Ep #104: Is It Really Possible to Avoid Taxation?

Benjamin Haas |

Ready to debunk the myth of completely avoiding taxes? Listen to our podcast as we explore the strategies, nuances, and misconceptions surrounding tax planning and if there's a silver bullet when it comes to paying taxes.


1:27 Is it possible to avoid taxes?

2:36 Roth IRA's can help control WHEN you pay taxes

4:35 Can rental real estate avoid taxes?

9:58 What about life insurance cash value?

13:59 Gifting can avoid taxes!


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Full Transcript:

Benjamin Haas  00:03 

Hi everyone and welcome to A/B Conversations where we will help you CFP your way out of it. A podcast where you get into the minds of a couple of Certified Financial Planners on how we think and feel about everyday financial planning questions and what should really matter most to you. A healthier financial life starts...now! Hey, Adam. 


Adam Werner  00:26 

Hey, man. 


Benjamin Haas  00:32 

I'm well, I am excited. That can't be true, am I really excited to talk about taxes? We hope you're excited to hear about taxes! Because, frankly, I think we came up with this idea. You know, we can see some of the stats on what people listen to or click on when we're doing content and taxes is usually one that people get a little perked up about. So, why not talk about the possibilities of avoiding taxes? I know, when we were talking about this to get set up, there's a lot of different professionals out there, whether it's investment, insurance salespeople, whatever, they love to talk about tax strategies and ways to be proactive with tax planning. So, let's do it. Let's talk about this concept of avoiding taxes and is it possible or not? 


Adam Werner  01:27 

It's interesting because, I think, for most people, like taxes are a great unifier. I think it doesn't matter where you fall, you know, politically, religiously, or otherwise, when it comes to taxes, people are looking to pay as little as possible within legal realms. But as you said, it is always a hot button and it certainly gets people's attention. We hope today will shine a little more light on some of those strategies to avoid and maybe it's not always just to avoid, there's, the words matter. So we'll kind of talk. 


Benjamin Haas  02:09 

Yeah, I'm glad you're starting there. It's not tax evasion, we're not going to tell everybody to start a laundromat business with a quarter deposit. Timing is going to matter, let's explore together. Is it really avoiding or not? There's going to be nuances here but I think the most obvious place to start is that Roth IRA. 


Adam Werner  02:36 

Yeah, so we'll talk through the different meanings of the word. As you said, I'll start with the Roth IRA and it can avoid taxes in the future. But the tradeoff is you're paying taxes today. So, I guess in that realm, you're not necessarily avoiding taxes altogether. You're choosing the timing of when you're paying the taxes and the tradeoff, as most people are well aware at this point with the Roth IRA is, I'm paying taxes on what I'm putting in today but you are avoiding growth or avoiding the taxes on any growth moving forward. Then, when you go to take that money out and you meet all the requirements by the IRS, you have to hold it for a certain number of years, it can come out tax free and that is a wonderful, wonderful thing. 


Benjamin Haas  03:35 

Right! In the financial planner world that we live in, we love this vehicle. We’re trying to find and use more creative ways to get money into that vehicle, whether it's converting, whether it's the new rules and secure act 2.0 that allow money to maybe move from one bucket to the other, workplace accounts, you know, there aren't some income restrictions there like there might be on your own. So creative ways to do that. Yes. I'm glad you clarified that. I think that's the obvious one. We have other ones that clients bring to us that are definitely grayer. I would say maybe more commonly referred to as not tax avoiding but misconceptions on timing of taxes. I'll give you a recent example: I'll just buy real estate, right? I can depreciate the asset, that'll avoid taxes. Adam, true or false? 


Adam Werner  04:35 

Oh, man, it's neither. It's like somewhere in the middle because I think again, it comes down to the timing and there's nuance in all of this. So, you threw out the depreciation example when it comes to like a rental property. In theory, you're depreciating, you have expenses, you have income from the rental property we assume. Maybe you end up showing a little bit of income, or maybe let's even just assume you're going to show a loss on that rental property from an income tax perspective, with your depreciation, your expenses, and all of that, that you can then offset against all of your other income. So, in theory, you could be avoiding some of those taxes. But I think where that nuance comes into play is specifically with the depreciation. Yes, you're kicking that tax can down the road or you're avoiding some of the taxes today on your income. But if and when you decide to sell that property in the future, by taking that depreciation, you're just reducing your cost basis over time. So, whatever you paid for the property, you're reducing that amount and then when you go to sell it, whatever that difference is, between the cost basis, which could be very low if you've owned it and depreciated it for a long period time, whatever you sell it for, that's now all taxable at capital gains rates. So again, you're not necessarily avoiding it forever. You're avoiding it for a specified period of time that you can control to some degree. 


Benjamin Haas  06:11 

So again, wrapping that back into planning, I would say to choose to do something just because of taxes is usually not how we go about recommending what to do and what not to do. Because if you are truly just trying to shelter yourself from taxes, to your point, then maybe owning real estate in this concept of the scenario that you gave, will work. But you almost have to see that property is like a legacy property for your family. For instance, now I'm going to pass away and there's going to be a step-up in basis to my heirs. Right now, we're getting to your point earlier and now we're getting into some nuances. But is property ownership really what you want for them? Isn't there a lot that goes into that? Isn't there a lot to consider with tenants and other expenses and blood, sweat, and tears? Yeah, of course. 


Adam Werner  07:03 

So I think something you said there is key to all of these different areas in the purpose, right? Well, the real estate, it's multifaceted, where you get different uses out of it. Roth IRA, investment vehicle first, taxes are a component of that but not necessarily the primary driver, but could be another one. We'll talk about life insurance but before I get into that, I think it is important to whatever that tax avoidance or the tax deferral feature is, that shouldn't be the primary factor. Right? So let's talk about the insurance and maybe I'll make my point a little bit clearer. So, life insurance cash value, so permanent policies that have cash value features to them. Oftentimes, we'll say sales people, life insurance agents that like to pitch the idea of using insurance not only as an investment vehicle, but also for a retirement income vehicle where you can access your cash value later in life tax free. Therefore, you're avoiding the taxes. That may be true to an extent, but at what cost and what is that tradeoff? One of the huge tradeoffs is, it's insurance first. We are fundamental in our approach to life insurance and investments. Try to keep them separate, insurance is insurance, there's a cost that goes along with that. Get the coverage you need for as long as you need it, get rid of it when you don't need it anymore depending on the situation. Investments should be investments. Where that gets commingled, it gets a little messier. 


Benjamin Haas  09:03 

Yeah, I think benefits, I'm kind of thinking to not squash this, right. There is certainly reason to try to build cash value if to your point, if you need insurance, build cash value, have that flexibility later, maybe it's long-term care with life insurance. Maybe it's serving multiple purposes that you really need the coverage until the kids are out of the house, mortgage, I get all that. But to do it just to think about, oh, I'm going to have tax free income, there is cost of insurance, there is expenses to the insurance contract itself. It's not an efficient investment vehicle so I totally get your point that when I first hear somebody say, hey, I want to try to shelter some taxes. Why don't I buy life insurance? We have to start this conversation somewhere else. 


Adam Werner  09:58 

I think our follow up question is usually going to be well, why? To try to pinpoint what is that driving force? What is the priority of what somebody is looking to accomplish in that strategy, but you hit on it and I just want to reiterate it. Yes, you could in theory avoid some of the taxes, be able to access cash value tax free that you've basically already paid in. Number one, you've already paid taxes on the money that you're paying premiums. As you said, there are expenses within a life insurance policy, not only is there you know, expenses on what they call, like a sales charge, when you put money in, the insurance company is going to take some off the top for administrative costs. There are ongoing expenses to the investment side of things to the cash value, if there's an investment down, and there's cost of insurance, just for any life insurance policy, there's a cost that gets deducted from your premiums that pays for the insurance. So again, you may not necessarily be fully avoiding it, you may just be trading the taxes in for additional costs that are going to the insurance company. Then depending on the scenario, that may be still a beneficial tradeoff to make but it's not the pure black and white, if I buy this insurance policy, I'm just completely avoiding the taxes and I get to keep everything in my pocket, it's not quite that straightforward. 


Benjamin Haas  11:25 

I don't want to turn this into a permanent life insurance podcast here but one other thing to note on that, that we would want to be very conscious of because we see where things go sour. Sometimes people come to us because there's a fire to put out. You still need leverage and a life insurance contract cash value to the death benefit. If you start pulling money out there because they're like, hey, it's retirement income, at some point, the insurance company is going to go, there needs to be enough cash value in here to cover our risk of you passing away and needing to pay out a death benefit. So, it's not like your own investment account where you can just take as you want and not have to replenish. I think when you take money out, it's technically a loan so a lot of complications. So back to the theme of the podcast, are you avoiding taxes? Hmm, I think that's really gray and I would not throw that on the shortlist of hey, we're going to be quick to recommend this like we would maybe a Roth IRA or an HSA or something like that. 


Adam Werner  12:30 

Yeah, there's definitely way more moving pieces to the insurance side of things and that ultimately just comes down to being multifaceted in what you may get out of it. So yeah, do we want to pivot to what ways can we avoid taxes completely? 


Benjamin Haas  12:51 

Yeah, and maybe I'll tee this up for you because I think I know where we're going with this. If we're talking trying to truly reduce taxes in the given year. They're definitely proactive things we want to do to kind of understand what are your investment gains? Can we offset them with losses? Can we talk about ways that we can move money around with the Roth, if you have certain deductions that can take more? There's definitely proactive tax planning but if your question truly is, is there anything we can do to truly avoid taxes? The answer is yes but you're giving money away. This isn't about you keeping more money. This is about making sure the IRS doesn't get it. 


