Joe Biden’s economic outlook and policies differ greatly from what we have experienced over the past four years. The questions we need to prepare and plan for are: How will the American government pay for the proposed policies and what affect will those policies have on taxes?

The key to success over the next four years will be an understanding of the provisions of the Biden tax proposal and developing a plan to safeguard your finances against increased taxes.

 

Transcript (edited for clarity)

Ted Zamerski: Good morning. I’m Ted Zamerski, the Fulfillment Director at Tax Savings Professionals. I oversee our tax and family office services and want to welcome you today as we discuss Plan for Biden Presidency. I’m joined today by David Babinski, a member of your family office team and part of the NorthStar Enterprise. Thanks for being here, David.

David Babinski: Thanks Ted, it’s going to be here.

Zamerski: Today we’re going to discuss the election status, provide a recap of some of the provisions of the Biden tax proposal, and then discuss some of the strategies we have available for you to take advantage of.

The first thing I wanted to address, especially since there seems to be a lot of turmoil and animosity around this election, is that this is not a time to panic. We’ve seen this before. It was only four years ago that we had a Democratic president in office for multiple terms.

David and I have been in this business for a long time. We’ve seen presidents of both parties along with both unified and split congresses. So again, there’s no need for panic, but this is a time to plan.

Just to touch briefly on the election status, presumably Joe Biden is going to win the election. Republicans have gained some seats in the house, although not enough to affect control. And currently Republicans hold a slim 50 to 48 edge in the Senate with the last two seats to be determined in a Georgia runoff on January 5th. In order for Republicans to maintain control of the Senate, they would need to win one of the remaining seats, but would prefer, of course, to win both to mitigate the risk of any one Senator flipping during a vote in the future, creating a tie.

As you know, any Senate ties are broken by a vote of the vice-president. If the Democrats win both runoffs in Georgia, the Senate would then be split 50-50, and effectively become Democratic should Joe Biden indeed be sworn in as the next president.

So, what are the odds that the Democrats win both races in Georgia and ultimately shift control of the Senate? Interestingly, it becomes a straightforward probability question. Let’s assume that since the race was close enough for a runoff, that it was essentially a 50-50 split. Just like a coin flip, the probability of one party winning one race is 50%. And the odds of winning both is 50% times, 50% or 25%. You could handicap it a little more by adjusting for the exact number of party registrations and voter turnout, so maybe that 25% chance becomes 20% or 30%.

Why do I bring this up? Simply because if Republicans maintain control of the Senate and we have a split government, some of the things in the Biden proposal may not even come into effect during the next two years and we’ll have to wait to see what happens during the midterm elections.

David, before we jump into the overview, do you want to add your thoughts?

Babinski: I think that if we have a split Congress we’re not going to see some of the more aggressive proposals. If either one of those Georgia seats goes to the Republicans, There is going to have to be some negotiations between the Democrat and Republican party.

Now, if both seats go Democrat, then we’re going to have that same negotiation, but it’s going to be happening between what we call the Clinton Biden wing of the Democratic party and the Warren Sanders wing of the Democratic party. Basically, how aggressive can they get with some of these proposals, as opposed to being tempered by having to get some kind of support from the Republicans.

It really comes down to those two seats and some of what we’re about to talk about may or may not come to pass. That’s really the point I want to make right now. We always want to be aware of the winds that are blowing in Washington, but we also want to plan based on what the current law is.

And that’s why you said don’t panic, right? Another way to say that is don’t make any knee jerk reactions based on something that may happen that’s been floated. There’s a long windy road between these proposals and the law being changed. We’ll keep an eye on it and we’ll look at different strategies along the way. And when the time comes, we’ll come up with some best practices.

Zamerski: With that, let’s touch on some of the Biden proposals very quickly, just as a background overview.

Really there are just a handful of themes that are running through this, the first of which is high earners are going to be looking at a payroll tax increase. We’re going to see the 12.4% social security tax extended back in. It gets phased out in that $137,000-$140,000 range right now. And we’re going to see that, if Biden puts this through, when incomes go back over $400,000, they’ll bring back that social security tax.

Additionally, there are going to be some targets for high-income individuals. Marginal tax rate increases, we expect to see a return of the 39.6% bracket. Also with high-income earners, we’re going to see some capital gains tax increases. And I know that the preferred long-term rate has been around for a long time, but there’s talk for gains over $1 million being treated like ordinary income and making them taxed at 39.6%.

We are likely going to see some itemized deduction limitations, possibly capping the benefit at 28%, but I think almost certainly we will see the restoration of the Pease Limitation.

Everyone likes to talk about corporate tax rate increases and the corporations that aren’t paying their fair share and the expectation is to raise that from 21%. Biden has talked about a 28% limit.

Finally, potential wealth tax and increased estate and gift taxes. There will be some different numbers, but we’ll probably see the exemption lowered almost certainly at some point in time. It’s already built into the sunset, but we could see it sooner. There’s also talk about the step-up in basis being eliminated.

So, David, clearly the theme is one we’ve seen before: try to raise more revenue.

Babinski: If you have $400,000 of adjusted gross income or more, there’s going to be a target on your back. $1 million or more including those capital gains, it’s going to be almost confiscatory.

Let’s take Social Security, they’re calling it a donut hole. You pay Social Security on your first $137,000, and then it falls off. The actuaries crunch the numbers and when they give you your benefit in retirement, that’s the max that goes into the calculation. So, the thought process was, to be fair, we’re going to stop charging you because you get no personal economic benefit of paying tax on that higher amount.

