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Bridging the Gap: Building Wealth Tax-Free

Target group: Individuals looking to enhance their wealth

A wise man once told me, “there’s nothing like tax-free money.” Believe it or not, there are plenty of ways to build wealth without having to pay a dime in income taxes. The purpose of this article is to show you some ways to legally avoid your hard-earned dollars going to “Uncle Sam.”

Before making any financial decision, you should always consider the tax implications. Why? Taxes tend to be a person’s single biggest expense. From income taxes to property taxes to breathing air taxes, taxes can take up a sizable chunk of your money! So it would certainly be in your best interest to learn how to prevent that from happening.

Retirement Accounts

One way to build wealth tax-free is to ensure you are saving for retirement the proper way. You can utilize a Roth 401(k)/IRA by ensuring that you contribute up to the maximum match allowed to the Roth 401(k). Your company may or may not offer a Roth 401(k), but if they do, it would certainly be beneficial to take advantage. After you’ve exhausted the match, max out your Roth IRA. And if you can dig deeper into that Roth 401(k), then go for it. You can always roll the money over into a Roth IRA if you leave that job someday. This will allow you to accumulate money tax-free along with being able to withdraw the money tax-free after age 59 ½. Note that you must meet certain requirements to be able to contribute to a Roth IRA. However, there is a “loophole” in the Internal Revenue Code (IRC) that allows you to contribute to a non-deductible IRA and simultaneously roll it over into a Roth IRA. This strategy is known as the “Backdoor IRA.” Uncle Sam isn’t so bad after all.

The next way to take advantage is to utilize a Health Savings Account (HSA). Although most people think this is money you should spend right away on medical expenses, this is a huge mistake. It’s like spending your 401(k)/IRA money now. Why? You can put in money in the HSA pre-tax, accumulate money tax-free, and withdraw the money tax-free. This can be used as a supplement to the soon to be pre-historic Medicare and cover all your medical expenses in retirement! And if you don’t think medical expenses are high in retirement, you have something else coming for you. The key is to never touch the money in the HSA until you reach retirement to make that tax-free money work for you. And of course, you shouldn’t use the HSA for non-medical expenses to avoid any unnecessary taxes. It’s not like you weren’t paying enough taxes in the first place.

The next popular way is to obtain a permanent (cash value) life insurance policy. Some popular options include Whole Life and Universal Life. The reason why you might want to consider this strategy is because money in a permanent life insurance policy accumulates over time and you can start withdrawing the money tax-free (through a loan against the policy) in retirement (or basically whenever you want). Money can accumulate at a pretty significant rate in these accounts as well.

Real Estate

One of the most rewarding investments in the world is real estate. Let me show you a strategy they probably never taught you in college. You go out and buy a 2-3 flat with a fairly low down payment (preferably $0 which is very possible). You include the repairs (if necessary) as part of the loan. You decide to live in one unit and acquire tenants for the other units. The tenants will ultimately pay your mortgage while you sit on the couch and watch TV. Once the home appreciates in value, you refinance it and pull out the equity tax-free. Now you can take the money to the mall and spend it all or you can think like an investor and use the money to acquire a new property and continue the trend. You will almost never pay income taxes using this strategy. You can even sell the home tax-free using the homeowners’ exclusion rule or a Section 1031 like-kind exchange if you acquire a new property. You can also use a home equity loan tax-free for another investment if you please. One reason why you may never pay taxes is that the government rewards you for making investments. As such, depreciation and other costs will more than likely offset any income you make on a property.

Income Shifting

One way the rich keep getting richer is that they shift their income to other people. You can literally set up business entities and have your income shielded in them. You can also turn your kids into majority owners of your companies (while you still maintain control)! You can put certain investments in their name so that the gains won't be taxed. Your parents are also another prime target for this strategy assuming they don’t work. Please just ensure that there's a mutual understanding between the parties to avoid any legal issues. It would be a nightmare for your son to buy a Lamborghini in your company’s name after finding out that he “owns” a million-dollar company.

Trust Funds & Estate Planning

Imagine doing all this work, passing away, then suddenly, most of your money is inherited by Uncle Sam. Good estate planning is critical. Money that goes to beneficiaries are never taxed. However, you (the dead person) may have to pay taxes on this money! The government can literally tax you while you’re dead. However, with good estate planning, you can let your retirement accounts grow until you die and pass the money to your kids tax-free. You can set up a trust fund to have income and principal pass to your kids tax-free. Last, but not least, you can gift appreciated assets to your favorite charities tax-free. These are all excellent ways to transfer wealth tax-free to the ones you truly care about.

Investing

Although real estate was covered earlier, the group that by far pays the least amount of taxes is investors. Investors receive tremendously favorable tax treatment because remember, the government wants you to invest (so that they can later take the money away from you when your investments grow, but you’re so smart that you keep reinvesting the money to prevent them from your pockets). Some investment income can be shielded from taxes by taking advantage of long-term capital gains (basically when you sell an asset after holding it over a year). You can also shift your ordinary income into passive income and have your passive real estate losses offset your passive income. Lastly, as stated before, you can have your investment income passed down to your kids (by making them owners) for it to be taxed at a much lower rate (most likely 0%).

There are plenty of ways to build wealth tax-free. Although it may take some maneuvering to get around the tax code, it certainly pays off when you can virtually eliminate what used to be your single biggest expense. Always seek the help of a qualified tax professional if you’re not one yourself (you wouldn’t want to fix a bad leak in your toilet if you have very little knowledge about plumbing). Lastly, be sure to talk to an attorney when setting up your business entities to ensure you don’t do anything silly. If you have any questions, please don’t hesitate to reach out to me.

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