Adam Werner  13:39 

Yeah, and I think that's the key point we want to make there. I think there's this misconception that there's something out there that I just don't know about but everybody else does or you know, some very select, very smart people. 


Benjamin Haas  13:56 

What's the silver bullet? 


Adam Werner  13:59 

Yeah, know how to play the game and I can just keep this money for myself and not have to pay in taxes. But I don't know that that truly exists. To your point, a lot of the ways to avoid taxes is because you're giving up control or you're completely giving up the asset, you're giving up the investment. So that would be something like charitable giving. You're giving to a charity; you get the deduction on your tax return. Now, there's caveats that the standard deduction right now is very high and you'd have to itemize your expenses beyond that standard deduction to really take advantage of that. I think, is it $600 that a couple can deduct now? Not nominal tax impact. Similarly, a QCD, or a qualified charitable distribution, from an IRA or retirement account. Once you hit age 70½, you're allowed to essentially send money directly from your IRA to a charity with what would have been a taxable withdrawal to you. If you took out, say, $10,000 from your IRA, or if it goes directly to a charity or a few different charities, you're completely avoiding that because you never received it. So again, you are avoiding the income taxes but you're giving that money away. It's off your balance sheet moving forward. 


Benjamin Haas  15:20 

I think the moral in all of this still has to be again, what are you really planning for and we want to be tax efficient, but we have to kind of understand, what are you really looking to accomplish? If it is, again, truly avoiding, then those are two ways and maybe this is the later in life conversation, but you can gift other assets to other people, and maybe you're avoiding taxation to you but someone may eventually pay taxes on that money. Right? Someone, somewhere down the line, the IRS does not give a lot of handouts here, you know. So, in some ways you can control when you're taxed. But the idea of avoiding completely, it's not really on the table legally. 


Adam Werner  16:07 

Yeah, we'll say it's one of those areas where you can influence the timing and the control, maybe avoiding some of the taxes. But it's not as black and white, like I said, there's that misconception that there's just this silver bullet as you put it, that's out there. Like, if I just did this one thing, I'll just be able to avoid taxes completely, I'll be able to keep everything on my balance sheet. The one area that we will share here to kind of end it on my side is a health savings account. I know we've talked about health savings accounts before, known as HSA’s. They are one of the very rare vehicles, investments and otherwise, that is triple tax advantaged. So, you get the tax deduction up front, like contributing to a pretax retirement account, it grows tax-free like many retirement accounts. When you use it for qualified medical expenses, it comes out tax-free like a Roth IRA. So, it is kind of the best of all worlds but in the grand scheme of all the different kind of moving pieces in someone's financial life, it is merely a portion. Of course, there's limits, exactly how much to contribute over time. It's not an unlimited, you know, let's just funnel all my money in the HSA and I'll never pay taxes on it. It's a good strategy, but it's one of many that would be explored in someone's total financial plan. 


Benjamin Haas  17:38 

Yeah, so to kind of summarize that, at least on my end and then chime in if you've got anything else, we do want to be proactive in our thought about taxation. That's why we talk about tax diversification in the same way, we talked about investment diversification, right? Money that's going to be taxed now versus later. That can be tax-free. There are definitely ways to go about that and I'd also say if you know you're going to have a big taxable event. Right, there's something that occurred in your life, you have a windfall of some sort. Yeah, we mentioned selling a property. It could be many different things. There are things you can proactively do before the end of the tax year, to maybe look to minimize some of those taxes. So, I would say that if you're listening in because that's your situation, then let's talk about it. But the concept of avoiding completely, I think, be weary of that word. You're not missing out on some magical formula; it doesn't happen to exist. 


Adam Werner  18:27 

Right. So, I guess the key point there is, even if you're not fully able to avoid the taxes, that doesn't mean you shouldn't plan for it. As you said, there are still a lot of tax planning strategies that are well worth exploring just to be more efficient from a tax perspective. So, you may not be able to avoid it but you can certainly be more efficient with the timing of taxes and try to strategize from that aspect. Try to do a little bit better from a tax standpoint. 


Benjamin Haas  19:07 

And here I thought talking about taxes wouldn't be fun today and this was so much. All right, you have a great rest of the day. Thanks for doing this, catch you next time. Adam and I really appreciate you tuning in. Please note that the opinions we voiced in the show are for general information only, and are not intended to provide specific recommendations for any individual. To determine which strategies or investments may be most appropriate for you, consult with your attorney, your accountant and financial advisor or tax advisor prior to making any decisions or investing.  Thanks for listening! 


Investment Advice offered through Great Valley Advisor Group, a Registered Investment Advisor. Great Valley Advisor Group and Haas Financial Group are separate entities. This is not intended to be used as tax or legal advice. Please consult a tax or legal professional for specific information and advice. 


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