November 18, 2024 – In today's Lifetime Planning edition of the Financial Sense Newshour, we discuss a range of tax-efficient investing strategies that can save you significant amounts in taxes, particularly if you're in a high tax bracket. We’ll cover the advantages of investing in municipal bonds, high-dividend-paying stocks, and Indexed Universal Life policies. We also touch upon strategies for managing Medicare premiums and making the most of your retirement contributions through Roth IRAs and 401(k)s.
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Transcript
Jim Puplava:
Well, it's hard to believe there's only six and a half weeks left of 2024. Boy, this year has flown by. On today’s program, we’re going to be talking about tax strategies to lower your taxes now, but more importantly, to lower those taxes in the future. Joining us on the program is Crystal Colbert, who’s our senior advisor at the firm. And Crystal, why don’t we begin by talking about some of the opportunities that are available right now and will also be available in the future, especially now that Trump has won reelection. The risk of the Trump tax cuts expiring in 2026 is slim because that will probably be a priority for the administration. And since the Republicans hold both houses, that’s probably one of the top priorities for the president.
Crystal Colbert:
Exactly. So it’s looking like we’re getting some extra years here to do some of these Roth conversions. Obviously, one of the biggest things we’re stressing to clients is to continue to complete those Roth conversions because now we’ve been given a longer window. So, for this year, you know, for the 24% tax bracket, that’s always what we recommend up to. So for single filers, you can go up to $191,950 taxable income for that Roth conversion. And then for a married filing jointly couple, you can go up to $383,900 to stay in that 24% tax bracket in 2024.
Jim Puplava:
And then also next year, we already have the tax rates for 2025. If you’re single, it goes from $191,950 to $197,300. If you’re married, it goes from $383,900 to $394,600. So roughly about another probably $11,000 more. And capital gains, by the way, here’s another thing we’ll be talking about. You’re in a 0% capital gains tax bracket if you make $48,350 and $96,700 if you are married. The standard deduction is $15,600 if you’re single, $29,200 if you’re married, an extra $1,950 if you’re single and an extra $1,550 if you are married. Now here’s something that’s really important, especially if you are a salaried employee. If you underpay your taxes, the IRS penalty is 8%. Now, one way you can avoid that, if you’re salaried, is to just increase your withholding and make sure it gets in before the end of the year, and you will not face a penalty. However, if you are making quarterly estimates, if you’re retired and you’re making quarterly estimates, if you haven’t paid enough, you could be facing a penalty on underpayment. So what you want to do is put a stop to that and make your fourth-quarter payment. Make sure that you pay enough. Talk to your advisor or your accountant to ensure you’ve paid enough so you don’t face any further penalties. So, a lot of things that you can do. With that in mind, Crystal, why don’t we get into some of the tax planning moves that we can do to reduce taxes this year? Let’s begin with tax-loss harvesting.
Crystal Colbert:
Yes. So, tax-loss harvesting is a great strategy to offset some of those gains that you’ve had throughout the year. A lot of the time, if you have some sort of tax loss, you can actually carry it over from future years. So always check with your CPA to see if you have some tax losses that you can carry over, but they can offset some of your gains. If you don’t have that and you want to make sure that you’re offsetting some of those gains from this year and you have some losses in your account, then you can always sell that. If you want to keep it, though, you need to watch out for those wash-sale rules. So, you need to wait at least 30 days if you sell a security at a loss before buying it back.
Jim Puplava:
And one of the things that hits a lot of individuals who own mutual funds—mutual funds usually in October will have to declare their capital gains on anything that they sold. So, all of a sudden in November, you’re getting a statement. You’ve got, I don’t know, let’s say the mutual fund is $10 a share. They declare $1 in capital gains. When they declare that $1 in capital gains, usually the shares fall by that $1 amount. So, one way to avoid paying that capital gains tax is to sell the shares at $9. Therefore, you would have a $1 loss if that was your cost basis, and then you can turn around and buy it back within 30 days. So, let’s talk about something else. It’s not just about tax-loss harvesting, but Crystal, why don’t we talk about tax-efficient investing, especially if you’re in those higher tax brackets? Because one of the things that happens is, we mentioned where the 24% tax brackets end for this year—it’s $191,950 for single filers, and almost $384,000 if you’re married. But any amount over that jumps from 24% to 32%, so an 8 percentage point increase in the tax bracket. So, you want to keep everything else that you’re doing at a lower bracket. So, let’s talk about things that could be done to be more tax-efficient when you invest.
Crystal Colbert:
Yeah, so one of the things that you could do—because obviously a lot of states have state taxes too. We talk about federal taxes all the time, but, you know, here in California, we have a huge state tax issue, New York, etc. So, one of the ways to be a little bit more tax-efficient with your investing is potentially investing in Treasuries or a money market fund for Treasuries to avoid those state taxes if you’re kind of sitting in cash. The other way is you can consider investing in high dividend-paying stocks, particularly qualified dividends versus interest, where it's taxed at ordinary income. The qualified dividends are taxed at that preferential capital gains tax bracket, so you could be anywhere between 0%, 15%, and 20%, depending on where your income lies.
Jim Puplava:
Another issue too is, a lot of times if you’re taking capital gains and you’re retired, you’re on Medicare, and taking those capital gains can put you in a higher Medicare premium bracket for Medicare Part B. So, if you’re thinking of taking some gains, try to split them between this year and next year if possible, so you can keep yourself below those lower brackets. Because once you start taking large capital gains, there’s actually three things that you’re going to end up paying. You’re going to pay state taxes, federal taxes, but also you could be hit with higher Medicare premiums. So, you want to make sure that you keep that to a minimum.
Crystal Colbert:
Some of the other ways that you can consider trying to be a little bit more tax-efficient is if you are in one of those high-income tax brackets. You can always look at building, you know, a municipal bond tax-free portfolio where you’re not taxed at the federal level, and you’re not taxed at the state level as long as you’re investing in municipal bonds that are within your state. You could potentially look into the LIRP concept that we’ve been talking about in a couple of our last podcasts. It’s a way for you to contribute after-tax dollars while you’re ideally within the ages of around 35 to 55, but basically making after-tax contributions to an indexed universal life policy. You’re kind of overfunding that policy to allow for that cash value to increase over time, let that grow for a bit, and then in the future, you can actually withdraw tax-free policy loans against the policy to have that tax-free income and utilize that during retirement. Same thing with contributing to a Roth and getting money into that tax-free bucket—just having that grow and then utilizing it in your retirement years for some tax-free income.
Jim Puplava:
An example of tax efficiency—you know, let’s take a stock like Altria, which pays over 8%. If you’re in a 15% tax bracket—as most investors are either 0% or 15% for capital gains—you take 15% of an 8% policy and you’re making over 6% after tax. Likewise, if you have a Roth and you’re putting money into a Roth, imagine buying a stock like AT&T or Verizon that pays 6%, or stocks that pay 7% or 8%. You take it out of a Roth, and all of a sudden now you’re getting 6%, 7%, or 8% tax-free. There’s no way you’re going to be able to get 7% or 8% tax-free in a municipal bond. So, this is another reason why we love these Roth conversions, and we love high dividend-paying stocks because after-tax, you’re actually getting a higher rate of return after-tax than you would pre-tax.
Crystal Colbert:
One of the things to obviously watch out for, especially, is RMDs (Required Minimum Distributions) later on in life. That’s where most people’s tax brackets jump once they’re in retirement. So, as of 2024, if you’re 73, you’re required to take those RMDs. You want to make sure you know, with that size of the RMD, how it’s going to impact your Medicare taxes. Because as your income increases, your Medicare premiums increase. One way to potentially lower it is you can do qualified charitable distributions. For 2024, you can make $105,000 in contributions or qualified charitable distributions, and those will actually count towards your RMD. If you are married and you both have separate IRAs, you both can actually do the qualified charitable distribution. So, in total for 2024, you could potentially make up to $210,000 in qualified charitable distributions.
Jim Puplava:
And remember, you have to get these done if you’re turning 73. So, talk to your advisor. Also remember, a lot of times, Crystal, people will have multiple IRAs. They’ll have maybe a CD at a bank, they’ll have different brokerage accounts, and you need to add all those up because your required RMD is going to be based on what the ending value of those accounts was on December 31, 2023. So, make sure if you have multiple accounts that you’re adding them all up together and you take the RMD because you don’t want to have the penalties. I think they’re like something— they start around 25%, so you don’t want to get caught in that situation. And speaking of retirement accounts, let’s talk about that. If you are putting money into a 401(k), the limit this year is $23,000. If you’re age 50 and up, you can add an additional $7,500 on top of that. Another thing, if you are self-employed, you can use a simple retirement plan, something called a SEP IRA. The contribution limit is $69,000 for 2024. It’s $70,000 next year or 25% of compensation, whichever is less. So, 25% of your compensation or $69,000 for this year, that goes to $70,000. Now, if you’re a self-employed high earner—let’s say, I don’t know, you’re a lawyer or you’re basically in a business by yourself, and you have a high level of income—there are other kinds of pension plans that allow you to put a larger amount and fund up to a quarter million dollars in retirement benefits when you retire. They’re called defined benefit or cash benefit plans. Depending on your age, you can put $100,000, sometimes several hundred thousand, and even more away into a plan for yourself. So, if you are a high-income earner, that’s something you may want to consider to shelter that while you’re in a high tax bracket. If you’re making that kind of money, you’re probably in a 37% tax bracket for federal, and the highest bracket if you’re in a state that has income taxes. And then on top of that, you’re probably subject to the 3.8% Obama tax. So, you know, you could be paying over 50% taxes in a marginal tax rate. This is one program, if you’re a high earner, that can bring that down substantially.
Crystal Colbert:
Another thing that we always talk about is obviously doing Roth conversions and then potentially doing, especially incorporating your 401(k), doing a mega backdoor Roth for some future planning. So, you know, we always talk about Roth conversions up to the 24% tax bracket—that’s kind of that sweet spot. If you have a large IRA, start now. You know, there’s no age limit to when you can actually start doing Roth conversions. I actually do Roth conversions each year. So again, start as soon as you can, especially while we have these historically low tax brackets. For 2024, just a reminder, you can go up to $191,950 if you are single. And for married filing jointly, you can go up to $383,900. One of the things we always recommend is using your personal assets to fund the taxes. So, if you have a taxable account, use that instead of withholding the taxes from your Roth conversion because ideally, you want to get as much growing tax-free in that Roth as possible. Another way that you can start getting money into a Roth, if you know you’re in too high of a tax bracket and it doesn’t make sense to do Roth conversions—if your 401(k) plan allows for this—there is a way that you could do this mega backdoor Roth strategy that we’ve talked about a couple of times. So, in a 401(k) plan, you have to make sure to talk with your plan administrator to see if they offer an after-tax contribution account. So, you know how you have your traditional 401(k) contributions, you have your Roth 401(k) contributions—there should be a separate after-tax contribution where you can fund more into your 401(k). So, if your plan allows for that, number one. Number two, just make sure that the plan allows you to convert funds to Roth funds while the plan is active. So, one of the things, in order to do the mega backdoor Roth, is—there are still contribution limits. So, you have your $23,000 that you can do for employee contributions. If you’re age 50 and above, then you have that extra catch-up contribution, so you could go up to $30,500. If you have employer matches, you need to take those into account. The max amount you can fund into a 401(k) is $69,000 if you’re under age 50. If you are age 50 and above, you can contribute up to $76,500. So, if you wanted to implement this mega backdoor strategy, you would combine your employee contributions, any employer contributions, and then whatever is remaining up to that $69,000 or $76,500, you can contribute into the after-tax portion of your 401(k). Ideally, you would convert those funds into your Roth and then do an in-service rollover into your Roth IRA. So, that’s how you get that mega backdoor Roth concept. It’s a good way to fund a Roth if you can’t directly fund a Roth.
Jim Puplava:
Now, the next area that we want to talk about in terms of getting tax-free income or lowering your income is something called the LIRP. LIRP stands for Life Insurance Retirement Plan. This started out in Fortune 500 companies. A lot of these CEOs of these big companies are making multimillion-dollar salaries plus stock options, so they’re in high tax brackets. What a LIRP is, it’s a life insurance policy. It’s a universal life policy. It has just enough death benefit to make it a life insurance policy. But unlike a regular life insurance policy, in a LIRP, the emphasis is on cash accumulation. So basically, what you’re doing is you’re making premiums each year, usually for a seven to ten-year period. That money goes into a cash balance plan that is invested and grows over time. So, let’s say that you contribute for about seven to ten years, then you allow it to accumulate for another ten years. So, you’ve got basically 20 years of accumulation. This is why it works for somebody in their 40s or 50s. However, when you withdraw it when you retire—let’s say you’re 45, you contribute ten years of payments into a LIRP. Let’s say you’re putting $50,000 or $100,000 a year into the plan. Then you stop funding it after seven or ten years, depending on how it’s structured. Then you allow it to accumulate. So, you contribute from age 45 to 55, and from 55 to 65, you allow it to accumulate. And then at age 65, you can begin taking distributions that are tax-free in the neighborhood of 10% to 12% a year, all the way up to age 90. It’s a very, very powerful tax planning tool. It works really well for someone in their 40s or 50s who has a high-level salary. We see this a lot with the people that we work with in the tech industry, where they’re getting not only high salaries, but they’re also getting bonuses, stock options, and things of that nature. That puts them in a very high tax bracket. So, what we do is use this to fund the LIRP. We’ll show you how this works when we get to a case study.
Crystal Colbert:
So, yeah, if you can combine having that LIRP strategy along with converting your IRAs completely over to Roth and just leaving and having LIRP income along with Roth IRA income in your later years, you’re going to put yourself in a very strong tax situation where you could have little to no taxes owed because all you’re withdrawing is tax-free policy loans against your indexed universal life policy, and then tax-free distributions from your Roth. So, all that tax-free income doesn’t affect your Social Security or your Medicare premium. You could be potentially in just an amazing tax situation in your later years.
Jim Puplava:
Now let’s bring this to a close with a case study. This is the case study we’ll call Brian and Sharon. Both are high-tech employees with high six-figure incomes in the maximum tax bracket. Unfortunately, in California too, where the maximum tax bracket is 14.4%. Sharon is in her early 40s, I think she was 41 when we began this plan, and Brian was 45. So, what we did is we put together a LIRP program. They put $100,000 a year into a LIRP. They would pay that for seven years, and then their income at that time was $750,000—it’s actually higher now. Part of Sharon’s income went into a deferred comp with her employer, mainly her bonuses. So, that went into a deferred comp. The majority of Brian’s bonus we used to fund the LIRP of $100,000 a year. Now, the plan was that at age 65, they would begin retirement. At that point, the LIRP would have been funded for 20 years of accumulation, and they would begin taking. Sharon would retire at age 60 and take out her deferred comp over a five-year period from age 60 to 65. At age 65, Brian would retire and begin taking money from the LIRP, which would be roughly about $120,000 a year tax-free. Now because the LIRP was non-taxable, that would keep them in a low tax bracket. They also had personal investments, mainly the stocks of the two tech companies they worked for, and one of them is now paying a dividend. But what would happen is between the age of 65 and age 70, we would take their IRAs and convert them over into a Roth. So, technically at age 70, they would have two sources of retirement income. They’d be making close to over $100,000 a year tax-free from their Roth, and that would go up each year because we were doing high dividend-paying stocks. Then the LIRP would be paying them 12% tax-free or $120,000. So, at age 70, they would be taking home a quarter million dollars a year free of federal taxes, state taxes, and Medicare taxes. So, a really great way to plan if you find yourself fortunate enough to be in a high-tax profession—maybe you’re a doctor, maybe you’re a very successful lawyer, or you work in the high-tech industry and you have a high salary and a high level of income. This is a great way to set yourself up for a tax-free retirement.
Crystal Colbert:
So, just to kind of sum up, especially for what you can do in the here and now and in 2024, take a look at, you know, what your future income sources are. So, if you have a large IRA and you want to start reducing that and making some Roth conversions to reduce your future tax liabilities, you know, start that right now. If you’re able to do something like a mega backdoor Roth or, you know, find out more information if your employer allows for it in your 401(k), look into doing something like that to get more of your tax-free bucket increased to be able to use in retirement. If you’re interested in the LIRP strategy, if you think it’s something that could potentially work for you, you can always reach out to us here at the office. If you would like to speak with me, you can just ask for Crystal Colbert. The phone number for our office is 858-487-3939. Or you can email me directly at crystal[dot]colbert[at]financialsense[dot]com. And Jim, if they wanted to reach out to you?
Jim Puplava:
You can email me at jim[dot]puplava[at]financialsense[dot]com or once again call us, either at our regular line or toll-free: 888-486-3939. In the meantime, we’d like to thank you for tuning in to Lifetime Planning. Until we talk again, we hope you have a pleasant week.