Now they came up with the thought that, if you make more than $400,000, you’re wealthy and they’re going to penalize you by having that tax come back. That 12.4% starts to hit again after $400,000. Then, behind the scenes, we’re hearing is as that $137,000 goes up with inflation every year and the $400,000 stays where it is, those two numbers will meet and basically, you’re paying social security tax on all your income, no matter what your levels are. That’s one of the longer-range plans to plug up the hole in social security.

Basically, they’re spending money they don’t have, and they have to get it from somewhere. There are two places for the government to get money. And it’s so easy to spend other people’s money, especially if we let them. The two places for them to get revenue from is from the people that are earning it and from the people who die. So that’s who they’re going to always target. And right now, in this cycle, $400,000 seems to be the magic number, and estates over $5 million seems to be the magic number, and they’ve got their handout. Our job is to look at ways to mitigate that so that we could take advantage of any incentives that they put forward.

As you pointed out, Ted, the winds ebb and flow constantly. It’s just a matter of can we zig and zag with that and how do we parry and what do we do? We’re not going to panic. The tax code is basically a series of incentives, right? The tax code is Washington’s way to get things done that they want done. Think about it. If the tax code were about revenue, they would put a flat tax out there and we’d be done with all this.

But it’s not. It’s about who’s in charge and what pet projects get funded and what gets incentivized. So, we’re going to go from business deduction and 179 acceleration for R and D and investing in your business. And we’re going to go to carbon credits and solar energy and wind credits.

There’s always some incentive out there. It’s just a matter of what it is. Our job on this side of the screen is to keep our finger on the pulse of all that and make sure that we’ve got some best practices to take advantage of. If you’re over that $400,000 and there’s a way to get you under that, that’s our magic number for 2021.

Zamerski: A new twist I’ve heard a little bit about and I’d like to get your take on, David, is that when the tax increases come about that they may be retroactive.

We’re going to have an inauguration in January. It’s going to take time to get people in place to go through and iron out all the details. I wouldn’t think we’d see a bill before April or May. Maybe it’s later this year in the summer. There’s talk, though, about making it retroactive to the beginning of this year. And some have even thrown out the idea of even rolling it back to the date of the election and touching back into 2020, undoing some of the planning we’re trying to do.

Babinski: You’re saying this year, meaning the 2021 tax year, and that would be likely, I would say. They change some kind of law within the year and say it’s effective as of the beginning of the tax year. To go back and claw back revenue and do a split year for 2020, I don’t see that happening. The markets aren’t discounting that, and you would see some reactions happening if they thought was going to happen. Talk about an accounting nightmare. It’s such a bizarre year to begin with, with everything that happened with COVID, to throw that on top, I think would be more hassle than it would be worth legislatively.

But with that said, I do feel that any changes that happen will be as of January 1, 2021 for the same reason. To say, “The bill passed on April 9th and anything before then is this set of laws and anything after that is this.” is going to be way too much.

So, 2021, whatever change happens, whenever it happens, I feel it will be for the full year and 2020 they’re going to button up and just stay as the current laws are now. That’s, again, my opinion.

Zamerski: And I wouldn’t put anything past Congress when they come through with a vote. Generally, what I’ve seen in the past, when they try to make something retroactive it’s for the benefit of the taxpayer when they pass a tax cut or a break. It will be really interesting, depending on how late in the year this is. If they raise the tax brackets for example, and it’s in the middle of the year effective January 1, there’s going to be some withholding issues as well that people are going to have to look at that could impact their cashflow.

Babinski: Right. And like you just said, don’t put anything past them. Their goal is to raise revenue. They’re going to be as aggressive as the populous will let them.

Zamerski: We should also touch on for a moment the taxability of the PPP loans. Congress’s intent was that it was a forgivable loan and when you get that forgiveness, that it wouldn’t be taxable. But again, in their effort to raise money, the IRS issued notice 2020-32. It essentially says that while the loan forgiveness itself is not taxable, any of the expenses you paid with that grant money, or those loans, can’t be deducted. So, it has the same effect of raising your income and becoming taxable.

The AICPA is working on campaigns to connect with Congress because their intent was for this to not be taxable, for it to be an aid to the taxpayers who needed it. They have a letter writing campaign going on right now where you can find your congressman and copy and paste a letter urging them to pass something soon so that you get some direction basically stating outright that that money will not be taxed and that you can indeed deduct those expenses.

David, I do want to talk about how this impacts our planning.

Babinski: First let me jump on what you just said. It’s actually important when your representative in Congress actually hears from you. Somebody took the time to write a letter, send an email, put a letter in an envelope, put a stamp on it, that actually does have some weight. And it is such an important thing. Congress’s intent was to help people who needed it. But there is one extra layer. Their intent is also to keep tens of millions of people off of unemployment. They made a deal with us. Keep your employees on the payroll. No one was working. We were all home. No one knew Zoom and how to do all this. So, they said, “We’ll give you 10 weeks or 12 weeks where we’ll send you the cash. You keep your folks employed. That’ll keep them off the unemployment rolls. And no one was doing any work. To think that we were taking that money and lining our pockets with some kind of extra windfall profits? We were shut down.

If I hit my line of credit and pay my business bills with that, I still get to deduct my bills because I’ve got to pay the line of credit back, right? It’s a legitimate expense that I could write off. But now to say, “Because you borrowed from this certain loan and this certain loan is going to be forgiven, we’re not going to let you take those deductions.” It’s such an unprecedented slippery slope of a tax interpretation that I personally feel Congress has to address this. All of us as small business owners became the unemployment office and we did what they asked us to do. And then they come back and say that we can’t write off those expenses? What are they going to say next? If you make more than 10% profit on a product, you can’t write off what you use that for? It’s just so bizarre to me. They have to address this.

Here’s the flip side. My understanding was this was a forgivable loan, 30-year term, almost zero interest rate, whatever 1%, whatever your bank put on it. I have people in my circle who are running numbers saying, “I’ll just keep the loan on my books. I won’t ask for forgiveness.” If you took a $100,000 loan for quick example, and you would owe $37,000 in taxes on that, what if you just paid the loan back on a 30-year amortization and put that $37,000 in an investment account and pulled the interest off of that to pay the loan? In 30 years, your money is ahead. It’s a hassle, thank you very much Congress and the IRS, but your money is ahead if you run those numbers.

This is just another one of these unintended consequences and, candidly, the IRS overstepping and misinterpreting what Congress wants to do. And we’ve many, many examples of that. It is just so frustrating because they said it’s to help out the small business owner. I contend it was not. It was to keep people off the unemployment roles and they asked us to keep employees on and keep paying them with their money so that we could have business as usual as we got through the other side of this.

So, send the letter and change some of the wording from what the society is asking us to send, to let them know you are upset about this. This is a rug pull as far as I’m concerned.

Zamerski: It’s a very good point and certainly feels like going into negotiation and negotiation where the other party is negotiating in bad faith.

As we move into some of the strategies to address the themes, I have to ask, why plan, especially now?

Babinski: We throw this word plan around like it’s some panacea. The plan is really just getting focused. What is it that you want? You know the old adage, “If you don’t know your destination, any road will get you there?” We’re very deliberate when we talk to folks about the family office. We throw this term around: family office. We hold ourselves out as a multi-family office. What does that mean? The family office concept came from legacy wealthy families, like the Rockefellers and JP Getty and, more recently, the Waltons. They’re running their personal finances – after their business was successful or sold, after they’ve taken the money – and built a team around them and their family’s finances are being operated like a business with a multi-generational bend to it. That’s where the transition really happens. This is taking a step back and very deliberately becoming clear. Do I want to be more than my generation? Do I want to plan and build my family’s legacy so that it sustains itself and future generations to come?

It’s a very deliberate choice and that’s really where the planning comes in. Do I choose to do the things necessary so that I can have a successful retirement and so that future generations can build from where I am and not have to go through the same cycle of work a day, accumulate, pay my taxes, and then distribute in retirement?

This is an opportunity to take some of these best practices that we’ve gleaned from spending time with these decamillionaires and billionaires learning how they plan what their families are going to do. And they’re planning 100 years in advance, 150 years.

It gives you a different perspective than just trying to get to April 15th. And that’s really what the plan is, Ted. It’s perspective, getting clear on what you want, where you’re heading. And the flip side of it is where are you right now. We talked to dozens of people each week just trying to get a snapshot of what they have, where it is, how it’s titled, and who the beneficiary is. Step one of the plan is to identify what is the current situation all the way down to how it’s titled and who the beneficiaries are.

Now we have a springboard, we get clear on what the future looks like, and what’s important to you. And there’s no you need to sacrifice for your great, great grandkids. I have people who say to me, “I want $1 left in the bank, on my death bed and I want to enjoy getting there.” That’s fine. As long as you’re clear, we’ll show you a plan that gets you there. So, when you have these massive shifts in policy, it just brings the planning into focus that now would be a good time to take stock and ask the questions, “Where are we? Where do we want to go? Are there some tweaks we need to make to take advantage of what’s available to us right now?” Because when one door closes, another door opens.

There’s going to be some tool that we have in our toolbox that comes out of this changing of the guard and we’ll be ready. We’ve got a team in place and all we do is strategize. I meet four times a year with a mastermind group of CPAs and lawyers, and we come together with these best practices that these multi-generational families are using and we’re bringing them to our clients.

Zamerski: Well said. Let’s talk just at a high level about a couple of strategies that we can consider that hit some of these tax themes under the Biden proposal.

First, the expanded social security tax. There are a couple of things we can do here. One, I think we really need to revisit what a reasonable wage is. People called it playing the FICA game. They’d look at their salary and would try to pay as absolutely little as possible in salary and then take non-taxable dividend distributions from their S corporations. Of course, the IRS came onto that. When you see a doctor making $30,000 a year salary working full-time and then taking $300,000 in distributions, that’s going to raise some eyebrows. But what if someone’s paying themselves $200,000 and they could hire someone to come in and do a big chunk of the work that they’re doing for $150,000? Those are comparable reasonable wages. Then it’s okay for the business owner to drop his wage from $200,000 to $150,000, in this example, and take an extra $50,000 in distributions. That’s the reward for managing their business, and doing it well, just like you would with any other investment.

Another area to consider is looking at whether or not it might make sense to start taxing the S corp as a C corporation. When you add it all up, the high wage earners are going to be looking at a marginal rate of upwards of 55% to 56%. But when you factor in a middle range, $400,000 to $1 million C corporation, your effective rate on the dividends when you’re coming through in the income may be down as low as 45%. And on the larger corporations in excess of $1 million, maybe in that 51%, 52% range.

Look for an opportunity to run some numbers and see if there’s an opportunity to arbitrage the difference in tax rates between the entities. Then look at executive compensation for those that aren’t business owners, but who are highly comped executives that have stock options. If they’re incentive stock options, you don’t have to pay any FICA tax on the spread. The non quals you do, but they’re deferred at least until you exercise it. And then maybe there’s an opportunity with your employer to discuss whether or not you want to participate in some sort of deferred comp plan. It lowers your tax this year, no real favorable tax treatment in the end, but a timing benefit. You’ll pick it up eventually when you do come back down the road, but maybe it gives you an opportunity to work around that donut hole.

And David, we have a question I think a lot of people on this call can relate to.

“I’m a 100% owner of my S corporation. My wife and I file jointly. Would there be a scenario that makes sense to make my wife a 50% owner of the S corp, but then file taxes separately, trying then to accomplish to get both of our incomes lower than the $400,000 per year on the new Biden tax plan? This would hopefully avoid that payroll tax increase.”

My first glance answer is the only way to find out any of this is really to crunch and run the numbers, do a proforma tax return under those potential higher rates, and split them out. But I would add that, generally when you file married, filing separately, the IRS doesn’t really want people filing separately. And there are built in penalties in doing so. Credits get phased out, other limits come in, and the tax rate is a little bit higher. It really becomes, I think, a math exercise and looking at what that could be with any individual specific circumstances.

Babinski: Ted, everything that we just said for the last seven minutes comes down to this.

There’s going to be an opportunity for us to have a strategy call with everyone before the middle and end of next year. That’s what we’re saying about planning and everything we just said, we’re on top of. We’re going to have best practices. We’re going to have the calculators ready as this comes into focus. And we’re going to be able to run these exact scenarios.

That was an excellent question because that’s something that we would have looked at and that’s what happens all the time. They throw a handful of incentives out. They have what they think in their mind is going to happen because of those incentives, the industry scrambles, we all confer, and convene. We come up with best practices and we bring them back to you. And the reason why it’s so Important that we have access to this family office circle is that for 99% of the information out there applies to 99% of the people. And that’s because where most people get their information in this country is not driven by what’s best for those people. It’s driven by advertising revenue.

We’re going to talk about a couple of strategies we use for our ultra-high-net-worth clients to move net worth to the next generation using insurance. But, if you turn on the TV, you’re going to have Susie and Dave telling you buy term and invest the difference because their advertisers are the invest the difference people. It’s just that simple. It’s not what’s best for you if you’re clear on what you want to have happen multi-generationally. But it’s, what’s best for their advertisers. And that’s where we’re getting all of our investment advice, from the people paying the bills.

It’s not any different than it has been for hundreds of years. They call it the golden rule. He who has the gold makes the rules. We’re trying to bring some perspective and for those of our clients who align with this philosophy, that do want to try and build a dynasty. These are the strategies that we’re putting in place behind the scenes.

I know we’re going to cover the estate tax and it plays into exactly what I’m saying right now. Multi-generational wealth accumulation, that’s outside the purview of taxation, that is the goal. And that is what our family office team focuses on, day in and day out.

Zamerski: Looking at a couple of possible strategies surrounding the possibility of higher marginal rates. I know when we’re looking at Roth conversions, for example, that a lot of people have taken advantage of this, but there’s still a lot more work to be done there.

Babinski: Roth conversion is kind of my thing and that’s been our theme for this whole year. We put together this strategy called the double discount strategy. Once someone’s entire 401(k), SEP, current plan is converted over to Roth, there’s still this strategy where we’re continue to make the contributions every year. We’re still going to maximize the backdoor Roth, but when you think about it, we’re putting it in taking a 37% deduction, plus your state (If that’s applicable). And then we’re able to move it off to a Roth the next year at 15, 16, 17% total cost taxed, plus some of the other mitigation strategies, it becomes a cycle. It’s something that we’re doing year in and year out. The hump is to get over everything that you’ve got right now in the tax-deferred bucket. We want to move it over to the taxed-never bucket.

I call the taxed-never bucket, bucket 3 and there’s a cost to that. It’s a multi-year process and it’s based on facts and circumstances. Each individual person’s different, but we’ve got some strategies to help smooth that out a little bit by having that happen at a discount. And that’s what affords us to get that money into, in this case, a Roth conversion, which is a very strong bucket 3. Even if they change the tax laws and the Roth might eventually phase out as well because they need revenue, they should grandfather in everyone who was able to fund that. So, one takeaway I would offer, if you do not have a Roth IRA opened at all, one of the rules of a Roth IRA is it has to have a five-year seasoning. And even if you have a hundred bucks in there, and you convert $2 million, five years from now, at least you’ve had it opened and on the books for five years. At the minimum, even if you’re over the wage thresholds, convert a little bit of money to Roth with your current custodian and get that clock ticking in 2020. Roth is going to be a huge pillar of what we do.

Zamerski: Another good point. And then David, , at this time a year in particular, a classic strategy for traditional CPAs and financial advisors is to go through your portfolio and harvest your losses and use that to rebalance the portfolio. But they’re putting the losses on the books. If we’re looking at potential future higher rate, are we not indeed going to be better off saving those losses, pushing those into next year and instead harvesting gains and using that to diversify concentrated positions?

Babinski: In a way, isn’t that what the Roth conversion is? We’re paying more tax this year than we otherwise would have but knowing that we’re at this historic low marginal tax rates, we’ve got extremely powerful tools available to us to not only discount the amount converted, but then pay the cost of that conversion. It’s just makes a lot of sense again, with the philosophy that tax rates are likely to go higher.

Mathematically tax rates are likely to go higher because somebody is going to have to pay the bill that’s being accumulated with our debt. Why not take the steps necessary up to what can be afforded in your budget to pull that income into this year? Rule of thumb was always pull expenses in and push income out so that you can pay year in and year out the least possible. This could be the one year where it would make sense to take the gains this year, take the income this year and save, and then match it up or even save those expenses for next year is as much as you can.

Of course, we’ve got mechanisms set up with C corps and management companies. We might revisit that strategy just for this one year to do that so we can enjoy these marginally lower rates and enjoy these tools that we have now to help mitigate those taxes and then not be subject to this $400,000+, $1 million dollar plus, that’s being proposed.

But again, we don’t know. So, you have to run the numbers, as Ted said, based on everyone’s individual facts and circumstances.

Zamerski: Absolutely. And I know one of our goals has always been to leverage our scorecard savings, implementing the advanced strategies and really taking advantage of the ability and power to combine those.

 

Babinski: When I first got into this business, in financial services, Clinton became president and the federal estate tax, where the federal government required you to file a return at death and start paying tax was $600,000.

Think about that for a second. Your house, your car, your retirement accounts, your life insurance if it was owned personally. It wasn’t that big of a stretch. Your business, they value your business, the family farm, and there was a lot of talk about, “They’re going to lose the farm.”

$600,000 wasn’t much. And then it ratcheted up to $1 million bumped up to $5 million. There was one year there was no estate tax at all. George Steinbrenner died that year. His family owed zero. And then, it came back. And then with the Tax Cut and Jobs Act in 2017, it got bumped to $11 million and it’s been adjusted for inflation. The industry kind of took its eye off the ball. $11.5 million per person. That’s $23 million per couple. But what happens is, everyone’s lulled into this sense of security. Some of the strategies we were using over the years have fallen out of favor.

And then with the stroke of a pen, there’s talk of it going as low as $3.5 million. We talk to people every day that have that much in their retirement accounts, forget their business value, forget their outside investments. Now all of a sudden 40%, 45%, 50% of your estate is going to be lost to taxation at death.

One of the strategies when you’re talking about a family office, and part of multi-generational wealth creation, is getting money out of your name. I don’t practice law, but I can tell you what I’m doing. The family limited partnership where you have access and control. I own 1%, my wife owns 1%, but the family owns the other 98%. Any growth that’s happening in those, in that environment, under that shield, is outside of our estate and they could drop the state tax to zero exemption, and I would be fine because most of our wealth is being created outside of the estate.

That’s part of the perspective and the philosophy of the family office. Are we just trying to march to retirement with a lump sum of money and then spend it down and have $1 left at our death? That’s fine. And you could get that advice from a $2 magazine, if you wanted to. But if you’re looking for multi-generational wealth creation, that’s going to help you give the next generation a leg up, taxes are the key.

Zamerski: There is an opportunity we talked about briefly, David, where the estate tax exemption, essentially in the Tax Cut and Jobs Act and a little bit prior to that, was essentially doubled. It is inflation adjusted now, but that double was going to go away. For those people that do have the means, exactly what you were just talking about, getting that money out of your name out of your estate. If a couple has the ability to give away $10 million each, they should get that set up and do that kind of planning before they set this back. Whether it just reverts back to the $5 million in 2026, or comes down to $3.5 million sooner, depending on what the Congress looks like, that’s an opportunity to do that. So, you just want to be aware of these items that are out there in part of the big picture planning.

Babinski: If you have the philosophy that you agree that you want to start to build intergenerational wealth, some of these strategies make way more sense. And some of these discussions resonate better. Everyone right now has $11.51 million that they could transfer into an irrevocable trust – and again, I’m not a lawyer, we’re not practicing law, I’m just telling you what I’ve researched – there has been some guidance out of Washington that even if the exclusion amount goes down, they will not come back and call this back because it’s the current law of the land. But guess what? When December 31 hits or whenever they change the law, it’s over. I’ve been in the meetings where a family has had to write a seven-figure check to the government on money that was already taxed once, already taxed twice, and now we’re sitting there settling an estate. These multi-million-dollar checks are going, and they look at each other and say, “Where are we going to get the money?”

Most of the clients with substantial net worth, it’s a company, it’s properties, it’s some asset that isn’t just sitting in cash and the government wants settlement in cash. It’s a real issue and it becomes more in focus if they drop that estate tax to $3.5 million and don’t give you automatic stacking with your spouse, which was another trick that they used to lure $ 23 million. Or if it drops down to $3.5 million, and without an AB trust it’s only $3.5 million, it’s going to come into focus.

With that perspective, we’re putting together strategies that help our clients live a tax-free life and then pass the money to the next generation at minimum in a tax-free environment.

Zamerski: Do you want to take us through a couple of the examples that we’ve talked about on how to leverage the scorecard and transition and build that wealth?

Babinski: Let me just say it this way. There’s tactics, right? A tactic is I do this, I get that. And then there’s strategies, which is putting some of those pieces together.

One of the tactics we have, and I’m on multiple calls a week about this, is hiring your kids. That’s a tactic, right? Everyone has their own standard deduction right now. You don’t get an extra exemption for having kids. The goal is, if you own a business and you can hire your newborn as a corporate model and put them up on the website and put them on your Facebook, Instagram, whatever, and use them for marketing purposes for your dental practice or real estate management, whatever it is that you do, it’s perfectly legitimate. And a corporate motto is a great gig. Ask the Olsen twins. But at the end of the day, just having that money come into the household tax-free is great.

But what do you do with that? What do we now have? We now have a taxpayer under the Roth’s thresholds that is a 100% eligible to put money into a Roth IRA. Even a newborn child that has income and files a return can establish and start a Roth IRA. If the goal is to create intergenerational wealth, if the goal is to keep our estate under what’s going to be taxed at a 50%+, here’s a phenomenal window. Here’s a door that cracked open to get into bucket 3 in the name of the next generation. Or even grandkids, right. Hire the grandkids if you’re at that point. And then just kind of look at this map.

If you have the ability to put money into a Roth IRA, you can put $6,000 per year in. And let’s assume you can make a 7% return on that money and start when that child is zero. But even if they’re 15, the number of years it takes to get to the next illustration is the same.

So, a $6,000 contribution earning 7%, the kid is now 10 there’s, $88,000 in there. They get to age 20, it’s $263,000. And then they get a job and start taking over the contributions. But let’s just say at age 37, they’ve totally phased out. They’ve done their education. They’ve got a good job. Now they make too much for a Roth contribution and the contributions absolutely stop at 37. They’re now a tax-free millionaire. They’ve got $1,029,000 in that Roth IRA. It’s money that you’ve shifted that would have been in your estate but is now in your child or grandchild’s estate. They can’t make contributions anymore, but let’s just assume they let the thing run into their retirement.

The Rule of 72 says at 7.2%, money’s going to double every 10 years. So here we have $1 million dollars in 10 years grows to $2 million. $2 million grows to $4 million, $4 million gross to $8 million. And let’s assume retirement age is still going to be 67. Look at this. Without one penny of the fruits of their own labor, without inheriting anything from mom and dad, they’ve got $8.2 million, tax-free, sitting in a Roth IRA that they can draw on in retirement and then leave to their kids, your grandkids, or their grandkids, your great-grandkids.

That’s what we’re talking about. Creating a legacy. So many people hire their kids. The money goes into an account, and they buy the new latest sneakers or the best iPad or that iPhone or something else that, candidly, if was business bought, they could have deducted anyway.

Just remember these are the strategies, not tactics. We’re putting together a couple of the dots with the perspective that, yeah, I do want to spend some time to make sure that my family is better off once I’m gone than it is today. This is one of the base things we can do. You’ve opened the door for a Roth and to not fully fund that, is just a mistake. It’s so hard to get money into bucket 3, into that tax-free environment. There’s always some type of restriction. There’s always some type of barrier, and this is one of the most basic ones.

And, by the way, Roth IRA has a rule that says you can always get out your basis without penalty. We’re not going to go back on the slide, but you’ve got $200,000 in there and it’s time for your child to buy a house or pay for college or whatever. That basis can come out, completely tax-free. Now, it messes up your compounding over time, but it’s there as an emergency source of funds.

This is just one of those strategies that we like to put out there. If the kids are filing a return, by all means fund that Roth. You can even get at it if you need it. If we’re talking about multi-generational wealth transfer, let’s do it at the source. The best time to plan for taxation mitigation is before the tax is earned. So, let’s have this money accumulate in a tax-free environment and then we don’t have to worry about cleaning that up later.

We see so many people earning so much money in these investments and other things, but it’s still in a taxable environment. It’s just a headache waiting to happen.

That’s the strategy of hire your kids. Step one, a lot of people are doing. But step two? Are you taking the time to put it into a Roth and letting it grow and compound in a tax-free environment?

Zamerski: Staying right with that theme, David, one of the other popular strategies from the scorecard is tax-free rent. A lot of people take advantage of that. We’ve got travel business meetings and a number of other things too, that all go together. I know you had some thoughts on how parents can the take those and leverage those and start working on their legacy as well.

Babinski: We’ve started to introduce this concept of bank on yourself, or infinite banking, where you’re going to be able to accumulate some wealth, have it grow tax-free and accumulate, but then also have access to it.

This is a strategy we use a lot for people who do outside investments. I’ve got a successful dental practice, but I like to fix and flip houses; or I like to build, and I need down payments and things from time to time. Well, let’s take that scorecard savings and put it into a permanent life policy that is properly designed and then overfunded. What we’re saying is, take that scorecard savings money that would have gone to the government and put it into one of these vessels that’s going to give you uninterrupted compounding, but also gives you access to that principle along the way. You can pull it out, but you’re borrowing from yourself and you’re not interrupting the actual growth of it.

So, what happens in these types of policies? You could be your own bank because the money’s still compounding, it’s pledged. Then you take the loan from the general count of the insurance company. It’s almost like the best of both worlds. You’re getting this long-term growth and accumulation, compound interest, the eighth wonder of the world. But if you need cash, it’s available and you don’t have to fill out an application, you don’t have to pull credit. You don’t have to get anyone’s permission. You have to pick up the phone and say, “Send me a check.”

Let me just show you what the numbers for a policy we just put together for someone look like. This particular person was a 55-year-old. We’re saying put in $50,000 a year, which is a culmination of a bunch of their tax savings. In this case, so much of it was going into that accumulation value that in the first year, if they wanted to buy another rental or whatever, the cash is there.

But look what happens. Over that 10-year period, as they approach retirement, they’ve put this $50,000 in and as it grows, it’s not taxed. They could get at it completely tax-free, and it’s got cash value, that’s building up. Now as we get into retirement, we could use this as a secondary pension plan. In this particular example, if we look at what happens as they go forward at age 65, they could start taking out $40,000 a year. The cost of actually having this plan at this point is minimal. And you can see the accumulation value continues to grow and compound well above what they’re taking out.

That’s the key to this. You have to build the vessel; you have to allow it to grow. And now you have this cashflow. Now you get it to age 74 and you’ve taken out how much you’ve put in by age 76: you put in $500,000, you’ve taken out $500,000. And at any time, if you were to pass away at life expectancy, there’s at least that $500,000 that goes to your kids completely tax-free.

This is just from your tax-free rent and some other scorecard savings. You’re building the bank for yourself. You’re creating a legacy for the family. And if you didn’t need to take that income in retirement, it compounds even more because that accumulation value is always going to push up the tax-free death benefit. It’s always going to be what they call positive at risk amount. And that’s the amount that would go to your spouse and to your kids, completely tax-free.

Again, it’s just low hanging fruit. How do we get money into bucket 3? We’ve maximized the Roth. We’ve converted everything. We’re doing the super backdoor Roth. Now, here’s the next layer. We could start taking the scorecard savings and start building another taxed-advantage vessel that has flexibility and control, but it’s not going to be included in the annual tax return. So very, very powerful.

There’s always some barrier. You’ve got to be healthy. And of course, once you start a program like this, you have be disciplined. This isn’t the type of thing that, once it’s launched, you want to adjust. We need to plan properly for this to work.

Zamerski: When you were showing the illustration, talking about the how Roth IRA could serve as an emergency funding, it could use it for the down payment on the house, but you can do this for your children as well, in addition to the Roth.

Babinski: That’s right. Say the goal is to get as much money outside of your estate and get it down to the next generation or the one after that. Can you imagine if that was being accumulated on a 22-year-old? This is insurance, right? So, there’s a tiny little cost every year that goes to pay for that insurance and insurance is priced based on age and health. And very few people get healthier year over year and almost nobody gets younger. The sooner you can start the cheaper, and if you can do it on the next generation, the better.

There are some limitations. A lot of times the insurance companies will say the child can only be 1/10 of the insurance that’s on the parents. So, there are limitations. Otherwise, as soon as you have a grandkid, you’d be piling on tens of billion dollars’ worth of insurance.

That’s the facts and circumstances. That’s the planning aspect of this. How do these strategies work for you and your particular situation? And that’s the invitation here.

Zamerski: Absolutely. Your next illustration is probably my favorite of them all because you don’t even have to use your own money. It’s the culmination of everything we talked about.

Babinski: You’re right. This is like the penultimate plan. There’s a concept called premium financing. Now we’re talking about $5 million net worth to get in the door, $10 million to really participate. But again, this is multi-generational family office type planning. We have people with eight figure annual premiums going into this type of thing.

Let me show you how this works when you’re looking at transferring money to the next generation. Earlier I said a new Tesla is great, but it’s not as good as tax-free retirement. So, let’s take money that would have gone to the government and turn it into real wealth creation.

In this particular case, we had a 54-year-old who was contemplating selling his practice someday. We were able to get him qualified for a $10 million+ death benefit. Now, why is that important? The death benefit is the vessel. That’s the container that’s going to hold your money. The higher I can get that, the more you can stuff in there. In this particular case, we were able to qualify for a $580,000 a year premium.

We’re talking about big numbers here. This isn’t for everyone. But this person was going to sell their practice eventually and had no idea where that money was going to go when it sold. They couldn’t afford to put $45,000 a month away, so where do we get the $580,000?

Well, just like when you invest in real estate, because these are designed properly and they have so much cash value from day one unlike your traditional life insurance, the policy itself can be used as collateral. We’re actually borrowing the premium from the bank, the policy is being posted as the collateral, and the only cost to the client in this case is the interest.

He pays the interest out of pocket every year to carry that $580,000 as it grows. And then, whether he sells his practice in four years, eight years, 10 years, we’re going to pay that loan back from the proceeds of the practice. But we’ve already created the vessel when he’s young and healthy, which is the key because nobody knows what could happen.

Now, what happens to someone who’s 63, they sell their practice, and they pay this loan off from the bank? What does that leave them with? What did we just create for them? Well, now, if they want to consult and work for a couple of years, that’s fine, but we can start pulling income out of this. In this case, we said it’s age 72. So, from age 64 to age 71, it just kind of grows. They paid the loan back. It’s their policy. Once they pay the loan back, their cost of insurance goes down to almost zero. And at age 72, we could take $1,082,000, illustrated here, tax-free income for the rest of their life. For as long as they live, we can pull that out.

I just want you to think about this. We pay the interest on the money from the bank. We use leverage just like if you were buying an apartment building, it’s the same exact strategy, right? But here’s the other difference. If you just said, “I don’t want to use the bank’s money I’m doing well. And we could afford to pay this,” the $580,000 premium, when you borrow the money, you don’t have to pay tax on it. Whereas if you were going to write that check for the $580,000, it’s after tax. It’s really like $1 million a year premium. Think about that. This is $1 million year premium going in at only the cost of $580,000. And then we pay that loan off when, in this case, they sell their practice.

Now you’ve got this $1.082 million a year and say they live to life expectancy or a little bit before, we’re going to get $8.5 million dollars in the bottom right corner after they’ve taken $13 million of a withdrawals tax-free. And we’re still going to pass $8.5 million to the next generation tax-free, outside the estate if we, if we design a properly. That’s what we’re talking about, but you need to be clear on what your goal is. If your goal is multi-generational wealth creation for your family, this is a strategy, the penultimate strategy that we’re using, on the entry level.

