Time to pay real estate taxes

DSCN0002That time of the year has arrived. I must send in checks paying property taxes on my rental properties. Last year, I contacted my lender and requested them to stop escrowing money to pay for taxes and insurance. Instead, I would pay it myself. This way, there is no confusion and quandary over how much money to set aside in escrow on top of pure P+I payments (principal and interest).

This has simplified things for me, because I can see exactly how much is owed on each unit. I don’t have parts of my net work tied up in escrow accounts that might be stocking up too little or too much. Instead, I have an annual cost that has to be paid and is instantly reflected when I make the payment in my net worth tracking spreadsheet.

As I wrote four hefty checks, it is a bit challenging, since property taxes in Texas are a bit steeper than Tennessee. But knowing that my tenants are paying off the mortgages at record pace and I’m earning top rent, I feel good that I’m developing strong, cash flowing assets that will build strong retirement wealth down the road. And I’m constantly reminding myself that real estate is one of the strongest investments one can make in growing wealth.

Happy investing!

2013 taxes filed…whew! Say what?!?

TaxesThis past Wednesday, I finished filing my taxes. What?!?! Wasn’t that due back in April?

Well, yes and no. Income taxes in the United States are due April 15th. But you are able to file for a six month extension. As I’ve blogged before, my taxes are too complicated to get done in time. So my accountant has been chugging away, and we finally wrapped things up on the given deadline, October 15th.

And the celebration is that I got a big refund! How much? Well, I don’t publish actual numbers on this site, but try 4% of my taxable income. Now you go and calculate how much that would be for you, and tell if that wouldn’t make you happy.

Filing complex taxes is no small feat. Even though my CPA is well versed in real estate, LLCs, tax deductions I never knew about (like fees for pre-school for my kids), I have to produce all the paperwork for him to scour. This included closing HUD forms for buying and selling houses last year. One was missing. And then I remembered: we couldn’t make it to the closing and my father-in-law had been empowered to sign for us. I contact my agent, who gave me the title company’s number. I left a message and they fired me a copy of the HUD.

I was about to throw in the towel on child pre-school deductions given that I couldn’t find the church’s EIN number. But my CPA had checked some published registry and found them, cross checked against the street address I supplied. Woot!

Moral of the story: know where all your financial paperwork is. And don’t forget to keep email addresses and phone numbers for the people that can find critical bits for you.

So what will I do with this extra cash? Stand by. I’ll let you know.

Can you really live your retirement tax free?

TaxesI have heard a lot of radio ads for various shows and products where they like to brag how you can live on the “tax free side of life”. Perhaps you’ve heard them too. If this really possible? Or are they selling a bunch of malarkey?

Let’s dig in and find out. If you’ve read some of my past entries from here, you’ll surely have noticed me talking about things like EIULs, real estate, and MLP stocks and their tax advantages. In this article, I want to look at how EIULs operate compared to a 401K in the arena of taxes.

Now before we go any further, I want to make one thing clear.

There ain’t no such thing as a free lunch, especially in taxes.

When you dig in and see how various investments operate, it’s more about picking the best, most efficient tax strategy that will serve your needs. Since this blog is about building retirement wealth, I generally talk about the best tax strategy for your retirement.

401K taxes vs. EIUL taxes

That sounds pretty vague, ehh? Let’s use a concrete example: 401K taxes vs. EIUL taxes.

If you use your company’s 401K plan, you get the nice benefit of writing off your contributions. You don’t have have to pay a nickel in taxes for every dollar you stuff into your plan…today. The trade off? (There’s always a trade off). When you start making withdrawals, you will be subject to full income tax rates on every dollar you take out.

Many people are drawn to the allure of avoiding taxes today. It sounds great to take home more pay. I certainly liked the sound of that when I got started at my first job. The problem was, there was no one there to coach on the options and benefits of other vehicles by which I could pay taxes today and pay considerably less in retirement. As the saying goes, you don’t know what you don’t know.

If you buy an EIUL instead, you fund it with after tax dollars. Every dollar that goes in has a certain amount skimmed off for Uncle Sam based on your income. Then when you decide to withdraw money later on in retirement, you do so tax free. The trade off is that by paying taxes up front, you can skip paying taxes in retirement.

Which is better? Well from a tax perspective alone, I prefer the EIUL for two reasons.

  1. The total amount of taxes I pay will smaller, because the total money in action is smaller. In general, as I get older, I make more money, and pay more taxes. So the sooner I can move that money off the tax rolls, the better.
  2. Tax rates and policies are always moving around and the subject of elections. What will this country’s entire tax structure be like in twenty or thirty years? Who knows. I’m still waiting for my crystal ball to get out of the shop. Until that time, I’ve decided that I don’t want to gamble my retirement on such a huge unknown.

If you’ve read this blog, then you know I also advocate EIULs due to better and more consistent historical performance, but I’m leaving that aspect out of this article. For tax purposes alone, it’s generally better to pay up front than later on in life. (But this never precludes doing a complete analysis!)

The tax man cometh

I’ve run into people that don’t understand why EIULs let you “get away with dodging taxes.” Some of these people I’ve chatted with tend to believe any chunk of cash you receive should be subject to income taxes.

For starters, any time you start making withdrawals from your EIUL, the first batch of money is considered return of capital. Essentially, whatever money was put into your cash value holdings is simply being handed back to you. And as pointed out earlier, you already paid taxes on it. Is it really fair to tax you twice on money that effectively didn’t go anywhere?

After you get your premiums back, then you begin taking out loans against the cash value left. Loans are non-taxable events. For my friends that believe this is trickery, I wonder if they are ready to pay income taxes every time they finance a car. If you borrow $200,000 to buy a house, do you think you should suddenly be hit up with a $48,000 tax bill that year? And what about using your credit card? Every time you use it, you are borrowing money to buy something. Should that also be taxed?

I’m sure you don’t want to pay taxes on any of that debt, but what’s the underlying reason you shouldn’t? Because you will ultimately pay off your debt using taxable dollars. The government WILL get their cut of money based on this debt. They just get it in smaller chunks. Bought a $20,000 car? You will end up paying it off with $20,000 of hard earned money subject to good ole’ income tax laws. In fact, thanks to financing, you might actually be shelling out a little bit more, all paid with taxable dollars.

But wait! EIUL loans aren’t paid off!!! How can you justify THAT?!?

An EIUL is a life insurance contract. The amount of money you pass on to your heirs is tax free. It is an enticement by the government to leave something to support your family, friends, or whomever you wish. When you take out loans, the loans+interest are paid off by the death benefit. And don’t forget: it was funded with after tax dollars.

So as I wrote early on, there is no free lunch. You aren’t “getting away” with anything. You funded a plan with taxable money and structured things so that you could pay the taxes now instead of in retirement.

Filing taxes is now in progress

TaxesI’ve mentioned before how complicated taxes can become as your wealth building plan gets underway. When you enter the workforce and start punching the clock every day, you have what’s known as ordinary income. That’s IRS-speak for job income.

But if you start adopting some of the practices I’ve mentioned, your income begins to change. I still get a majority of my income from my daytime job, but now I also receive rent, tax deferred MLP distributions, and qualified stock dividends. I also get paid a quarterly check for a book I wrote three years ago. I also had some other awkward sources of money.

One thing I had to dig up was how to handle the fact that I didn’t receive a 1099 INT from any of my banks. I knew I had received interest. It turns out that banks will usually only send you such a document if you earned over $10 in a given account. I didn’t make it. Nonetheless, Uncle Sam still expects you to report every penny so I simply looked up each account’s December 2013 statement and wrote down the year-to-date interest.

As a rule of thumb, I thought about every way that money came into my hands last year. It helped me remember a couple things that don’t come in the mail. I gathered a pile of electronic documents and emailed them to my CPA.

Last year, I had a tremendous tax bill. That was because I had to deal with the aftermath of nuking my 401K. While it was a hefty bill, the results were fantastic. I found a giant source of capital to create my real estate portfolio. Last year, I grossed over 50% of my daytime job in rental income. That’s a hint that things will be GREAT down the road. And need I mention that with a purposeful plan set up by Jeff Brown, ALL of that rental income is tax sheltered?

I’m eager to hear the feedback from my CPA. It’s pure speculation, but I’m guessing I’ll still be short and have to write a check to pay the difference against withheld taxes. But who knows? Thankfully this time, we won’t have to file an extension.

Happy tax season!

Is doing taxes on your own right for you?

I am getting pelted by ads about doing your taxes. It’s become annoying.

On one hand, there is a pretty nice campaign showing how much money was lost by people last year that did their own taxes. The first thought that comes to mind is, “how do they know that?” The only way I can conceive of figuring that out is to go through each person’s self-done tax statement, have it reviewed by a professional, and then calculate the difference. Seems costly and time consuming. I’m sure that’s NOT what they did. So what they are saying must be some sort of estimate. I am skeptical of estimates especially coming from people that are trying to sell me something.

On the other hand, there are a slew of ads that basically say you know whether or not you had a baby, got married, etc. last year, so you should be able to do your own taxes. Did someone say non-sequitur? Knowing that you had a baby doesn’t confer you with knowledge of the tax code. Nor does it empower you to ask all the right questions.

The more wealth you acquire, the more “complex” your taxes

I can share my own history of preparing taxes. I used to do them myself. For awhile I had a Windows computer and I bought one of the popular software apps. It worked great. Then I moved to Linux. They don’t sell that software for Linux. The first year, I had to visit my next door neighbor, borrow their computer, install the software, and print out my taxes there. A bit embarrassing I might add. The following year, that software app company had a webified version. They didn’t promise Linux support, but I tried it anyway. Worked great!

Then I got married. My sister-in-law and mother-in-law both, at one time, worked for H&R Block. My wife had always let her sister do her taxes, so we let her handle them that year. That was great. Four years ago, things got a bit crazy. We sold a house I had built years ago, but was now considered joint property since we were married. And we bought a new house. The federal government had this “new home buyer’s” credit of $8000 as well as a “first time home buyer’s” credit of $6500. I was pretty sure we didn’t qualify for the $8000 credit, but the $6500 one sounded perfect.

My sister-in-law worked for hours, including making phone calls to the IRS. It turns out that we DIDN’T qualify because my wife was now considered a home owner of the first house. If we had bought the house before we got married we might have gotten both. But being married knocked both of our list.

And then we bought rental property in 2012. I had my accountant complete a cost segregation study on all four units to accelerate our rate of depreciation. I had also bought a big chunk of MLP stock which dispensed a K-1 form instead of a classic 1099. I knew our taxes were even more complicated and I couldn’t lean on my sister-in-law for this. It was simply beyond her skill set.

Simply put, our income wasn’t very “ordinary”.

“Ordinary” vs. complex income

When you clock in at your job, get your check every week, every two weeks, or twice a month, and then spend it on food, rent, etc., you have what’s called ordinary income. The bulk of your taxes are paid to the government by having it withheld from your paycheck. This mechanism was crafted during World War II because the government needed to get their money quicker. Before then, you simply wrote a check once a year, and at the time, not many people paid income taxes.

Suffice it to say, most of the people out there earn their living this way, and that is what a lot of these tax services are oriented towards. The do-your-own-taxes as well as tax agents at Walmart, H&R Block, or whatever are all oriented towards the majority of clients.

When you start getting money from dividend paying stocks, rental property, trusts, and other more complex structures, then you have moved off the beaten path. You need someone more experienced. The person working a kiosk at Walmart isn’t that highly trained for such special situations.

The criteria I have used to weed out the right person has been “do you know how to handle a cost segregation study and a K1 for my MLP?” I suspect the people at H&R Block or Walmart would stare back at you with a bewildered look on their face. They probably have never heard of a cost segregation study. I’d say the odds are higher that they’ve seen a K1, but not much. The guy I hired said, “sure, no problem” to both.

The answer isn’t whether or not you know that you got married last year. And the answer isn’t tied to whether or not you left money behind last year. The answer is rooted in how “ordinary” your income is. I won’t decide for you, but I thought I would share that if you become successful at developing passive streams of income, you will probably reach a point at which DIY tax preparation will be inefficient and possibly you cost much

Stock options and an 83(b) election – the road not travelled

Do you have stock options? Are you about to receive a grant? Are you negotiating for a new job position and they are offering stock options? Then this article is for you.

I have written about stock options before and the pros and cons about retaining them or cashing them in. Boil it all down, and it’s basically up to you and whether you want to go ahead and grab the cash when it’s available or hold on and speculate on getting better value at the risk of losing existing value. There is no “right” or “wrong” in that. It’s really whatever you’re comfortable with.

But when it comes to taxes, there are different options to your options, that you probably have never heard of. And TurboTax probably wouldn’t help you here. This is one of those, if you don’t know about, you don’t know about it.

If you receive any form of stock or a stock option, there is the “default” way that the IRS views your situation and will tax you. Basically, as your stock vests, i.e. becomes available to you over some periodic schedule like four years, you can buy-and-sell immediately, and collect your profit. The IRS will view every nickel of profit as ordinary income and apply regular taxes. If your stock options vest over a four year period, and your company grows at a tremendous amount each year, your tax bill each year will go up, Up, UP. Yuck!

If you file an 83(b) exception at the time you initially receive the grant (but way before anything vests) you instead get to pay ordinary income taxes on the value at the time of issuance, and then later on, you only pay long term capital gains on the growth of the company’s value. The difference between a 28% and a 15% tax on your profits can become significant.

Let’s look at an example. Your company issues you 10,000 shares with a strike price of $1.00/share. Assuming it becomes available to you four years later, you have the option to buy the lot of stock for $10,000. The idea is that maybe your company goes public and the stock price if $20/share. You plunk down $10,000 and then sell the lot for $200,000, leaving you with a tasty profit of $190,000. And Uncle Sam will have his hand out, asking for $53,200(28%rate)

What does it look like if we file an 83(b)? First of all, you pay up front, within thirty days of issuance, $2800 in taxes. This is based on a 28% tax rate. From here on, any profit you glean will be based on long term capital gains. The same four years pass by, and ta-dah! The company is trading at the same $20/share. You buy-and-sell, and pocket $190,000. Only this time, you only have to pay Uncle Sam $28,500, being a long term capital gain. That totals $31,300, which is a $21,900 savings.

Maybe you’re a founder, and are actually getting issued 100,000 shares for a strike price of $0.01. Again, if you IPO four years later at $20/share, and never filed that 83(b), you would owe $559,720 in taxes. If you had filed that special 83(b) in the beginning, you would instead pay $280 up front in taxes, and four years later, a hair underneath $300,000. That is $260,000 in reduced taxes!

What risks are there in filing an 83(b). The risk is tied with the chance that your company doesn’t take off or ever acquired or IPO. In the first scenario, the amount of money on the line is $2800. In the second scenario, $280 is on the line. If you never cash in, you never get to harvest the incredible tax savings. So the question is, would you spend $2800 up front to save $21,900 later on in taxes? Or would you pony up $280 to save $260,000? Usually (99% chance anyone?) the answer is a resounding “yes!!!!!”

So why do you think the IRS has such a narrow window to get this? Because it’s almost always better to file the form and get your big tax deduction at the end.

I mentioned “the road not travelled” in the title. That’s because when I received the three different stock option letters over the past three years, I didn’t know anything about this. I could have saved a lot of tax money. But if there’s another one, I’ll be ringing up my CPA as fast as possible.

P.S. There is an entirely different range of issues when you start discussing Alternative Minimum Tax and how it can be impacted by stock options. I chatted with my CPA for thirty minutes on the phone about 83(b) elections and AMT so I could understand all the ramifications. It pays to have a CPA that understands this stuff inside and out, and yet won’t push you into particular situations. Suffice it so say, he or she is probably NOT working at an H&R Block stand at Walmart. Mine is on the other side of this country. That’s how far I went to find the right person.

How to build retirement wealth

If you are a new reader here, perhaps it’s time for an introduction. I like sharing my opinions on how I am building retirement wealth. I also like to document how my own investments are doing. Some of these ideas might sound outrageous or in contradiction to what you’ve heard from your financial planner, financial adviser, or some popular radio hosts.

But the concepts I lay out in my articles are backed up by historical evidence. In fact, I look at history to try and determine the best ways to build wealth. Do you know how you always hear “past returns are no guarantee of future returns”? While true that there is no guarantee, trying to shirk the past and it’s strong evidence is reckless and frankly won’t lead to a good retirement.

So what are the investment vehicles I employ?

  • No mutual funds.
  • No 401K or IRA wrappers.
  • Direct ownership of stocks (not mutual funds).
  • Leveraged real estate
  • Over funded cash value life insurance (also known as permanent life insurance)
  • Build wealth using various forms of arbitrage

These may the types of vehicles I use, but it also includes the concept of actively managed wealth building. Some of these vehicles may be considered passive forms of income, but it takes an active approach to do it right. The concept of simply dumping money into a mutual fund inside your 401K and assuming it will grow to serve you in retirement just doesn’t work.

No mutual funds

The Dalbar report has been monitoring mutual funds and tax deferred savings plans for 20 years. According to the 2013 report, mutual fund investors have significantly underperformed the S&P 500 over the past 3, 5, 10 and 20 years. In 2012, they reported the average performance of investors in equity funds was 4.25%. They further indicate that this is mostly tied to investor behavior rather than fund performance.

The performance numbers are clear: people investing in mutual funds average poorly. Dalbar goes on to make a judgment that it’s the consumer’s fault. This might or might not be a valid judgment. But is that relevant? If people don’t do well, and haven’t been for 20 years, do I really want to plan my retirement under the assumption that I can beat the average? I’m sure it’s what most others think. Dave Ramsey is happy to quote the FDIC in saying that 97.3% of people don’t follow through on their promise to pay off a 30-year mortgage in just 15 years with extra payments.

So why would we expect people to follow through on their attempt to not buy when things rise and sell when a market correction hits? I prefer to build my wealth building plans using the averages.

No 401K or IRA wrappers

401K and other government wrappers come with an incredible entanglement of regulations, restrictions, and other tricks to basically keep your hands off the money. The concept is to get you to put away money and keep your hands off of it until you reach retirement age. But many investment houses take advantage of this situation in the sense that mutual funds and other vehicles available tend to have the highest expense ratios.

People will eagerly point out things like IRAs as giving you more control, but the government has strong limits on how much you can put into an IRA. Suffice it to say, the limits on IRAs aren’t enough to build a retirement plan.

And do you really think the government designed the 401K to help you set aside money and save on taxes? The government wants you to put away money today without paying any taxes, so that you will grow the money into something bigger, and then start paying full blown income taxes when you reach retirement. Yikes!

It’s true that I have a Roth IRA and a 401K, but that is money I put in before I realized it wasn’t working. As you’ll see below, most of that money has been re-applied and is already making way more than what it used to. The only money I have left is trapped in my current company’s 401K and I can’t get to it. The Roth IRA I have is small as well and would serve little benefit if I extracted it.

Direct ownership of stocks

This one really stuns some people that I meet. I don’t like the dismal performance of mutual funds combined with their fees. Instead, I prefer owning stocks directly. If you look at all the studies done over the years, there is one stock market strategy that has proved fruitful: buying and holding dividend-paying stocks.

If you look at people like Warren Buffett, they have created billions by acquiring strong companies when they were on sale. Warren Buffett has also bought cash flowing stocks and companies, and reinvested their proceeds in other strong companies. This has created a compounding affect that has let him beat the S&P500 for years by great margins. The book value of Berkshire Hathaway has averaged it’s growth by 28% during the boom years, and by as much as 18% during bad recessionary times.

It’s not hard to find solid companies. In fact, there are many blog sites dedicated to this, such as Dividend Mantra and Dividend Growth Investor. The companies they invest in are not fly-by-night shady outfits. Instead, they mention thinks like Coca-Cola (KO), Walmart (WMT), and other names you’ll recognize. Companies like Coca-Cola have created millionaires for decades. You can find a list of companies that have paid consistent dividends, increasing them year after year, for over 25 years. It’s not that hard. It turns out, these are some of the best investments regarding inflation. A company that has managed to increase payouts to its shareholders through thick and thin is pretty solid.

Leveraged real estate

After the 2008 housing melt down, many people won’t entertain investing in real estate. The problem is that newspapers were reporting the worst scenarios regarding foreclosures. The truth is, 99% of mortgages are current and paid for. The number of people that suffered rate hikes on risky loans while having insufficient money to keep up were a fraction of a percent.

Real estate has shown a more consistent growth rate than mutual funds. And real estate is one of the easiest investments for middle class people to get into. Using prudent leverage, an average 4-5% growth can turn into 20-25% growth in your investment capital. That certainly beats the 4.25% average growth of mutual funds. Again, this is what happens if you use the averages. You can make more and take on riskier, higher paying options, but why take a risk? You’re already ahead of what mutual funds in 401K wrappers have to offer.

Since real estate was a no brainer, I cashed out my 13-year-old 401K from my old company, paid 37% in taxes and penalties that year, and used it to buy two duplexes with 20% and 25% down. I couldn’t be happier.

The rentals I own are paying me a nice monthly profit as the tenants pay off the mortgages for me. I keep a fair amount of cash in reserve to handle vacancies. And seeing my property yield monthly cash helps me to focus on that instead of pure growth in value.

Over funded cash value life insurance

This is one that stirs a lot of discussion. People have been preached to that cash value life insurance is a rip off and to never, ever, ever buy it! Phrases like “buy term and invest the difference” as well as “don’t mix insurance with investments” flies all over the place.

The thing is, many of the people that preach this opinion have an incomplete knowledge of how it works and how it was designed to function.

To be clear, I’m talking about EIULs, or equity indexed universal life insurance. And the critical component is over funding the policy to the limit set by the IRS. Essentially, buy a policy where you get the minimum amount of death benefit for a given amount of money. That causes your cash value to build faster. If you get the maximum amount of death benefit, then your cash value grows very slowly and it becomes an ineffective tool in storing wealth.

EIULs that are over funded give you the option down the road to borrow from the cash value. Essentially, you borrow money (without paying it back) and when you die, the loan is paid off with the death benefit. Whatever is left over is passed on to your beneficiaries.

EIULs have the benefit on not investing in the stock market, but instead in European options on the market. This is how they institute caps such that your principle is guaranteed to growth somewhere between 0% and 15% of the index it is linked to. If the index goes negative, your cash value stays the same. But if the market goes positive, so does your cash value.

You may not be aware, but that facet is incredibly powerful when it comes to wealth preservation. So many people have seen huge booms in their mutual fund holdings, but the overall performance is knocked back to that Dalbar average of 4.25% due to losses. If your account shrinks by 30% in one year, and then grows by 30% the following year, are back to where you started? Nope. $10,000 would drop to $7,000 and then grow back to $9,100. But if you had an EIUL, that $10,000 would stay put, and then grow to $11,500 (0% loss followed by a 15% gain based on the caps).

EIULs are very expensive for the first ten years; a fact many people like to point out such as Suze Orman and Dave Ramsey. But after ten years, the fees drop to almost nothing. After twenty years, the fees will probably average between 0.5-1.5%/year. Sure beats the 2-4% average cost of mutual funds. And then you get to start taking out tax free loans (compared to mutual fund payments at income tax rates), there is even less to fret about in retirement.

Once I understood the entire picture of what EIULs could and couldn’t do, it was a simple decision to stop investing money in my company 401K and reroute that money into an EIUL.

Build wealth using various forms of arbitrage

Something people are unaware of is how banks make money. Banks borrow money from the Federal Reserve at rates like 3.25% and then turn around and lend it out at 4.25%, pocketing the 1% difference. You can use the same concept.

I took out a HELOC against my home for (PRIME-0.25%) with a floor of 4%, so right now, it costs me 4% to get this money. Then I bought a position in Vanguard Natural Resources, an MLP that has been paying 9% distributions on a monthly basis. As I pay off the HELOC, I am essentially pocketing the 5% difference.

This is also referred to as equity harvesting. All that equity in my house was earning 0%. I am getting the cheapest form of money available, a mortgage, and using it to collect cash flowing assets. After I pay off the HELOC, I can redirect the money towards paying off investment mortgages, buying other dividend aristocrat stocks for even more passive income cash flows, or increase my position in Vanguard Natural Resources. And at that point, I can also renew the HELOC to get more investment capital.

When people ask “would you take out a $50,000 loan on your house and invest it?” my answer is a resounding “yes!”

Stay tuned

I hope you enjoyed this introduction to the concepts of build wealth at the Wealth Building Society. Wealth building isn’t hard, but when you boil things down to sound bites used by radio entertainers, some of the worst advice gets out there. Are the people that are telling you to only take out 15 year mortgages and pay them off as fast possible retiring on mutual funds? Are these people maxing out 401K and IRAs, or are they building wealth through writing books, running TV and radio shows, and piping their business equity pay offs into rental property?

Term Life OR Universal Life Insurance: A Fallacy

I often see articles where people are debating whether to buy term life insurance or permanent life insurance. It is a fallacy.

I actually have both. On one hand, I have a 20-year, level premium, term life insurance policy. This is to protect my family over the next twenty years as I build my investment portfolio. If something goes wrong, they will be protected. They will have money to support themselves. It can support them for a whole year while they decided what to do with everything I leave them, including real estate and stocks.

But by the time I reach retirement and have built up a treasure trove of cash yielding rental properties along with some stocks, they won’t need term life insurance anymore. At that time, my EIUL should be fully funded and allow me to start taking out tax free loans. When entering retirement, it’s important to be as tax shielded as possible. That’s because many of the tax deductions we get today like mortgage interest, kids, and other things, will not apply then.

Heck, taxes are a greater drain on retirement income than fees, so I’m still curious why people focus so heavily on fees. By taking out tax free loans from my permanent life insurance policy for 25 years, I predict my wife and I will be able to take many trips, visit the grand kids, and do all kinds of fun things. That will certainly be better than taking a job at Walmart as a greeter.

If you manage to scrape together $1 million in your 401K plan, are you ready to live on $40,000/year? It might sound tricky, especially given how little we know where inflation will take us in the next few decades.

To summarize: don’t get sucked into the dichotomy of term vs permanent life insurance. They were designed to serve different purposes. Use them as they were meant, and you should do well. 

Taxes are settled; net worth increases!

The last numbers for the month of July are finally in, and I have updated my monthly net worth spreadsheet. The results are spectacular!

I finally got my taxes completed, meaning I have paid off the IRS for my early 401K withdrawal. The giant liability I’ve been carrying for nine months is now zeroed out. Instead of my early 401K withdrawal costing me 50%, it ended up only costing me about 37%. Cue the happy feet.

My networth has growth by 10% from just last month. Total growth since last August when I began tracking is at 80%. Some of this is tied to estimated values of my rental properties, so it should be taken with a grain of salt. It will probably take a few years before those values settle down to something closer to reality. And you don’t REALLY know until you sell, right? But it’s good enough for now.

All my real estate holdings are settled now that I’m done moving into our new home and selling off the old one. I’m not buying any more real estate for probably five years at least. Next year’s tax bill will be MUCH smaller and also easier to produce. Now that I’m established with my new CPA things should be smooth sailing.

The bills to Uncle Sam have been paid and the outcome is fantastic. Instead of fretting over whether or not my 401K will grow or shrink each month or worrying about the high costs of those funds, I am looking at an annual incoming cash flow of about 25% of my investment capital. Remember, I only had to put 20-25% down on the rental properties. So based on those rents combined with the monthly distributions from VNR, I have a pretty solid, consistent cash flow coming in. Divide that by the total money I invested, and that’s where you get 25%.

It’s true that probably 70% of that cash flow is used to service debt. But that’s okay. First of all, the debt is fixed and finite; rents and distributions are not. Based on history, the odds are pretty good they will both rise at some point. The cost for getting my money free from the clutches of that 401K have been paid. With this type of cash flow, I should probably recover the losses in just a few years.

The key here is that with a stable cash flow positive income, I can now wait for the market to speak. When property values rise high sometime in the future, I can sell bits of property and re-leverage things. I also have a huge boon of unused depreciation starting to accumulate that will help me reduce if not eliminate the tax bill down the road. That should allow me to reinvest a maximum amount of cash and continue to build wealth much better and more reliably than mutual funds wrapped in a 401K ever could.

You can check out the chart below to get a rough estimate if the time frame it will take me to recover the losses and leave the old 401K plan in the dust.

Happy Income Tax Day!

Happy Income Tax Day!

Kind of a strange greeting, right? But this is one of my happiest years when it comes to taxes.

What may sound even stranger is the fact that this year, I have to write a bigger check then I ever had to in the past.

The reason I’m so happy is because when I file my taxes and write that humongous check, I get to zero out that giant liability that has been a part of my net worth tracking spreadsheet for almost a year.

My tax liability has been a guess, and a very conservative one at that. Basically, I assumed I would lose 50% of my 401K early withdrawal. That is probably a tad high. If instead, it comes to around 48%, my net worth will actually grow a little. It also means the vast majority of my 401K money is now out of that restricted, costly plan and instead totally in my hands. Whatever stupid tax that was tied to using that mechanism will be paid in full and behind me.

I have entered a new era. For about a year, my plan to dump my 401K and instead switch to something more productive has been in progress. This will be the last major step to making the transition. (See the graph to get a picture of what I mean by more productive).

Don’t get me wrong

I don’t like parting with such a big chunk of cash, but it means that the old way of saving up money in a deferred plan is gone. Instead, I’m now building up a portfolio of valuable assets that come with some of the best tax laws in the land. From here on, I will be focused on having the most tax advantaged strategy in play all the way into retirement.

If you’re new to this site, then that may sound strange as well. Aren’t deferred plans great because they let you duck income taxes while you save? Strangely, no. They were designed to instead make you pay even bigger taxes when you reach retirement. In fact, after avoiding taxes for 30 years, it might take as little as five years to blow through all the tax savings.

Retirement should have as small of a tax footprint as possible

That is no longer going to happen to me. Instead, when I retire, I will receive a big chunk of my rental income shielded by depreciation. I will also have the option of taking out tax free loans from my EIULs (I plan to have more than one by then).

These things all help deal with the fact that I probably will have paid off my primary mortgage, have no more tax deductions from my children, and would essentially be tax naked. I might have to pay some capital gains taxes when I sell a chunk of Berkshire Hathaway, but the dividends coming from things like VNR will be tax free thanks to its MLP status.

It seems a little strange that people so obsessed with fees happen to ignore the biggest fee out there: taxes. When you reach retirement it’s probably a good idea to avoid as many taxes as possible. That is the point when you are most vulnerable and who knows what the tax rates and structure will be then.

But in order to get from here to there, I need to pay a bunch of taxes right now. This is what it takes to launch my wealth building plan, and today marks the day when its in full gear. See why I’m so happy?