Curious about what tax categories your investments fall under? Interested in learning what kind of investments help you reduce your tax liability? In this podcast episode, Justin Buddy Arce, Financial Advisor from NWF Advisory Group talks about
- When and how to pay taxes
- What taxes to pay
- The various tax categories for your investments
Enjoy this episode with Justin Buddy Arce.
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Jessica: OK. Hello, everyone, and thank you for joining us on this exciting webinar on: How-To Invest More Tax Efficiently. Our goal is to help you keep more of your investment earnings and grow your wealth exponentially. Just a little bit of housekeeping here. Before we begin: can somebody please type in the chat box whether you can hear me and see our screen share? I have an example on the screen share that shows how you can get to the chat function. Perfect. Thank you, and this webinar is being recorded and we will make sure that you also get a recording of it afterwards. We I just wanted to let you know coming up in 2020, Upside Avenue is excited to announce its educational webinars series. We’ve surveyed our investors and followers to find out what financial and investment topics everyone is interested in, and then we look for Subject matters-matter experts all over the country who can speak on these topics and have developed this educational series that will hopefully help you manage your finances and make better informed investment decisions. We want to make sure that you’re living your Upside. So, lookout for the registration information for January’s Webinar in your email and we’ll also share it on our Facebook, Twitter and LinkedIn. So, today’s exclusive webinar is about How-To Invest More Tax Efficiently. We have an absolutely fantastic guest speaker who is no stranger to sharing his knowledge in the finance and investment industry. He has spoken at various career centers and business clubs, including Citrus College, UC Irvine, Cal Poly Ponoma, an US Santa Barbara on financial Wellness and literacy. He’s been a financial advisor since 2010 and specializes in wealth management and wealth transfer, and he enjoys being an independent advisor, particularly in helping his clients reach their financial goals through comprehensive and holistic advice. Born and raised and still living in sunny California. When he’s not helping his clients, Justin can be found hiking, weightlifting, cooking, traveling and he also plays on a Men’s Sunday Basketball League team, appropriately named “Net Profit.” So, please give a warm welcome from NWF Advisory Group, our guest speaker and friend: Justin Arce. Justin, I’ll turn over hosting over to you now.
Justin: Alright, thank you for that kind and warm introduction Jessica. I really appreciate it. Thank you to Upside Avenue for having me today and good morning. Good afternoon and I guess the good evening to those who will be listening to the recording. Thank you everyone for-for joining us today. Got a lot of good information to go through with you guys in terms of how to invest more tax efficiently. I hope that all of you are comfortable because for the next three hours. We will be reading through the IRS tax code Handbook. No, I’m kidding.
We’re going to be packing in about 20 minutes worth of information and opening it up to Q&A. At the end. I just have a little bit of housekeeping on my end to-to run through really quickly. It’s a disclosure that I have to read and that is: I offer security and insurance through Royal Alliance Associates. Investment Advisory Services are offered through NWF Advisory Services, which is not affiliated with Royal Alliance. Investing involves risk, including the potential of loss of principle. No investment strategy can be guaranteed a profit or protect against loss. Past performance is no guarantee of future results. The material being presented is for informational purposes only. Although many of the topics presented may involve tax, legal, accounting or other issues, neither Royal Lions nor any of its agents, employees or register representatives are in the business of offering such advice. Individuals interested in these topics should consult with their own professional advisors to examine tax, legal, accounting, or financial planning. Aspects of these topics and how it applies to their specific circumstances.
So now that we got that out of the way, you know, just want to make it clear today that I’m not making any recommendations. This is geared to be big picture and to be educational we’re going to try and stray away from talking about individual products. Anything like that. And there’s three main things that I essentially want to accomplish. I want to identify what are the tax buckets that investments can fall in. I want to explain the types of taxes that someone might pay, and then I want to go through the tips and tricks on how to invest more tax efficiently.
So, let’s jump into a brief summary as to the three different tax buckets we’ve got, the taxable bucket we’ve got, the tax deferred bucket, and we’ve got the tax advantage bucket. So, taxable bucket how this bucket works. Most common vehicles that go here would be like your banking accounts. This is going to be your savings or CDs or money markets. This would be like your brokerage accounts which can house stocks, bonds, mutual funds, ETF and REIT, and the appropriation of taxes when the money goes in you, you’ve gotten your paycheck. You’ve made your-your tax payments. Federal state income taxes. You then put it into this taxable bucket. This money would grow taxable, so, a 1099 is generated each year as dividends and interests are paid out, and then once you take money out of this bucket, taxes would go through the form of what’s called a capital gain or capital loss that there’s been a loss in this bucket. Jumping to tax deferred, which is the most common bucket that is out there, this is going to be like your 401K, 403B. If you work in the nonprofit sector, deferred comp and annuities are the most common types of investments that go in this bucket. They provide tax benefits to individuals today because when your money goes into this bucket, it goes in pre-tax.
So, it provides someone in an instant tax deduction. For example, let’s take an individual who’s making $50,000 a year. Let’s say they contribute $10,000 a year to their 401K. They’re able to tax deduct that 10,000 of contributions. They lower their taxable income from 50,000 down to 40,000, so that’s what they showed to Uncle Sam each year, and how much they’re going to pay taxes on. Now, once that money is in that bucket, it’s going to grow tax deferred. Which means we’re not going to get a 1099 each year to pay taxes on the interest that’s being earned within the account. Taxes will then be owed once money is taken out of the bucket. So, when someone gets to retirement because the majority of the investment vehicles in this bucket are retirement driven accounts, now keep in mind that there are certain restrictions with accessing money that are in these buckets. For instance, these buckets are accessible without penalties after age 59 and a half. And if someone does try to access money before 59 and a half, they can do that through forms of loans through their employer sponsored plans.
First time home purchase, medical expenses, college reasons, up to certain limits. If one of those reasons do not qualify, then there could be a 10% tax penalty on top of the taxes that someone needs to access this money within this bucket. Now we’re going to add a new section down here. Which non-qualified annuities are kind of a special category within themselves. They fall somewhere between the taxable and tax deferred bucket, but most of their characteristics are with or within the tax deferred bucket and so with non-qualified annuities. Money goes in after tax which means someone gets their paycheck, they pay their taxes on it. Once that money is in that bucket, it will grow tax deferred. So, a 1099 will not be issued each year. But then once money comes out, taxes will be owed on the growth only. Now, Lastly, the bucket that’s probably the most underutilized, which is going to be after tax investing with tax free earnings. And that’s going to be the tax advantage bucket where similar to the taxable bucket money would go in after taxes. So, after someone gets their paycheck and pay their taxes, they contribute to this type of it of an account.
The money would grow tax deferred and once money is taken out of this bucket, all if not most of the growth. Would be tax free and so some examples of investments that would fall within this bucket. Would be Roth types of vehicles such as Roth IRA’s, Roth 401K’s, municipal Bonds, 529 or ESA plans, which are educational savings accounts. So, for the use of-of educational purposes and cash value, life insurance could also be an instrument that falls within this bucket. So, we’ll put all of them side by side and understanding that just like with the basics of investing principles, you want to be diversified. Someone doesn’t necessarily want to put all of their eggs into one tax bucket, but instead have a little bit of exposure to each tax bucket, because, long term, we want to take taxes when we’re essentially going to be in the lowest tax rate or tax bracket, but then also understanding that there are couple of different taxes that someone can take.
Someone can pay income taxes or they can pay capital gains taxes when it comes to investments and so income tax is going to be based off of how much money you’re earning. Which bracket that you’re gonna fall in. Whether that’s going to be a 10 or 12 or 22 or 24% federal tax bracket, and then also keeping in mind what state that someone’s in there could be state taxes. I know that in the state of Texas there are no state taxes. But here in California we do have a 9.3% state income tax. Income taxes are typically going to be owed on dividends or interest, paying investment vehicles, and then you also have capital gains taxes where a capital gain is essentially created when someone buys something for a certain price and then sells it for a higher price at a later time. Conversely, if someone buys something at a certain price and then sells it for a lower price, there could be a capital loss. Now for the purpose of the example, we’re just going to assume that capital gains are long term when it comes to capital gains, so, it could be short term or long term. In most cases they will be long term, but to go through an example, let’s say someone buys a home for 250,000 and they sell that home for 400,000. Well, that’s gross. Of 150,000 or a capital gain of 150,000.
Now capital gains, I’m gonna be taxed at a lower rate than income taxes. Typically, if someone’s in the 22 or 24% federal tax bracket, their capital gains are most likely going to be 15%, which is a difference of about 7 to 10% left. If someone is in the 10 or 12% federal income tax bracket, capital gains could be 0%. So, let’s go through an example of someone needing $100,000, assuming that they are at the 22% federal income tax bracket and the 15% capital gains rate. Let’s say they took $100,000 from a tax deferred account. And let’s assume that 100,000 was taken from that account. 22% federal income tax bracket. That would result in $22,000 in taxes. Now, let’s say someone took that same 100,000 from a taxable account. Assuming that all of that was gross. If they were in that 15% rate – 15% on that 100,000 is 15,000 in taxes, so that’s a difference of $7000. So, depending on when someone needs money and what the purpose of the money is for in the amount of money that they need to take, it’s important to identify which bucket someone’s going to be pulling from, because long term the taxes detriment can really add up. Lastly, the tax advantage account because taxes are paid when money is put in, but they’re able to grow tax deferred, and when they’re pulled out, taxes aren’t owed. That would be a 0% tax on that same 100,000 someone needs to provide himself, which would result no money in taxes at all. So here we have, so to speak, the tax see-saw.
You know when someone should pay taxes is dependent on when they’re going to be in the lowest tax bracket and then also where their investments fall in terms of-of-of their tax ramifications. Will they owe income taxes? Will they owe capital gains taxes and which rates will be the lowest. When it comes to capital gains to qualify for long term, the investment had to have been held for at least a year. To qualify for short term, the investment would have been held for less than a year. Now, long term capital gains are going to earn the lower rates of zero 15 or 20% short term capital gains will be treated as income, so will owe federal income taxes on short term capital gains. Now, there’s only two things that are promised in this world, and that’s going to be death and taxes. We can’t avoid it. We can’t get around taxes, but it’s all about being smart and knowing when to pay taxes and how to pay the lower rates. So, how we can retain the most from our investment is to pay taxes at a lower tax bracket. So, to give you an example, and I’m not making recommendations here, but one of the questions that I get a lot is should I add to a 401K or should I do a Roth? And typically speaking, if someone is younger or maybe early in their careers and they anticipate to make a lot more money, get promotions, get pay raises as their career advances. Typically speaking, they’re going to be in the lowest tax bracket that there will ever be in right now, and that tax bracket will only go up overtime.
So, someone in that situation might want to consider things like Roth contributions because they pay taxes at a lower rate now and then they can reap the benefits of all that money growing tax deferred and tax free from when they take it out later in life. Now, Conversely, let’s say someone is-is counting the end of their careers, and they’re getting ready to retire in the near term, and maybe they’re going to live off of less money. Maybe they’re in a-a high tax bracket, making the most money that they ever have, and they’re going to reduce their-their standard of living or just live off of less in retirement. That person might-it might make more sense for them to-to contribute to something that’s tax deferred. That’s going to provide them an instant tax benefit today. And defer taxes until later when they’re pulling out outlook at a lower rate. It’s also important to understand the tax characteristics of an investment. So, we talked about things in the previous side, such as stocks, bonds, mutual funds, ETF’s and REITs. I think that there’s-there’s two main things that take into consideration here and number one is when you buy something and it appreciates that capital appreciation that’s typically going to be associated with capital gains. And then you have something that’s paying a dividend that’s creating income, which could be a dividend paying stock, which would be most bonds, which would be like REIT investments (Real Estate Investment Trusts) interest and dividends are going to be taxed as income unless they are qualified dividends, because qualified dividends will receive a reduced rate. Non-qualified dividends will be taxed as income.
So, understanding the characteristics of the investment where your growth is going to come from will also help point someone in the right direction as to what types of vehicles should be in what tax buckets. To give you an example of this is because bonds are paying dividends which are creating taxable interest that have to pay federal tax bracket rates at. Typically, those types of investments might make more sense in a tax deferred account. Whereas a stock that’s maybe capital appreciation driven, which has a high potential to growth that might be more suited in a taxable bucket, because that will get taxed at a lower capital gains rate. So, you know, depending on what-what someone is investing for, what is the destination that they’re driving to, and what types of tax bracket that they are in will determine what federal rate and what capital gains rate is all gonna play factors into what-what types of buckets someone should utilize and what types of vehicles should be placed in-what types of buckets? Now, I wanna give a shout out and go through a quick understanding of real estate investment trusts in the tax benefits.
You know, I want to thank Upside Avenue for having me here and then we’ll open it up to Q&A, but then talk about some of the tax benefits that real estate investment trust can provide to someone. Now, because real estate investment trusts have to pass through 90% of their profits down to the investors, it provides a-a double tax savings on-on earnings. Because corporate taxes aren’t owed and dividends will then pay taxes at the individual investors rate.
Now real estate investment trusts are also great because they provided benefit to individuals getting exposure to real estate who might not have the capital to get into real estate directly, but instead they can get into a-a unit trust to give them exposure to the overall real estate market, which also happened tends to be non-correlated to the stock market. And then the tax efficiency is going to depend on someone’s tax bracket. Understanding that real estate investment trusts, they can pay non-qualified dividends that can pay qualified dividends. They can be utilized in taxable bucket, tax-deferred buckets, and tax advantage buckets is just gonna depend on the type of real estate investment trust that it Is. So, you know, we can’t avoid taxes.
The age-old question is: do I pay taxes now? Do I pay taxes in the future? It’s all about paying taxes when you’re going to be at the lowest rate and a lot of what we talked about is accumulation of investment vehicles today. It’s also important to understand the tax characteristics of taxes when money is being passed down. So, we’ll go back to this one slide that shows the three tax buckets because we-we talked about the characteristics of-of taxes while someone’s alive and accumulating assets, something else that would be taken into consideration is if money is leftover and not going to be used and passed down to the next generation, the taxable bucket can receive stepped up cost basis, which is a tax advantage to beneficiaries tax deferred buckets. When they passed down, taxes will be owed in the year that money is received or over a five-year period or can be stretched out over life. Tax advantage buckets will pass down tax free to the individuals inheriting those monies.
So, those are all different types of characteristics. Also, to take into consideration, again, I just want to reiterate that I am not making any recommendations today. Today was purely designed to be educational. And I’m going to hand it over now to Jessica. And then we’ll open it up for Q&A.
Jessica: OK. So, we do have one question here. Any tips or advice on the best, most efficient way to transition a Traditional IRA to Roth?
Justin: So, that-that is a loaded question. With Roth conversions typically, you know, someone wants to assess what what tax bracket that they’re in now? What tax bracket that they’re going to be in in the years to come, and then also a set at 70 and a half. What tax bracket they might be then. I know those are sometimes difficult things to project, but there’s typically three-three windows that someone is in when it comes to Roth conversion, and that is the current tax bracket there is. The Golden window from when someone retires up until 70 and a half, and then post-70 and a half. So, it’s important to-to see within those three timeframes when will I be in the lowest and what’s not going to bump me up to the next tax bracket or assess how much tax deferred accounts are going to grow and what my RMB is gonna be at that time. It’s a good question to-to go over for someone specific situation with their financial advisor joint with their tax professional. Those two individuals should be working together to assess those types of things. Hopefully that that gives a general sense.
Jessica: OK. Great question. Any other questions? OK, well thank you for that excellent presentation, Justin. The information you provided is invaluable and I’m definitely going to review what I’ve invested to make sure I’m making everything as tax efficient as possible. Justin will actually be speaking, again, as part of our Upside Avenue educational webinars series. We surveyed our investors and followers to find out what financial an investment topics. Everyone is most interested in learning about and then we look for subject matter experts, like Justin, who can speak on these topics. So, lookout for the registration information for January’s Webinar in your email and we’ll also share it on Facebook, Twitter and LinkedIn. In the meantime, if you’d like to contact Justin, here’s his contact information and we ask you to start living your Upside with Upside Avenue. We provide access to a professionally managed, diversified portfolio of income producing, Multi-family real estate for as little as $2000. You can visit our website upsideavenue.com or send us an email or call us with any questions. Thank you everyone again for joining us and we look forward to hosting you again on our Upside Avenue webinars series.
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