Good Insurance vs Bad Insurance

All insurance is a waste of money until it comes time to file a claim. The trick is in determining which insurance is good, protecting you from serious financial harm, and the bad.

When I talk about good and bad insurance I’m not talking about fraud or an insurance company acting in bad faith. What I mean when defining the quality of insurance is the value it brings in protecting against loss.

In most cases, people want the least amount of insurance possible without putting themselves at risk of a financial loss that would destroy them. Auto insurance has a minimum requirement in every state. However, some states allow you to opt out. For example, Arizona allows you to provide a bond, certificate of deposit or deposit cash with the DMV for the minimum coverage levels in lieu of actual insurance. Another example is Virginia where you can opt to register as an uninsured motorist for an annual fee as long as you have a clean driving record.

Lenders require insurance on assets they have as security. There is no insurance requirement for any real estate you own unless the property is mortgaged. 

Then we get to life insurance. There are strong feeling when life insurance is discussed, except it isn’t that simple. There are times life insurance products are powerful tools in wealth preservation. All too often life insurance is used incorrectly. We will explore where value exists with life insurance.

Most insurance is neither all-good nor all-bad, though there is more all-bad insurance than you might expect. Most falls somewhere in the middle. To gain the greatest value with the least expense requires a modest understanding of what each type of insurance covers and a modest amount of simple math. That is how you keep your insurance costs low and protection high.

You want good auto insurance should the need arise to file a claim. But too much or the wrong insurance is wasted money, or worse, lack of coverage when needed.

 

Good and Bad Auto Insurance

We will start with auto insurance since it is practically a requirement if you drive. 

State laws require a minimum level of insurance. Auto insurance is highly regulated in each state to protect lenders making auto loans and to protect those injured in an accident. 

The issue of good and bad insurance with auto coverage involves the various facets of the policy.

Collision: No state requires collision or comprehensive coverage, but lenders do. If you don’t have a loan on a vehicle you can eliminate this insurance expense.

Should you? There is a very small amount of math required in determining if insurance coverage is worth it. 

Example:

Value of vehicle: $20,000

Premium per deductible:

$5000: $500 per year

$1,000: $1,250 per year

$500: 2,500 per year

(Keep in mind insurance premiums vary widely between geographic locations, the age of the insured driver and driving record. The above example numbers are not meant to be indicative, but rather instructive.)

First, the most you can lose if you total your vehicle is $20,000. Second, the larger the deductible the lower the premium paid. 

Your financial standing plays a role in how much collision coverage you should buy. If you have a seven figure net worth you may choose to forgo collision coverage all together regardless the value of the vehicle. You may have no real choice but to buy lower deductible coverage if you don’t have the resources to pay for a $5,000 deductible or if the lender requires a minimum amount of collision insurance.

I want to look at this from a purely financial viewpoint. A $500 premium for a $5,000 deductible means you will need to have a greater than $5,000 claim every 10 year to come out ahead. Insurance companies are not stupid. They sniff out risk better than a bloodhound. If you have frequent claims it is unlikely the premium would be so low.

A good rule of thumb (though not for everyone) is not to have collision on a vehicle worth less than $5,000. The accountant in the room hasn’t had collision coverage for decades. Since I haven’t had a claim in forever it has been a good deal.

Where the tire meets the pavement is between deductible levels. The premium is $750 per year more for a $1,000 deductible than a $5,000 deductible. When looked at correctly, this means you are paying $750 per year for an additional $4,000 of protection. 

See the issue? In just over 5 years the premium pays the entire $4,000 of additional coverage. You either have a lot of accidents or you are better off with the higher deductible.

It gets worse with the $500 deductible. Now you need to file a claim more than once a year for the insurance coverage to pay off.

My example is extreme, but it illustrates nicely how you should calculate the level of insurance you really need.

Comprehensive coverage, if listed separately, should be calculate the same way. 

I’m not here to tell you how much insurance you should or should not have. I want you to understand the math so you can make the best consumer choice for you. The simple example above helps you optimize your coverage while keeping premiums as low as possible.

Liability: There are two forms of liability insurance required by most states: bodily injury and property damage. Bodily injury cover someone else’s injuries if you cause the accident; property damage is damage to the other person’s property, such as their vehicle.

Here is where the math goes out the window and risk is the primary concern. Wrongful death gets expensive fast. Same with medical bills if someone is injured. If you cause an accident, even if unavoidable, your liability risk can destroy almost any lifetime of savings. Something as simple as a slick road due to black ice or fog can put you in jeopardy. 

The more you have to lose the more liability coverage you will need. Laws differ by state so it is important to have a serious discussion with your insurance agent. They get paid when you buy a policy. Be sure to discuss your situation fully with this person to verify you have adequate coverage and that you are covered for what you think you are. You may even wish to have an umbrella policy in addition to your regular auto insurance. 

Liability and collision are the expensive parts of an auto policy. The best way to save money is to have a clean record: no traffic violations or accidents.

Underinsured (UIM) and Uninsured (UM) Motorist: This is the area where price shopping can get people in trouble. Agents can shave a few dollars off the premium to beat the competition by quoting the minimum requirements for UIM and UM. This can be a huge mistake!

UIM and UM are generally pretty cheap. Jacking the coverage to the same level as your liability coverage can be as little as a few dollars per month. You don’t save a lot by skimping on UIM and UM, but you will be surprised what you risk

Why is UIM and UM important? First we need to review who is covered by each area of the policy. Liability coverage protects them. In other words, your liability coverage deals with injuries and damages to someone else. UIM and UM protects you when the other guy has inadequate insurance and is at fault!

What does this mean? The best way is to look at an example.

A highly intoxicated driver runs a stop light and hits your vehicle, killing the intoxicated driver and your significant other in your car. The intoxicated driver is uninsured. Your insurance liability coverage deals with the intoxicated driver’s death and vehicle damage. Like most drivers, you have ample liability coverage so you come out of any litigation with no financial damages since the insurance company paid the claim. The family of the intoxicated driver stands to gain well into the six figures in damages for wrongful death, depending on the state where the accident occurs.

You, however, are covered by your UM because the intoxicated driver in uninsured. Since you have minimal coverage ($25,000 in many states) you may get a claim payment barely enough to pay for the funeral. This is why I strongly feel UIM and UM coverage should be as much as the liability coverage. Anything less and you are putting a higher value on the life of a stranger over family and friends.

 

There are more types of auto coverage, like medical, to consider. You can dig deeper into the details here if interested. 

Homeowners insurance is for more than fires, natural disasters or burglars. Good homeowners insurance provides large amounts of liability protection for a variety of risks.

 

Good and Bad Homeowners Insurance

Here are a few tips when reviewing your insurance covering real estate owned. 

First, the liability issues above still apply here. No state requires you to have homeowners insurance; your mortgage lender will. 

Once again I remind you that liability coverage is only one part of the insurance protection. Underinsured and uninsured is still in play.

Most people think homeowners insurance covers you if your house burns down or hail destroys your roof. And that is part of what your policy should cover, depending on the coverage purchased. 

Deductibles come into play. Generally, a higher deductible is favorable since it has lower premiums. Homeowners insurance premiums usually have smaller discounts for higher deductibles. Going from a $1,000 deductible to a $10,000 deductible may save so little you may wish to purchase the lower deductible policy anyway. A single claim could cover the entire additional premium cost for many years.

There are several types of homeowners policies available. You can review what each offers here.

Here is why homeowners insurance is necessary in my opinion. A slip and fall on your property can expose you to serious liability risk. There are a thousand ways something can happen on your property that makes you liable. You might have plenty of money to rebuild your home, but an extended lawsuit can leave you exhausted and broke. Just having the insurance company take care of the legal costs and hiring attorneys to defend you can be worth the price of the policy.

Once again, your homeowners insurance agent is someone you need to talk with. The default for most people is an HO-3 policy. You might need to consider riders. Review the difference between deductibles. Some coverage may not be worth it. Example: additional roof coverage in southern states that experience frequent wind/storm/hurricane damage can be so expensive that you would need a total loss more often than ever 10 years. 

Your financial situation will help you determine what risks should be mitigated and which to assume yourself.

 

Good and Bad Life Insurance

Nothing gets the dander up faster than a discussion of life insurance on a personal finance discussion board. Some hate all life insurance and some think it has value. The truth is somewhere in the middle.

Term Life: Let’s start with term life. It is cheap when you are young and provides a fairly large benefit. The problem is that is gets very expensive when you get older. It is considered temporary insurance for a reason.

Who should have term life insurance? Young families come to mind. If a breadwinner in the family dies there can be serious financial issues for survivors. 

Single premium term insurance also plays a role in tax strategies such as in charitable remainder trusts

Business owners can use a buy-sell agreement to protect all the owners of an entity. Term life insurance is cheap enough to cover all parties involved and if one happens to die the funds are available for the remaining owners to buy out the deceased’s ownership. This avoids having to deal with beneficiaries of a business partner or a complete stranger if the ownership is sold to a third-party.

Who should not have life insurance? It is my opinion that single people without dependent children probably do not need term life insurance. If no one depends on your income stream who is the life insurance protecting? When this is the case it is better to save the premiums paid.

Cash Value: Cash-value life insurance gets most of the complaints in the personal finance discussion groups and for good reason. Fees are high and if you really do the math, cash value is usually a really bad idea for a savings or investment account. 

Business owners sometimes use cash value life insurance to protect their business. Key Person and Key Employee policies are powerful tools to protect a firm with indispensable persons, such as an owner or employee with specialized skills.

The baby should not go out with the bath water. Cash value life insurance is an appropriate tool in the right situation.

Annuities: Annuities also get a bad rap in the personal finance discussion groups. Fees are once again high. Annuities protect on downside risk, but cap the upside by a significant amount, depending on the policy purchased.

However, there are instances where annuities are the preferred tool.

A Medicare complaint annuity can shelter monies from the look back rules. Generally, monies can be sheltered if the Medicare compliant annuity is funded prior to entering a nursing home. The rules are complex and we don’t have the space to discuss all the details here so I will allow you to further your research here

Annuities can also be used in several tax strategies such as NIMCRUTs

Business owners can also utilize annuities in a tax advantaged manner, as discussed above under term life insurance. 

Annuities can be used for asset protection.

(As full disclosure, the author had a life insurance license in Wisconsin for over 20 years. I did not renew my license about 5 years ago since I did not sell much life insurance and did not want to be restricted in what I could say in this blog.)

Now that you are aware of my life insurance credentials, I want to share an instance where I think an annuity is appropriate. 

I had a client entering retirement many years ago. His health was good, but his family history wasn’t favorable. He wanted a certain level of income now with a higher income income later when his wife retired. He also wanted to guarantee a certain level of income for his wife should he die young.

The solution for guaranteed income was a series of annuities. We started with an immediate annuity (a low commission product so it at least had reasonable value) that paid out for five years before being exhausted. This provided the monthly income stream for the early years.

The remainder was placed into two additional deferred annuities. The first of these was triggered in five years when the first annuity was exhausted. It was a second to die policy so the income stream covered the client and his wife. An inflation rider was added so income is keeping up with inflation. The final deferred annuity was an emergency fund. If they ever needed a larger amount of cash or wanted a larger income stream they had options.

As you can see, some people have a situation where an annuity is a reasonable choice. My client was set on having an annuity. I spent considerable time with my client explaining how this strategy worked because once done there was no going back. So far it is working according to plan.

Life insurance is not designed to protect you. It is designed to protect them. Know when life insurance is a good choice.

 

Bad Insurance or Just Plain Junk

My head hurts when I think about some of the stupid insurance people buy.

Top of the list is the insurance to cover small purchases. If you buy a $100 item you do not need to pay $20 insurance to protect it. Many credit cards protect the item for free if the item is purchased using that credit card. And if you can’t fix or replace the $100 item without the insurance you can’t afford the product in the first place.

Since there is so much junk insurance out there (think of the extended car warranty scam phone calls everyone gets). Most of this stuff is completely junk with profits sometimes as high as 98%. Yes, some of these junk policies (assuming they are not a scam or fraud) pay out as little as 2% of premiums in claims.

A good rule of thumb is that small levels of insurance are not worth it. 

Another bad insurance is dental. Some dental insurance is good, but much of it is a disguised discount only. In other words, you pay less for a dental cleaning and so forth if you buy the insurance. If you have a large dental expense it may work periodically. However, these policies are designed to only work if you come back to the dentist often! And you still pay most of the bill; the insurance is really only a discount! Dental insurance can work in some instances, but usually is self-serving for the dental practice.

Any insurance that covers something you’re already covered for is bad insurance. Credit and debit cards come to mind. Most credit cards have a long list of benefits. Some replace an item if broken or stolen within a year or two. My credit card covers cell phones that are broke and good thing. A few years back I bought a new phone and an ice patch at the office had me fall square on my phone with all my weight, crushing it. The credit card company covered the whole thing at no cost to me.

 

Good Insurance

Disability insurance is expensive, but can save a family struggling financially.  If you don’t have the resources to live through an extended disability this type of coverage can protect your hard-earned nest egg.

Long-term care insurance is good for certain situations. If you are really poor it probably isn’t necessary (what can they take if you don’t have financial resources) unless you want the ability to choose a better long-term care facility. If you have a high net worth you can self insure.

It is those folks in the middle most at risk. A $300,000 net worth, for example, can be severely damaged if you end up in a nursing home. A few years of this and there is no nest egg. If you have a spouse or others counting on your legacy it is best to protect it.

Life insurance is a powerful tool in estate planning. The number of policies available is large. You need to work with a qualified tax and accounting professional along with a qualified estate planning attorney when estate planning. The issues are many and complex.

The cheapest and best insurance usually protects against rare occurrences, but when they happen are high ticket items, taking you out financially. The goal is to avoid the train wreck. A broken laptop should not be a major catastrophe requiring insurance coverage. A $100 toy certainly does not require insurance! But a $1 million lawsuit is a life changing event. You might want to protect against that.

 

Common Sense

When it comes to insurance common sense goes a long way. Junk insurance like the stuff you get offered at Amazon or Best Buy when purchasing a cat pillow is insane. And the premiums are frequently 20% or more of the product price. Are these things built to fail before the manufacturer’s warranty expires? 

Intelligent insurance purchases take a small amount of math as you saw at the open of this blog post. I help clients in my practice on a regular basis decide what insurance and deductible level that is most appropriate for them. One size does not fit all. It always comes down to some simple math.

Shock insurance, the stuff that gets offered to you at the spur of the moment where intelligent people would not even expect to be pitched, is the worst. I avoid insurance offers that come to me.

Always shop around. Get a few quotes from highly rated insurance companies. Get the best policy for your needs and no more. If you don’t want to overspend on insurance, avoid insurance you don’t need. 

As always, use common sense. Talk to the insurance agent when shopping for auto, life, long-term care, disability and homeowners insurance. They get paid to help you make a proper choice. If you don’t ask they will sell whatever you ask for and cash their commission check. Good agents want to talk with their clients. Don’t push them away. It is their job to help you.

And always do some independent research. This blog post is a good start. Check prices and what policies cover. Doing research when you need to make a claim is not research; it is reacting. That is the wrong way to do it.

 

 

More Wealth Building Resources

Worthy Financial offers a flat 5% on their investment. You can read my review here.

Blockfi is currently paying 7.5%.

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

Winning With Benjamin Franklin’s Virtues

$100 bill. Benjamin Franklin.

Benjamin Franklin might be the most important of the Founding Fathers. His steady hand and silence shouted more than hours of oratory. When younger minds became heated at the Constitutional Convention, Franklin sat quietly until it was obvious the attendees were at an impasse. Franklin, silent during most of the proceedings, suggested a break. Gently, he spoke with several delegates during the pause in the debate. Cooler minds returned and a nation was formed. It is fair to say the United States of America owes its existence to the virtues of a single man. 

Ben Franklin knew he was not perfect by any stretch of the imagination. As a young man he set out to make himself a better person. He learned and shared sage advice still relevant today. At the core he listed 13 virtues he felt were important to master. They provided the formula for happiness, wealth and success.

Long before the modern FIRE (financial independence/retire early) movement, there was Benjamin Franklin. I learned from Franklin that retirement is overrated if you find those things you love to do and keep a healthy level of curiosity in your life. Unhappiness breeds the desire for retirement.

Winning at life, in marriage, financially, in your health, spiritually and physically were covered by Franklin. It was simple to set up, yet difficult to follow. Franklin, fully aware of his shortcomings, listed the virtues he wanted to uphold. Then he held himself accountable each day; never beating himself up for failing, but gently encouraging improvement each and every day.

 

Ben Franklin’s 13 Virtues

The best place to start is by listing the 13 virtues Franklin considered so vital. After this I will share a worksheet you can print and use for your Virtues Journal. Then I will share some of Franklin’s wisdom before finishing by sharing a program that provides the framework needed to maximize your study of these virtues.

Temperance: Eat not to dullness; drink not to elevation.

Silence: Speak not but what may benefit others or yourself; avoid trifling conversation.

Order: Let all your things have their places; let each part of your business have its time. (Author’s note: I take this to mean to stay focused on the task at hand. I doubt Ben would have been a fan of constantly checking email or smartphone.)

Resolution: Resolve to perform what you ought; perform without fail what you resolve. 

Frugality: Make no expense but to do good to others or yourself; waste nothing. 

Industry: Lose no time; be always employed in something useful; cut off all unnecessary actions.

Sincerity: Use no hurtful deceit; think innocently and justly, and, if speaking, speak accordingly.

Justice: Wrong none by doing injuries, or omitting the benefits that are your duty.

Moderation: Avoid extremes; forbear resenting injuries so much as you think they deserve.

Cleanliness: Tolerate no uncleanliness in body, clothes, or habitation.

Tranquility: Be not disturbed by trifles, or at accidents common or unavoidable.

Chastity: Rarely use venery but for health or offspring, never to dullness, weakness, or the injury of your own or another’s peace or reputation.

Humility: Imitate Jesus and Socrates.

Feel free to download or copy this Ben Franklin virtues poster.

It should be noted than Franklin fell short by his own admission most days. Temperance (drinking intoxicants) seemed to be a struggle. 

The goal is not perfection; the goal is to be aware of weaknesses and improve consistently over time.

Now to track our progress. 

Print out a page for each week. Place a dot in each location each time you go against the virtue. You can have multiple dots on a single day and virtue.

Print out a page each week for your virtues journal. Place a dot under the day of the week and the virtue when you fail to live up to the virtue.

Example: If you spent money foolishly on Monday, place a dot in the Monday column on the frugality row. You can accumulate more than one dot is a day under one virtue.

In a short time you can visualize where you are coming up short and where work needs to be done. Remember, this isn’t to belittle yourself! This exercise clarifies where you need improvement. Make a conscious efforts to improve in weak areas. Always be vigilant. Knowing where you tend to stray is a powerful tool in slowing down the negative behavior.

 

Wisdom From Ben Franklin

Franklin is an endless source of common sense and wisdom. His autobiography is must-read material for anyone serious about building wealth. Much of this wisdom was shared in his annual publication of Poor Richard’s Almanack. For 27 years Franklin built upon a solid foundation of wisdom, giving us arguably the greatest source of information on living a good and happy life, and on building financial wealth.

A good example of this powerful writing is the essay in the 1758 edition (the last year Franklin published the almanack), and included in his autobiography: The Way to Wealth. It is hard to fathom this was published 350 years before contemporary bloggers, podcasters and financial gurus. Ben Franklin put all us moderns, with our word processors and auto-correct, to shame centuries ago with a simple pad of paper and pencil. We can only aspire to such greatness.

I’ll share a few financial (frugal) quotes here. If you want more I highly recommend Franklin’s autobiography and biography by Walter Isaacson

Select quotes from The Way to Wealth:

Industry need not wish, and he who lives upon Hope will die fasting.

Keep thy Shop and thy Shop will keep thee; and again, If you would have your business done, go; if not, send.

If you would have a faithful Servant, and one that you like, serve yourself.

A little Neglect will breed great Mischief.

Buy what thou hast no Need of, and ere long thou shalt sell thy Necessities. 

Beware of little expenses; A small Leak will sink a great ship.

The second Vice is Lying; the first is running in Debt.

Lying rides upon Debt’s Back.

Of course there is much more. 

And when have you heard similar words in  modern English? From Warren Buffett? Charlie Munger? Dave Ramsey? the Wealthy Accountant!

Every nugget of financial wisdom is as old as the ages. This stuff has been known for millennia. We keep repeating it generation after generation because nothing is less common than common sense

That is why my work is never done. Every day another crowd of people struggle with financial issues and people like me try to spread the good word.

 

Benjamin Franklin Circles

It is easy to think Ben Franklin lived in a different time, a time alien to our modern world. In some ways this is true, but the differences are not as vast as you might think. 

Franklin understood the value of quality conversation, where ideas were exchanged and knowledge grown. Franklin frequented salons, where people gathered, socialized and built grand ideas, like creating a nation like none other in history. 

We can still meet in the same fashion. But, we also have the added advantage of virtual meetings. With Zoom we are no longer limited to those locally that can attend meetings.

There is a movement afoot that acts much like the salons of Europe and America in the early and mid eighteenth century. They are called Benjamin Franklin Circles. There are several ways to start your own circle. I’ll let you use the link to dig deeper into the topic. 

The Franklin Circle can be a local gathering or virtual event. The group is a year commitment. Once per month the group gathers to discuss another of Franklin’s virtues and how to best build that virtue in ourselves. 

The group can also enjoy the socializing and good conversation Franklin did in his day by extending the group into additional virtues and topics. 

You don’t have to reinvent the wheel. The link above is a beginning point if you are interested in starting a Circle.

There are also numerous guides to help with the process. (The guides are also useful as personal study materials.) Here are a few guides with links. All can be downloaded and printed out.

Ben Franklin Circle Toolkit

Meeting Guide for Franklin’s 13 virtues

Meeting Guide for an additional 12 virtues

Virtual Meeting Guide

Dinner Party guide

Use these guides to step back in time and into the future.

 

Final Words

It is impossible to give a proper review of Benjamin Franklin in a thousand words or so. Hyperlinks above expand the subject material greatly, and the two books mentioned and linked in the text do provide reasonable coverage of a remarkable man and his sage wisdom on health, living the good life and financial wealth.

I hope I whet your appetite enough to encourage a deeper drink from the well of knowledge Franklin brought us. You will find all successful people are, knowingly or not, using Franklin’s advice on some level as part of their success.

But more than that, these virtues can make us a better person. You don’t have to start a nation or build your financial empire as large as Charlie Munger’s to benefit from the time tested wisdom of Franklin. You do have to start taking accountability of yourself as Franklin did. 

A small amount of progress each day compounds to a massive amount of knowledge and wealth of all kinds. It is simple, yet requires the simple action of taking the next step. 

Begin today.

 

More Wealth Building Resources

Worthy Financial offers a flat 5% on their investment. You can read my review here.

Blockfi is currently paying 7.5%.

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

The Goal is to Pay No Income Taxes, Legally

Taxes. They come in many forms. Some are hidden: corporate taxes are built into the cost of goods and services you buy; excise taxes are included into products like gasoline. 

Others are more visible like sales and property taxes. And then we come to the most visible and dreaded tax of all: income tax. When people complain about taxes they are usually talking about income taxes.

Avoiding income taxes should be easy considering the size of the tax code and the millions of loopholes available. And that is the problem. The tax code is so big that it is daunting so most people have their eyes roll back in their head when they should be facing the tax code head on.

We will discuss several avenues to a zero out your income tax, but first some ground rules.

  1. Keeping your income low is not eliminating taxes; it is eliminating income at a 100% tax rate. Our discussion will focus on ways to eliminate income taxes at any income level, with only a slight nod to lower incomes where incomes taxes rarely apply.
  2. Tax credits can cut your taxes significantly. I’ll point out a few of these obvious gems, but will not hang my hat on mainstream tax credits to eliminate your income tax.
  3. No using cheap gimmicks like “have three kids” to eliminate your income taxes. I will assume no children in most of my strategies here.
  4. Debt is not tax-free income. Borrowing more money is NOT a tax strategy! No universal life craziness on this blog, either.
  5. Our inquiry will focus on tax strategies available to a large number of people and legal ways of converting taxable income into tax-free income.

Before we begin our analysis I want to point you to an excellent article on this topic published by the Root of Good blog in 2013. The Tax Cuts and Jobs Act of 2017 (TCJA) changed many of the rules the Root of Good blog post used. Still, it is a good place to get ideas for the flavor of strategies available.

I also discussed 10 Ways to Legally Stop Paying Taxes in a prior post on this blog. You may wish to review that post as well if you are serious about reducing or eliminating your income tax.

 

Income Tax on Income Under $100,000

A short nod to readers with a five-figure income. 

There are so many tools for eliminating incomes taxes on incomes under $100,000 that I will only scratch a few. 

  1. Social Security benefits can be partially or totally tax-free. This link provides more details.
  2. The TCJA eliminated exemptions, but jacked the standard deduction. In 2017 the standard deduction on a joint return was $12,700. In 2021 the standard deduction is $25,100 on a MFJ return; $12,550 for MFS and single taxpayers; and $18,800 for heads of household. This means a married couple filing a joint return gets a $25,100 deduction right out of the gate. 
  3. Long-term capital gains enjoy a large 0% tax bracket. In 2021, the 0% tax rate for LTCGs income threshold is $80, 800 for married couples filing a joint return; $54,100 for heads of household; and $40,400 for single and MFS taxpayers. The easiest way to look at this is to add all your taxable income together and stack the LTCGs and qualified dividends on top. The portion below $80,800 for a MFJ return is taxed at 0%. Add this to the standard deduction and a married couple filing a joint return can enjoy $105,900 of income without an income tax with this one strategy alone in 2021. This is an incredible tax opportunity for those retiring early. 

A plethora of tax credits are available for low incomers. Your facts and circumstances will prevail. 

The Child Tax Credit (CTC) is a bit more complex in 2021 than in prior years. Portions of the CTC phase out well into the six-figures

Other common credits that can reduce your income taxes are:

  1. Earned Income Credit
  2. Saver’s Credit
  3. Education Credits
  4. Child and Dependent Care Credit

There is also a small credit for nonbusiness energy improvements for homeowners. Then there is the Premium Tax Credit. This is a big credit for those with lower incomes. You can do more research on the PTC here.

There is another new massive temporary tax-free employee benefit made available under the CARES Act. Employers can pay to the employee or the student loan provider up to $5,250 for student loan repayments. This break is available for tax years ending December 31, 2025 or before. That means you have several years to accumulate this tax-free income.

Note: You can’t take the student loan interest deduction if your employer provided the tax-free funds. However, if you made additional student loan payment you may get an additional deduction there as well. Example:

  • Student loan interest: $2,000
  • Employer paid $5,250 of your student loans
  • You paid an additional $2,000 of your student loans.

In this scenario you could also qualify for a $2,000 student loan interest deduction as long as you are below the income threshold. What is less clear to this accountant is if you need to pay the interest out of your funds and the principle from employer funds or not, and how that would be segregated.

One last gift from Congress for those with a modest income. If you have a health savings account qualified health insurance plan you need to fill that HSA savings account. Contributions are deductible, earnings grow tax-free and the whole thing comes back to you outside income taxes if used for qualified medical expenses or Medicare premiums once you turn 65.

Eliminating your income tax requires planning. The government erects obstacles you need to navigate. It is worth the effort. No need to succumb to anti-social behavior.

The Easy Income Tax Deductions

Now we turn to taxpayers with higher income. Some of these strategies apply to people with lower income as well, but the focus in the remainder of this article is on eliminating income taxes for taxpayers with a six-figure or higher income. 

Let’s start with some low hanging fruit. Here are several sources of tax-free income:

  1. Some alimony. Use the link for more details.
  2. Child support payments are always tax-free.
  3. Inheritances, gifts and bequests.
  4. Cash rebates
  5. Most employer provided healthcare benefits.
  6. Foster care stipends
  7. Worker’s Compensation benefits
  8. Disability benefits if you paid for the premiums.
  9. §121 exclusion of up to $250,000 of gains from the sale of your primary residence per person.
  10. Foreign Income Exclusion
  11. Death benefit from a life insurance policy

A source of income I do not consider tax-free income is employer matching in retirement funds because the employer contribution always goes to the traditional part of the retirement plan, even if you elect to have your 401(k) contributions treated as Roth contributions. The income is not tax-free; it is tax-deferred. This is where I disagree with the Root of Good blog post. That post suggested deductions for the current year eliminated income taxes when all it did was push them into the future where tax rates on retirement plan distributions are uncertain.

The same can be said about souped-up retirement plans like cash balance accounts. A lot of money can be deducted currently with these plans and investments grow tax-deferred. But somebody at some point is going to pay the national uncle on the east coast. 

 

Two Unique Sources of Tax-free Income

Now I want to share what I consider two very powerful tools for generating massive amounts of tax-free income.

The first involves the cash rebates listed above. Most credit and debit cards provide some kind of cash-back these days. Some offer airline or travel rewards. In either case, these rewards are tax-free. 

We need to delineate what is a rebate and what isn’t before continuing. When you get a bonus on a bank account that is interest income. Selling tradelines are also income. What I’m talking about is sign-on bonuses and the continuing cash-back rewards offered by the myriad credit card companies.

This leads to an interesting situation. The sign-on bonuses can be large, say, $500 for $3,000 of spending in the first 90 days, plus the regular cash-back the card offers. Churning cards and manufacturing spending can turn no real spending into large amounts of cash-back fast, which is still tax-free. 

There are so many ways to game the system with cash-back rewards. I suggest a deep dive into Doctor of Credit (DoC) if this interests you. Be warned, this is a rabbit hole. The number of ways to get a steady stream of small incomes is nearly endless. DoC provides a nice ongoing list of opportunities to profit. Subscribing to their mailing list is a must in such situations. (Note: I am in no way related or connected to DoC. This is NOT an affiliate link of any sort.)

Eliminating your income tax requires planning. The government erects obstacles you need to navigate. It is worth the effort.

A Billion Dollars Tax-free

A common complain in my email is that I focus too much on people with higher income. That isn’t true! I spend plenty of time outlining tax strategies for people with lower levels of income. The ones I tend to avoid helping (until now) are the uber-rich! (Except when consulting. Most consulting clients tend to be very high earners.)

One of the most powerful tools for generating tax-free income is the Roth IRA. The mechanics are as such: Money going in is after -tax (meaning it has been taxed already) and money coming out, including profits, are not included in income once you reach age 59½. (In most cases your basis is available for distribution at any age.) 

Most people don’t see the massive loophole. Any asset placed into the Roth grows tax-free. What asset could you possible own that grows really fast, turning a small amount into a really big amount in a short order of time?

Let me give you a hint. There is at least one guy (it is a guy) who placed less than $2,000 into his Roth IRA and turned it into $5  billion! Think about that for a minute: $4,999,998,000 tax-free. Sure beats winning the lottery and anybody can use the same strategy. One particular accountant in the room did, only to a much, much smaller degree.

Peter Thiel, a co-founder of PayPal, started with less than $2,000 in his Roth IRA and parlayed it into $5 billion. So how did he do it? And more important, can you?

Well, let me give you a hint. I have done it, only with a lot smaller balance.

It started many years ago when I ran a small hedge fund. Using my Roth I was able to turn a small amount into a much larger amount, all tax-free. In less than two years I can touch those gains and never pay a penny in income tax ever! Until then I can keep investing and growing the pile more. (The basis is currently available.)

What about you? How can you super charge your tax-free income? Simple. You can either invest in market securities or index funds and enjoy those returns, or, invest in your own company, placed inside a Roth. Cryptocurrencies can also be placed inside a Roth. 

It is the early years of business growth that pound returns north fast. Peter Thiel invests and continues investing in start-ups. You can do that to a lesser extent, but you can easily start a business with the shares held by the Roth. The biggest obstacle is finding an IRA administrator that allows such investments inside Roth IRAs. You may have a local firm that handles such Roth IRAs if you look. You can also check Equity Trust. (Not an affiliate.) Be sure to do your due diligence before moving money.

 

There are so many opportunities available to eliminate your federal income tax. You can mix and match the strategies listed above and more in an endless number of ways. I spend most days at the office consulting with clients on just such issues. Sometimes my hands are tied and the benefits are limited (still profitable for the client, but limited). Most of the time we crush the tax beast. 

One word of caution before I leave you to your cup of coffee. Never fall for the old trick of lower taxes for the current year only. That is a very easy game to play that ultimately screws the client (that is you, my taxpaying reader). When I work with clients I consider “all years involved”. That means investments into a traditional retirement account requires consideration for the tax consequences when the money comes out.

Now, get creative, but stay legal. You want to keep your money and enjoy it too.

 

 

More Wealth Building Resources

Worthy Financial offers a flat 5% on their investment. You can read my review here.

Blockfi is currently paying 7.5%.

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

Identify Your Ideal Client

The most common mistake I see in my practice when a client starts a new business or side hustle is that they try to be everything to everyone. This leads to overwhelm, burnout and alienates the ideal client. By identifying your ideal client you increase your chances you will have clients you love working with. And that takes the work out of work.

A prime example of this is when a client tells me they are starting a restaurant. Their logic is that everyone needs to eat, to which I reply, “Yes, but they don’t have to eat at your place.”

If a restaurant is the business you want to be in (in other words, you LOVE the idea of working with food, employees and customers at a hectic pace all day) then you better be focused. Will you serve ethnic food? Take out? Delivery? Hours?

Advertising you have good food will not cut it. People want to know what you serve. The best restaurants are always known for their specialty. In Menasha, where my office is located,  Mihm’s Charcoal Grill is known for their butter burger. People joke it is a heart attack waiting to happen. Their burgers are so moist and delicious! They are tucked away on a side street and the place is small. But those butter burgers are to die for, literally. People wait in line for that stuff! Business is good at Mihm’s. If you are ever in the area give them a try. You’ll visit more often afterwards.

Learn from successful business how to find your ideal client.

You don’t have to reinvent the wheel when searching for the ideal client or customer. Take a page from those who have done it successfully in the past.

In Wisconsin we have a gas station called Kwik Trip. They have the best coffee and pretty darn good food, too. 

You would think a gas station is impossible to differentiate from other gas stations. If you thought this you would be wrong. Kwik Trip has become a destination. People travel across the Wisconsin border just to visit a Kwik Trip. (Are your ideal clients this fanatic about what you do?) The stations are well-kept, clean, employees trained and properly paid. It shows.

Several years ago Kwik Trip showed how to find the ideal client and nobody noticed. Except me! I recommend a version of what they did to certain clients when the strategy is appropriate.

Here is what Kwik Trip did. They printed up a bunch of coupon sized glossy flyers one-third the size of a regular sheet of paper, printing on both sides. On the flyer was a $1 off coupon for any pizza. They also announced they delivered. Next to the coupon was a list of all the pizzas available and a notation that Kwik Trip made their pizzas fresh in-house. There was also information for ordering your pizza online and picking up later.

So far nothing special Anybody, or business, could do this and it would make no difference or would cost a fortune distributing the coupons.

Kwik Trip took one hour, just one hour max, to implement a stroke of marketing genius. Yes, they had the coupons available at their gas stations and yes, employees handed them out.

But they also had an employee deliver to each business near each gas station a wad of these coupon flyers. 

Wow! People didn’t read they delivered, they saw it in action. And they focused on their ideal client: people at work looking for a delicious, low-cost lunch. 

People have a hard time passing up a discount, especially when the price of the product is already reasonable. Dropping off a thick wad of coupons at each local business allowed people working near the gas station several opportunities for the discount. Kwik Trip sold a lot of pizzas. I mean a LOT of pizzas and still do to this day.

How is this the ideal client? First, Kwik Trip promised delivery and they focused on delivering pizzas to the closest customers. Second, by focusing on local small businesses many delivered orders contained several pizzas. (It is cheaper to deliver five pizzas to one location than five separate locations.) Many people also picked up their pizza, fresh and ready, when they arrived.

I suggest to my restaurant clients they modify this strategy for their personal situation. I have never seen this strategy fail! For a few hundred dollars and an hour or so of time you explode your restaurant business. 

The perfect client values my services and advice. They engage and implement. They consider my firm part of their team and work together with that mindset.

The Ideal Client for You

What about other side hustles and businesses? How do they find the ideal client? The ones they love working with? The clients/customers that turn a job into a vacation because you love doing it so much?

The strategies listed above were to get you in the right mindset. Your business is probably different from Kwik Trip or Mihm’s. 

Before you can have ideal clients you need to identify what your ideal client looks like and where they live and work. This is important: You must be very specific and detailed! It’s not enough for a dog walking side hustle to list “all dogs”.  

Below I am going to outline the ideal client for my tax and accounting practice because, as you might guess, I’m looking a few few excellent new clients. Maybe most people need their taxes filed, but I don’t want everyone as a tax prep client. 

Specifically, I’m looking for a client that needs bookkeeping. That will include tax prep work, payroll and consulting, too. 

Below, I will outline my specifics of my ideal client. This means that most people that walk in the door or email will not get an offer to be my client! Read the last sentence 30 or so times if you are a business owner. Don’t act desperate. Many potential clients are a poor fit. 

Remember, most clients on the prowl for a new accountant left their previous accountant for a reason!

I expect a new client will be a long-term relationship. This is not a one-and-done. I am not interested in cleaning up years of bad books only to have the client go AWOL for five years, returning with same same exact mess, IRS notices and all. Note: I don’t mind fixing messes as long as the mess stays fixed.

 

Ideal Client Sample

First, we need to be honest with ourselves. Why did we lose clients in the first place? Are we starting out in business? Are there things we need to fix internally before bringing in new clients? Are employees properly trained?

For readers on the Facebook page of this blog, you will already know why I am in the market for two, maybe three, new clients. To bring the rest of you up to speed: My office has had a high fatality rate. Over the past year over 4% of my clients died; over 1 in 25!

These clients died because they got old. It wasn’t a disease issue. Most were clients since the 1990s. Those that didn’t die decided to retire. Who can blame them. And then there were a few business clients close enough to retirement that took the opportunity when the economy was shut down for a while. The timing was right for them.

I think the reason for client loss isn’t an issue I need to deal with internally. Now I can focus on what I want new clients to look like:

  • Must be U.S based. Some international sales are okay, but too much international and I need to bring in outside help.
  • They can be located anywhere in the U.S. If outside my local area, must be willing to use our secure portal for document transfer.
  • Will need more than tax preparation. Must also desire bookkeeping and consulting, plus maybe some payroll.
  • Landlords are a specialty of mine and would love a few new clients that are landlords with multiple properties.
    • Landlord clients should also be interested in consulting over all the tax reduction strategies possible. 
  • New business clients must be in a growth phase or stability phase. I don’t mind helping a firm wind down, but prefer new clients as long-term relationships.
  • Must consider my services a value. If taxes, bookkeeping and consulting are done begrudgingly, I’m not a good fit for you.
  • Pay my fee in a timely manner. 
  • Find my fee a value.
  • When reviewing a potential new client I need to see at least a 5x return for the client, preferably 10X (see next bullet point).
  • An ideal client is one that probably has fees to my firm of $5,000 or more per year. $400 of bookkeeping a month get them there. Even a small amount of monthly bookkeeping coupled with tax preparation and consulting should be sufficient.
  • The minimum return to the client can come from tax reduction or additional business profits annually. An increase in the value of the business is also considered. However, the new client should be able to clearly see at least a 5X return on any fees they pay me. That means they should see $25,000 minimum in increased profits and tax reductions annually.
  • A new client should be eager to communicate with my firm regularly. Disclosure of all pertinent information is a must. They must consider us part of their team.
  • Must provide data in a timely manner.
  • Must file all tax returns by the due date, plus extensions.
  • Must remain current on tax payments. No self-inflicted tax wounds that require unlimited time trying to contact the IRS.
  • Must be pleasant to work with.
  • If they are leaving an accounting firm it should have been an amicable separation (firm closing/owner died/firm can’t handle all its work). Not a deal breaker, but a warning sign if they had problems with their previous accountant.
  • If they have employees they use a proper payroll service so payroll taxes are paid and federal, state and local regulations followed. 
  • No paying employees or contractors under the table!
  • Reports all income and expenses. No tax cheats!

 

I know the list is long, but it isn’t that hard for a new client to make the cut. They need to follow the rules, work with their friendly new accounting team and pay their bill. 

Yes, I do make exceptions.

Yes, I say “no” to a lot of potential clients. I would rather take an afternoon nap than deal with the angst of having bad clients on my books. You, as the client, want the same thing. These rules also apply to me!

Feel free to use my list and modify to your needs. I know I will so don’t be surprised if I come back over the next weeks and months and clarify the list more.

Finally, if you are in need of an accountant that cares enough to be this specific, contact me. I really am in the market for two or three new clients of the right type. If it isn’t a good fit, I sometimes give referrals if I know a professional that might be a good fit. Sometimes it isn’t you; it is me. 

And this is how you love your work, have less stress, start the day excited and make the world a better place. 

It is also profitable for all parties involved, as it should be.

 

More Wealth Building Resources

Worthy Financial offers a flat 5% on their investment. You can read my review here. 

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

Self-Sabotage: The Biggest Risk Once You Have Money

Having money can change you, and not always in good ways. The risk is greatest for those who start out poor. For those lucky people, they have an additional challenge before them. If they fail they go all the way back into the swamp. Self-sabotage is an insidious demon.

Money doesn’t make you a better person; it makes the kind of person you are more pronounced. If you are a kind and generous person, money will tend to make you more kind and generous. And if you are a a-hole, money will make you a much larger one. 

Today I will share with you three stories: two personal and the other from a client. My hope is that you, kind readers, will learn from these lessons rather experience them personally.

I work hard sharing ideas on building wealth and lowering taxes. These are worthy goals that make the world a better place. What I don’t talk about often is the risks people face once they make it. There is no greater thrill than to watch someone born in poverty finding their way to an abundant life. All too often this is the moment they destroy their lives. Usually it is temporary; sometimes not. These lessons can help you avoid the same fate.

 

Turning on the AC

Believe it or not, you need to give yourself permission to be successful. Most people get exactly what they think they deserve. When their net worth declines the mental thermostat is turned up to bring them right back where they think they belong. And when things start going well, all too often the thermostat is turned down until the AC kicks in and pulls you down to where you think you belong.

There were two times in my life where I kicked on the mental AC is a big way. Working with clients on a regular basis as a tax professional I should have known better. I should have seen it coming. Yet, I let my guard down and suffered financially in each case.

My background starts on a farm in the backwoods of Nowhere, Wisconsin. We were poor, yet happy. We didn’t know better. We milked cows, planted and harvested crops and enjoyed life to the fullest in our sheltered world. 

By the time I reached high school I realized there was another world out there. I was driven. Coupled with the energy of youth I kicked tail and took names.

The family farm went through a wrenching bankruptcy in 1982, the year I graduated high school. I’m not certain, but I might have been the only one in the family with a positive net worth. Not bragging. Just had no debt so the nickels and dimes in my pocket was my edge.

Destructive financial habits are set at a young age. Learn to give yourself permission to have nice thing, a good life and financial success.

As hard as losing the farm was on me (I always thought I was going to be a farmer all my life) it was a blessing is disguise.

Rather than dig into a farming lifestyle I focused on blazing my own path. I started several businesses. We call them side hustles now. One of those businesses was preparing taxes for up to 50 people. It took seven years to realize that would be the course my life would take.

I started buying real estate. Most properties were single family homes and duplexes in the beginning. I bought larger and varied types of property as I gained my sea legs.

By 1990 I figured out I was going to be a tax guy. (What better way to keep your real estate profits than by learning the Tax Code inside and out?) 

My dad and brother joined me in a real estate partnership called LuK Enterprises. No LLC. Nothing special. Just a family general partnership. 

My tax practice that started as a side hustle preparing 48 returns per year jumped to 148 returns the first year full-time and 402 the second year. I never looked back.

A backwoods farm boy saw his net worth and income explode. My tax practice started earning real money by 1992-3. I was living the dream.

And my subconscious started to scream You don’t deserve this! 

By all outward appearances I was handling the wealth rather well. Except for an early mid-life crisis.

I bought a Z-28. It was a sporty little number. Bought it from Fox Communities Credit Union (back when they sold their repos to the public rather than ship them to auction). Sold it a year later at a profit. (As much as the car made me look cool, it was small even for me back in those day. I could barely get in and out of the driver’s seat.)

This is the part of the story where I will refrain from an info-dump. Suffice it to say, I did not feel good about myself. I felt like an imposter. Farm boys don’t end up like this.

So I sabotaged myself. And boy did I do a number. Looking back it I was lucky to come out alive.

My income stagnated for a few years while my net worth kept growing. I had a good setup and it worked while I was flipping out. Fortunately.

The worst part is I saw it coming! When I couldn’t self-destruct, I upped the ante and made it known I was off the rails. I never hurt anyone or put anyone at risk. But I certainly loaded both barrels and pulled both triggers with the barrels pointed at my feet. Toes were flying everywhere. Now you know why I limp; self-inflicted financial wounds.

It took a long time to undo the damage and in some ways never did. The good news is my tax practice eventually started growing again. I sold most of my real estate 5-10 years later, converting equity into cash. I rebuilt my life and moved on. Lesson learned? I wish it were that simple.

 

Self-Destruct

You would think once a farm boy became seasoned he would not be so prone to industrial-strength stupid. Ah, but I’m going to make you proud.

You see, I have a strong drive to learn and try things. Drake Software developed a DIY program based on the professional version used by my firm. I thought this could be a real profit generator while providing a powerful tax preparation tool for those going it alone. I got half of it right.

The software worked just fine and Drake kept improving the product. I think it is the best product on the market. Unfortunately, it is hard to get people to try your tax software when the major players are dug in deep. Even price didn’t encourage people! They gladly pay more for TurboTax when I see many of these folks in the summer when they need issues fixed their software screwed up.

I needed a hook to get people to try the product. That is when I came across a blogger called Mr. Money Mustache (MMM). 

I loved Pete’s (Mr. Money Mustache is Pete Adeney) work, especially the frugal ideas he espoused. His real claim to fame is early retirement. He dumped traditional work at age 30 and had a stint in real estate before rocketing to fame in the blogosphere. 

Retirement never interested me. There are too many things I want to do. Mix in some OCD and I’ll probably twitch in my grave, to say nothing of my behavior while alive. But for Pete the message resonated. He worked hard building his blog and his IT background gave him a serious advantage. He likes to make it look easy. Blame it on social media and cherry picking daily activities to report.

Well, I packed my bags with a plan to meet MMM and sell him on the DIY tax software idea. 

I attended a Camp Mustache outside Seattle that year. As long as I was there I figured I may as well give a presentation on some tax strategies. Pete took an instant like to me.

Pete made me his tax guy on the spot. It was time to spring my idea. He shot it down posthaste. 

Little did I know how badly the wheels fell off! It was the worst possible outcome and I had no idea what was about to hit me.

Pete published a post about my presentation on his blog, a blog with the better part of 10 million page views per month. Do you have any idea what that does to a small tax office? It nearly destroyed my business. But that isn’t where I went off the rails.

And I had no partnership with Pete on the tax software.

While still at Camp Mustache people started asking me if I had a blog. Well, ah…

I purchased the URL for this blog a few years prior with plans for what eventually came to pass. My timetable was pushed forward is all. I now needed to have a blog up and running!

With a push from an A-list blogger I was on the map. Blog traffic jumped right out of the gate.

Traffic climbed and people took notice. People knew me! A farm boy! From the backwoods of Nowhere, Wisconsin! And my brain started to plot revenge. This isn’t right.

Fame (even if only modest in scope) brings out the less desirable people of the world. Some would email or call, trying to use me as a relay to contact Pete. (Me: Call Pete yourself. Them: He doesn’t answer. Me. Then he doesn’t want to talk to you.) Others wanted to pitch me. And 20,000 people wanted me as their tax preparer!

I was a popular dude, at least from what I ever experienced prior in my life. I was getting more uncomfortable by the day. I never connected well with the FIRE (financial independence/retire early) community. I found nothing familiar about them, except for the frugality.

Pete was the father of the FIRE movement. I felt obligated to attend more gatherings and conferences. I hated it with every fiber of my being. My brain was working hard now on a way to sabotage me. 

Beat self-sabotage.

The best things in life are worth having. You are worth everything you have and more.

The zenith was at hand. This blog was nominated for a Plutus Award: The Best New Personal Finance Blog of the Year. And I won! I think a lot had to do with me being Pete’s tax guy.

But that is not where my brain loaded both barrels again. 

The night before the awards ceremony I had three late visitors to my hotel room. Remember how I told you fame, even a small amount, attracts the least desirable people in the world? Well, three showed up at my door. The worst part is I knew who they were and liked them! Not so much now. The warts are too visible to me now. There goal was to hurt me and I fully cooperated!

Without going into too much detail, I found my way to get out of the trap I felt I was in. After the awards ceremony I wrote a blog post, and boy was it a blistering attack. I pulled it down a few hours later and eventually deleted it in my files. But the damage was done. It was a terrible post, a rambling attack on all I felt slighted by. I gave new meaning to the acronym FIRE.

Blog traffic slowly declined as the FIRE community kept their distance. (Who could blame them? Even I scare me sometimes!) Now I’m working on rebuilding this blog. No more awards, no more conferences and a lot fewer emails.

Without a doubt I could have done things differently. I did not have to be an ass about it. It is easy to point finger. The thing is, I can’t control them, but I can control my behavior. 

If I wanted out I should have politely excused myself and left it at that. There was no reason to bring a blow torch into the picture. (Note: A large number of people in the FIRE community still communicate with me. They are good folks and forgave the wayward child.)

Of course, there is plenty more. Buy me a beer (or three) and I’ll tell you more than even I know. 

My stories were only to warm you up. The real reason for today’s post involves a long-term client. Her risks are no less than what I faced. Hopefully I can help her navigate the swamp better than I did. I’ll let you be the judge.

 

Rags to Riches

The year is 1992. Brenda walks into my office for the first time. (Faces and names have been changed. Brenda is aware of this post and approves.) She said two words at best. I prepared her return. As soon as she was finished she turned with a snap and left.

As the years went by I discovered she had a story that breaks the heart. She was molested by her step-father from the time she five or maybe even younger. This had a profound and negative impact on her adult life.

Brenda had no self worth. She didn’t talk because she was so abused. As a young adult she got pregnant, married the man and later divorced him. She told me she was practically forced into the marriage when she got pregnant. 

After the first failed marriage she jumped into an abusive relationship next. That marriage also failed. 

The details are too sordid to include here. Suffice it to say, she was one suffering young lady. 

Fifteen years ago, after she put her failed marriages behind her, Brenda finally met a decent man worthy of her love. Brenda took her time to get it right this time. She took years to make a commitment of marriage. She wanted a real marriage; one that lasted. (They have an awesome marriage I am proud to report.) 

Brenda was still deep in debt and lived in a $500 mobile home. Life was not good. Financial problems were crushing her. All she had was a man that loved her. Her body and spirit broken from an abusive step-father and marriage to a man no less abusive had crushed her spirit. 

Over the last 10 years she made every attempt possible to dig out of the financial hole she was in. She had a good man in her life. She now had a reason to live, to build a life worth living.

Somewhere around this time she started talking to her tax professional a bit more. Even before this blog I worked with clients on financial issues as well as tax. Brenda would be a special case, handled pro bono.

She listened hard. Much of the advice she refused to take. If it worked it would be too much too fast. I could see it on her face. Her AC kicked in below the freezing mark!

Slowly her finances improved. She got out of the mobile home and bought a “real” home. Her debt declined to a manageable level. Her retirement account was growing. She was starting to live the dream. Her credit score approached 800; it had been in the 500 range most of her life.

All the while this was happening I could see in her face she felt deep down she did not deserve a life as good as it had become. She was about to release a subconscious financial bomb, something I am all too familiar with.

The money grew; her lifestyle did as well. She now has more money than she ever had in her life. She has a good job. A good stock market meant her index funds (my advice) exploded! She was sitting on a nice stack of green.

Not an overwhelming amount, mind you. A nice stash of moolah, for sure, but not enough to go crazy.

All the pandemic craziness worked on Brenda’s mind. She wanted to get away. 

Earlier this year she informed me she was checking out.

While my flare-outs were much more entertaining (ahem!), she is doing what she knows best: running away. It is a common trait among abuse victims. She has enough money for a gap year or so, but she also has some debt. There is a bit more financial work to do before she can punch her card.

When I talked to her recently she informed me she tendered her resignation at work. She has a good job! One she actually keeps instead of switching jobs every few years. And she likes the people there; the people there like her! 

I asked her to reconsider before the two-week notice came due. She has stability in life now. She doesn’t have another job lined up and doesn’t know where she wants to go. She is scared because this kind of life is so alien to her. 

I suggested she cut her hours instead because it will not take long for her finances to start screaming for help if she takes early retirement too early. 

She can always quit later if that is her desire. My advice was to think before she leapt. 

Her employer allowed Brenda to rescind her resignation. She will be taking a shorter workweek and more days off. That makes sense to me. No bridges in flames and more time with her family. Now if she can only convince herself she deserves such a rich life.

There is no magic answer. Sometimes, when you are too close, it is hard to see the forest from the trees. We are all guilty of it. It is also the worst time to make a decision…

…without input from a third-party interested in your well-being.

The story hasn’t ended. She could easily crash and burn. She is at a dangerous time. Things have never been better for her, but deep down she is still fighting the demons of a past that tells her she is worthless. 

It is hard when you care for your clients. I hurt when they hurt. I can’t fix her or any client for that manner. She has to find her own way. All I can do is hold the lamp and hope she makes the right decision.

 

Advanced Self-Sabotage

Brenda’s and my stories have multiple lessons. But there is one more lesson. 

Self-sabotage doesn’t always take place once you have had some success. Often, we have an idea that when fleshed out has real promise. Before we ever begin our brain envisions the successful outcome. 

To prevent any overheating our brain tells us to sabotage the effort. Procrastination kills more wealth than all other dangers combined. 

There are so many ways to burn your future. The goal is to short circuit the thermostat. Life when you were a child built many of these walls. They need to come down.

You do deserve a good life, filled with financial abundance and good friends and family. Break the thermostat. Let your dreams flourish.

 

Coda

There is no other line of work for me. I make a difference. Every morning I jump out of bed ready to serve. It gives my life meaning, helping others find meaning in theirs. 

I made enough mistakes, some rather large as we just saw. Perhaps if the right person came along I would not have committed the slash and burn I did. I doubt anyone knew how deep the knife cut. I needed to open up and accept help.

Coming from the outside I can help people see the forest from the trees; provide a gentle guiding hand. I have plenty of experience, and the scars to prove it. I have no problem telling my stories, even the less flattering ones. 

The story doesn’t end here. It never really ends. Each day is a challenge to live up to our potential and convince ourselves we are worth everything we have.

 

Have you ever self-sabotaged? Of course you have. Same as Brenda and me. How did you find your way back to the light? What lessons did you learn? How did you convince yourself it was okay to be wealthy, to have life good? Are you still picking up the pieces?

Many times the conversation ends up on Facebook. Consider adding the conversation to the comments here so others that come along later have a full guide on how to avoid the self-sabotage we all plan when things go better than we feel deep down we don’t deserve.

 

 

More Wealth Building Resources

Worthy Financial offers a flat 5% on their investment. You can read my review here. 

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

7 Tools to Build Wealth After 50

There is an old joke in my office that goes like this: Everybody can retire in 15 years starting with nothing. I can prove it. Most people overspend until their birthday has a 5 in front of it. Then they panic. OMG! I have only 15 years until retirement! And then they get serious and get it done.

Of course it isn’t that simple. Many people do save early. Yet all too many suffer a diminished retirement due to financial habits in the years leading to retirement. A heavy debt load can move the starting block to negative territory, making the drive for retirement all the more challenging. 

No matter your age or financial condition, you can always improve your situation. We will focus on tools for those 50 and older in this post, but make no mistake, each tool listed here has potential for people of all ages.

Using the story above, people who get serious about retirement can reach that goal by age 35 and even younger. The FIRE (financial independence, retire early) community is a prime example of people moving the urgency of retirement from age 50 to an earlier age. Which leads us to a simple concept: Decide when you want to retire by picking the year you will get serious about planning for retirement. Start at 25, retire by 40; start at 40, retire by 55; start at 50, retire by 65; never start, never retire.

The closer you are to retirement the more important it is to make financial decisions that will keep you on course. A major financial setback in the final run to retirement can be devastating. Today we will deal with those risks and work to mitigate them.

 

1.) You Need a Budget

When I was a wee tyke I was already budgeting. It was a simple ledger listing income and expenditures. If I wanted a new Wrist Rocket slingshot I needed to save for the purchase. (This is a true story.) That required a plan.

A budget is not about deprivation! A budget is about knowing where you are financially and managing income and spending. 

A simple spreadsheet can do the trick. This is something I have used since I was in middle school. Back then I used paper and pencil. Later I graduated to Excel and similar spreadsheet software. It doesn’t have to be fancy; it just has to work! If you want bells and whistles you can try You Need a Budget. Fancy or something simple, all works as long as you start and remain consistent. 

Budgeting is more than limiting expenses in each category. A budget shows you where you are spending and this allows you to eliminate waste without any sacrifice. Sometimes you will notice an expense that is out of line and it will become a conscious choice to reduce spending in that area.

The point is budgeting gives you control of your finances. You can’t manage what you don’t understand. As much as you think you know where your money is going, there is no way to really know and manage money properly unless you can see it. That is what a budget does. It works for anyone at any age, but is vital if you are reaching the end of your working years. This frees up money so you can pay-yourself-first.

 

2.) Eliminate Debt

It is hard to enjoy retirement when you are managing debt payments. A mortgage would be bad enough, but credit cards, auto loans and student loans are things you want wiped off the slate before you enter retirement.

Remember: Paying off debt is a form of investing. It is a backward way of thinking about allocation of excess funds. Investing is straightforward. Yet, paying off debt also has a return. High interest debt is a cancer to a budget. Paying off the debt reduces the interest expense. That lowers expenses and makes budgeting a world better.

Getting into debt is easy; getting out can be a serious challenge for many. There is help. If you have reached the crisis level consider contacting the National Foundation for Credit Counseling

Most people can reduce and eliminate their debt by tracking their income and spending on a spreadsheet. Budgeting is the place to start so you can visualize your finances. This should reveal the low hanging fruit. Modest tweaks to your finances can yield a significant boost to your free cash flow

Dave Ramsey has made a career out of helping people get out of debt. His baby steps and debt snowball programs have helps thousands of people get out of debt and stay debt-free. I have witnessed many clients over the years benefit from Dave’s system. If you have debt you might want to consider looking into Dave’s programs. You can check out his books from the library if you don’t want to spend a penny. Financial Peace University is a good program. Or you can own his book The Total Money Makeover for under $12 at the time of this writing from Amazon. (Note: Many years back I was a Dave Ramsey Endorsed Local Provider in the tax field. Dave Ramsey is not an affiliate, but the Amazon link is.)

Enjoying the retired life. It can be all fun and games.

3.) Take the IRS Up on Catch-up Contributions

Once you reach age 50 the IRS allows you to supercharge your retirement savings. Congress made these rules because they stood behind me when I was working and quickly realized I was not joking when I say people get serious about retirement when the calendar stamps 50 candles on their birthday cake. 

Of course, you can start before age 50, too. You can stash away serious money with a 401(k) or other retirement program. Once you are 50 and older you can top off your annual retirement contributions with an additional $6,500 in a 401(k), 403(b), 457 or SARSEP; $3,000 for SIMPLE plans; $1,000 for traditional and Roth IRAs (these are all 2021 numbers). 

 

4.) Start a Health Savings Account (HSA) if Allowed

The HSA is one of the best financial tools in the tax code. If your health insurance is HSA qualified, be sure to contribute to an HSA savings account. Contributions are deductible. Withdrawals are tax-free if used for qualified medical expenses. You can’t use HSA funds to pay for health insurance premiums, but you can use them to pay Medicare Premiums. That means if your medical expenses are low your HSA becomes a wonderful tax-free tool as you prepare for retirement.

For 2021, you get a $1,000 contribution limit increase if you are 55 or older. 

Consider Fidelity or other low-cost investment house for managing your HSA funds.

 

5.) Consult a Tax Professional

Most people reading this are not concerned about starting their financial plan; they already started and want to manage their finances to maximize benefits while reducing taxes.

Even in retirement taxes are still a major expense. Consulting with a tax professional is a high-value investment. 

In my office I make it clear to clients I am not interested in saving them money for one tax year only. My goal is to get the lowest tax possible for all years involved combined! 

Retirement is different than your working years. The rules change and the tax code is different once you push into the traditional retirement years. You spent your entire life looking at income and the slice you will dedicate towards retirement investments.

Now you need to balance Social Security income, retirement income, tax brackets, tax credits and more. Social Security benefits can be tax-free, but it is getting harder to accomplish that. This is where a good tax pro comes in. Required Minimum Distributions play a role. Pension income and capital gains, too. Tax professionals who can navigate the moving parts are worth their weight in gold.

Steps you take today will affect your taxes in future years. I consult with many clients approaching retirement and in retirement each year. It is always a profitable consulting session for the client. The moving parts are numerous. A seasoned tax pro can help you navigate the options. Your facts and circumstances determine your optimal path. One size does not fit all.

 

6.) Insurance

Insurance is a strange animal. Each person’s situation is unique. Your health will determine the health insurance policy best for you. Some people might need life insurance, many will not. What about long-term care?

Insurance has a built in profit for the insurance company. Insurance should not be considered a good financial investment. Instead, it is a tool to help manage and protect your wealth.

As your financial resources increase you might wish to increase the deductible on your policies. Depending on the value of your vehicle, you may wish to forgo collision completely. 

Insurance gets expensive as you get older, especially health insurance. It might be a wise choice to have disability insurance or long-term care coverage. Your personal situation will determine the proper course. 

Discuss the issues with your insurance agent and then have a disinterested third-party  (someone not getting paid a commission for the sale of the insurance policies) to review the choices provided. A financially knowledgeable family member or trusted friend might be a good choice. Or, you can discuss the options provided by the insurance agent with a tax professional or attorney that is versed in these matters.

 

7.) Legal Matters

All the bad party jokes have attorneys as the butt of the joke. While attorneys get a bad rap, they are the most powerful tool out there in protecting your wealth as your nest egg grows. 

Estate planning requires a legal professional. Do you need a trust? Will? Durable Power of Attorney?

Attorneys are also trained in asset protection. When you have only a small net worth there is less to worry about. Once you build serious retirement assets you need to take steps protecting those assets. 

Finding a qualified attorney is the challenge. I use Legal Shield (not an affiliate) in my office. They can answer simple legal questions and refer you to an attorney specializing in the area of practice you need. 

 

Risks

The biggest risk is not starting or starting too late. The second biggest risk is a financial disaster as your approach your retirement date. 

You do not want a financial surprise after 50. There just isn’t enough time to recover as you get older. And who want to work forever anyway? (You might enjoy working, but you don’t want to be required to work over poor financial planning.) 

Tax planning  and legal help are vital. The key is to review each facet of your life annually once you reach 50: investments, health, tax, legal, et cetera. Several tools have been provided above. I encourage you to use them. 

Retirement isn’t out of reach. You can do this. If you are looking forward to an early retirement you can use most of the tools in this post; if you are over 50 you can lock and load on powerful programs that supercharge your net worth. 

It all boils down to a plan. With a proper plan retirement will be the blessing you dreamed it would be. 

It is never too late to start.

 

More Wealth Building Resources

Worthy Financial offers a flat 5% on their investment. You can read my review here. 

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

US Savings Bonds and Taxes

Millions of Americans own U.S. savings bonds. They are the perfect gift for a newborn and young children you want to teach habits of thrift. U.S. savings bonds also get special tax treatment and can be used as a higher education funding tool for some taxpayers. We will focus on the tax benefits of Series EE, Series HH and Series I savings bonds in this article. 

We will start with the basics of each series of bond followed by tax benefits and potential tax pitfalls surrounding savings bond ownership. A savings bond calculator is provided at the end of this post so you can find the current value of U.S. savings bonds you currently own.

 

U.S. Savings Bond Basics

Series EE Savings Bonds

Paper EE bonds were issued at a discount. Example: a $50 face value bond was purchased for $25. Paper EE savings bonds are no longer issued, but continue to accrue interest for 30 year from the issue date.

Electronic EE bonds are purchased in any amount $25 and over and are issued at face value. Example: A $50 bond is purchased for $50. Interest accrues from the face value.

Interest is tax-free at the state or local level, but taxed on the federal level. Interest is not taxable until the year redeemed.

Taxpayer can elect to pay taxes on the interest as it accrues. If the election is made it applies to all EE bonds currently owned and EE bonds purchased in the future. Accrued interest is reported the year of the election. The election must be made on a timely filed return (Rev. Rul. 55-655). The election can be revoked by attaching a statement to the return the year of revocation.

EE bond interest used to pay college tuition may be tax-free (details below under Tax Strategies).

EE bonds purchased between April 30, 1997 and May 1, 2005 earn interest at 90% of the average yields of the 5-year Treasury notes for the preceding six months. Interest accrues monthly (the value of the bond increases each month) and interest compounds semiannually. If the bond does not reach face value in 17 years a one-time adjustment is made to bring the bond’s redemption value to the face value.

EE bonds issued after April 30, 2005 earn a fixed rate of interest. The rate is outlined on the issue date and is fixed for at least 20 years. The price is guaranteed to double (reach the maturity price) in 20 years or the bond is adjusted accordingly. There is a 3-month interest penalty for bonds held less than 5 years.

If the EE bond owner dies there are two ways to report the deferred interest:

  1. Include the accrued interest on the owner’s personal tax return — called the decedent return. Beneficiaries pay tax on interest accrued after death.
  2. All the interest is taxed by the beneficiary when redeemed or, if elected, as it accrues annually.

Series HH Savings Bonds

The U.S. Treasury has discontinued issuing HH bonds after August 31, 2004. 

HH bonds:

  • Were issued at face value.
  • Paid a fixed interest rate semiannually.
  • Are subject to federal income tax.
  • Are not subject to state and local income taxes.
  • Were only issued in exchange for Series E and EE savings bonds.
  • The accrued interest from the E or EE bonds was deferred until the HH bonds matured, but
  • The interest on the HH bond itself cannot be deferred.

 

Series I Savings Bonds

Series I paper bonds come in 5 denominations ($50, $100, $200, $500, $1,000 and $5,000) and you can use your federal income tax refund to purchase them.

Electronic I bonds are available in any amount $25 and over. Purchases can be made via Treasury Direct

Are issued at face value. All interest is paid at redemption or maturity.

The interest rate contains two components:

  1. A fixed rate of interest effective for the life of the bond, and
  2. A semiannual inflation rate that is based on the Consumer Price Index for all Urban consumers (CPI-U). 

Interest is added each month and compounds semiannually. 

Once again, interest is subject to the federal income tax, but is not included in income on the state and local level. Federal income tax is due when either the bond matures or is redeemed. Cash basis taxpayers can elect to pay taxes as the interest accrues using the same rules as for Series EE bonds (where interest is taxed annually) [IRC Sec. 454(a)].

Interest used to pay college tuition may be excluded from income. See Tax Strategies below.

 

Tax Strategies

In a world of low interest rates, U.S. savings bonds can be a powerful option with tax advantages. Not only can you earn a higher rate of return on your emergency funds, but the interest is excluded from income tax on the state and local level.

You also have the option of paying the federal tax on the interest when you redeem the bond or when it matures, OR you can elect to pay as you go. Your personal tax situation will dictate which method affords the lowest tax over all years involved.

I have included two charts in this post: How Long Bonds Earn Interest and Who reports Interest on U.S. Savings Bonds.

The first chart is important because savings bonds have an interest-bearing life. No interest will accrue or be paid after the stated number of years. Interest accrued during the interest-bearing years is not lost even if the bond is held longer than the interest-bearing life term.

The second chart helps you navigate the tricky rules for who reports the income on their federal income tax return. 

If you buy a bond for a grandchild (or any other person for that matter) the interest is reportable by that person unless the bonds are not titled in their name. 

The interest from bonds bought in the name of co-owners (as bonds for children are usually purchased) is reported on the federal income tax return of the co-owner whose funds were used to purchase the bond, even if the other co-owner cashes in the bond and keeps all the proceeds. 

Gifting: Gifting a savings bond prior to maturity accelerates accrued interest. Prior unreported interest is reported in the year the bond is gifted. The bonds need to be reissued into the transferee’s name.

Charitable Contribution: If you donate a savings bond to a charity the interest accrued needs to be included in your federal income. The value of the bond is then included with your other charitable contributions on Schedule A.

Higher Education: The interest on EE and I bonds can be tax-free when used for higher education. there are some rules that need to be followed:

  • The bonds must have been purchased after 1989 by people 24 years of age or older on the first day of the month the bond was purchased.
  • The bonds redeemed must be used for undergraduate, graduate or vocational school tuition and fees (Example: lab fees) for the taxpayer, spouse or dependent.
  • Tuition must be paid in the year the savings bonds are redeemed.
  • Room and board costs and books are not eligible expenses.
  • Qualified education expenses are reduced for tax-free portions of scholarships and other forms of tax-free tuition assistance. Education credits on your tax return also might be reduced. 
  • The bonds must be in the taxpayer’s name, not the dependent (child).
  • Grandparents can only use this tax break if they can claim the grandchild on their tax return as a dependent.
  • Income limits apply. For 2021: Joint returns begin phasing out the education exclusion of U.S. savings bond interest when modified adjusted gross income (MAGI) exceeds $124,800 and is completely phased out at $154,800. Everyone else begins to phase out the exclusion when MAGI exceeds $83,200 and completely phases out at $98,200.
  • Claim the exclusion on Form 8815.
  • Compare the various strategies for tax benefits regarding education expenses. 529 plans, tax credits (American Opportunity Credit or Lifetime Learning Credit) and Coverdell ESAs all play a role. The savings bond interest exclusion is a last line of defense when prior planning has been lacking or when personal facts and circumstances recommend that course of action. 

 

You can use the savings bond calculator  below to determine the current value of paper bonds. 

U.S. Savings Bond Calculator

Log in to your Treasury Direct account for the current value of electronic bonds.

 

More Wealth Building Resources

Worthy Financial offers a flat 5% on their investment. You can read my review here. 

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

Minimize Taxes on Day Trading Profits

The risks associated with day trading extend beyond the actual investment. Before the trade is placed consideration needs to be given to the tax implications. 

Profits and losses for day traders can be taxed under the rules for an investor, trader, mark-to-market trader or dealer. There are pros and cons to each method.

Facts and circumstances prevail. Yet, the rules are not always clear. 

 

Investor vs. Trader

The factors you need to consider when determining if you are a trader or investor, include:

  1. Holding period.
  2. Frequency of trades and dollar amount of those trades.
  3. Does the taxpayer pursue the activity as a livelihood?
  4. Time devoted to the activity.

On the surface this may sound straight forward, but as Endicott vs Commissioner, TC Memo 2013-199 shows, it is not.

Endicott used a strategy of selling covered calls. He did not trade every day and usually allowed the options to expire.

Most people would consider Endicott an active trader. He had 204 trades in 2006 and 303 trades in 2007. The court concluded this was not substantial trading. However, in 2008, Endicott made 1,543 trades, which the court said was substantial.

Endicott had purchases and sales of around $7 million in 2006; nearly $15 million in 2007; and about $16 million in 2008. The court agreed these were all substantial amounts. But the court couldn’t keep it simple. They went on to say “managing a large amount of money is not conclusive as to whether a petitioner’s trading activity amounted to a trade or business.” The court is saying large amounts of money being traded is not enough. This is why tax professionals say “facts and circumstances” so often.

You can use this chart to help you make a determination for your situation.

Characteristics of Traders and Investors

 

Cryptocurrencies

Remember, these rules apply to taxpayers who buy and sell securities or commodities only. These rules do not apply to cryptocurrencies. The IRS considers all crypto as property. The SEC clearly states wash sale rules only apply to securities.  This means wash sale rules do not apply to crypto. Significant tax-loss harvesting is possible as a result.

 

Tax Implications for Investors, Day Traders, MTM Traders and Dealers

The chart at the end of this post provides a guide on how taxes apply to investors versus day traders. The advantage of being a trader is the deductibility of margin interest and other business related expenses on Schedule C. Both investors and traders still face the capital loss limits, but traders get the additional deductions of related expenses and margin interest. (Long-term capital gains are taxed preferentially. As a trader, all the LTCGs get the favorable treatment while expenses can be deducted against other income, usually taxed at ordinary rates.)

(The capital loss limit allows the taxpayer to deduct losses of up to $3,000 ($1,500 if married filing separately) against other income.)

To avoid the capital loss limits you can elect to be a mark-to-market trader. Wash sale rules also do not apply to to MTM traders.

Dealers are required to follow MTM rules. (Dealers have a place of business where they engage in the buying and selling of securities for customers. )

A trader can elect to use mark-to-market rules [IRC Sec. 475(f)]. Most tax software has an elections page where you can check a box and the election is automatically populated.

Mark-to-market rules:

  1. All securities gains and losses are treated as ordinary income or loss.
  2. Securities held at the end of the tax year are deemed sold at FMV.
  3. Basis of securities deemed sold at year-end are adjusted accordingly.

The biggest advantage of making the MTM election is to avoid the wash sale rules and to sidestep the capital loss limitations.

The MTM election can be revoked, but you must wait at least 5 years before you can elect again. