visit us at partnersforprosperity.com. If you liked this episode, make sure you subscribe and leave a review.