Now, from here, we’ve got micro-captive insurance. There are so many other tactics that are then put together into these advanced strategies, but it’s really facts and circumstances. And once you’ve paid your bills and you have the vacation home and the cars you want, there is a whole next level of planning that’s available. That’s what we’re trying to show you.

An election like this, where they’re about to come and knock on your door with the bag open, they’re going to want to take your money, that’s where these tactics, and then strategies, come into focus. That’s what we wanted to convey today.

Zamerski: I did want to just add a couple of things and we did touch on them briefly as we went through today’s conversation. As we look into the future and, you said this several times, David, I know our goal was to get as much of that money into that bucket 3 and Roth IRAs or insurance are the opportunities to do just that. In fact, as far as I know, they’re the only two that actually really live in bucket 3. But let’s talk in the future. I’ve heard a few people say that old conventional wisdom of I’m going to be in a lower bracket. Even if you’re in a lower bracket in retirement, I think those lower brackets are going to simply have higher rates. So, I think your success is going to guarantee that you’re going to be in those higher income brackets. These things are going to be here with you for life, for the most part, so now’s the time to take advantage of them. As we pull all that together, David, how does this impact retirement account drawdown strategies?

Babinski: Again, once you’re into that tax-free environment, you’re living on pennies on the dollar, right? Anyone who is accumulating these massive 401(k) programs, you have a joint owner, right? You have a joint account with the government, but here’s the rub.

They haven’t told you what their share is yet. Can you imagine going into business with someone and they say, “Well, let’s wait until the end and I’ll tell you how much of the business I want to own?” There are some rumblings out of Washington that 70% could be the highest marginal tax bracket at some point. And it has been in the past. You’re working hard. You’re taking risks, you’re coming home and watching the stock market every day. Your spouse wants to throw the TV out the window, your computer out the window. And all of a sudden, you get into retirement and you’re keeping 30 cents on the dollar.

This folds right into a successful and early or a wonderful retirement because we take that joint owner off your account, and you own it. The analogy we use in the Roth presentation is if you’re a farmer, would you rather pay tax on the seed before you plant or would you rather pay tax on the harvest when it’s bountiful and filling multiple fields? Mathematically, you want to pay tax on the seed, if you can afford it.

That’s the exercise that we take everyone through.

Zamerski: On that point, I wanted to follow up with a question: “My advisor said that I should not convert to a Roth. I’m in that 37% tax bracket. Plus, I have state income tax. What am I supposed to do about that?”

Babinski: Again, as long as your account is going to beat inflation, mathematically, if rates go up one iota, you’re better off in a Roth. But that’s just rule of thumb. That’s the people who manage assets and get getting paid for that saying, “Keep your account as large as possible. We don’t care that the government’s a 50% owner. We’d rather manage your $1 million IRA than your $630,000 Roth IRA.” You really have to run the numbers based on your circumstances. And let’s be honest. If you’re in that marginal 24% tax bracket and you have a little countdown ticker on your computer saying that you’ve got six years, three months, three days and four hours until retirement, a lot of those little axioms are right for you. That’s the person they’re talking to. If you’re one of our clients and you’re trying to save $60, $80, $150,000 a year in taxes, we have some places to put that that can benefit you and your family for generations to come.

It’s just apples and oranges. It’s just noise. We’ll help you cut through the noise. That’s the whole philosophy behind the family office. We’re going to bring best practices from people we talk to that have multiple commas in their net worth. It’s just a whole different perspective.

If you share that philosophy, these strategies, and then these tactics start to make way more sense than some line or some soundbite from a TV host or a radio host. It’s just that simple. Where do you want to land? What does the future look like for you? And do you want the family to have a picture of grandpa above the mantle or not? That’s what it comes down to. There are a lot of people who don’t, and that’s fine. And there’s some people who say, “You’re right. I want to get off of this cycle. I want to start educating my family about how money works. And I want some help and someone to guide us through.”

Zamerski: Here’s one last question and then we’ll close up here. It’s more a statement, but maybe we can turn it into a question. “Some of the strategies you talked about seem great, but also very complicated. I’m very busy in my practice. I just don’t know that I would have the time to follow through.” The question there is probably how can we help with that?

Babinski: That’s a family office, right? I’m doing my thing and I need to surround myself with competent people that have my best interest in mind that I can trust. And that’s the ultimate answer.

You do not have to become an expert in any of these strategies. You just have to know that they’re going to work for you. They align with your values. And that you can trust the people that are pulling the trigger and executing on this. It does take some discipline on your side, but again, back to the sound bites, “People spend more time planning their vacation than they do their lifelong finances.” On some level that’s true. There is responsibility. You have to take the bare minimum amount of time to download and dump your current data into our systems and then give some guidance on what’s important to you. I say to people all the time, “You can have these three-hour monster meetings, but my preference is to meet more often for 20 to 30 minutes at a time.” Let’s get to the point. What’s the next step. Let’s get it done and move on. We’ll scramble around behind the scenes, and we’ll talk to you next week for 20 minutes or 15 minutes. We’re very aware that there is no time for these monster three- and four-hour meetings. We try to be very efficient with everyone’s time.

It’s a process. It could take 30 years. That’s why we need to get into that process. And that’s the essence of planning. Where are you? Where do you want to go? And in very small bites, we will start to course correct that plane on that journey to get you where you want to go.

Zamerski: You hit the nail on the head, David. I tell people all the time that this is not an event, it’s a process.

If you have interest in what we’ve discussed today or have additional questions, please call us at (772) 257-7888.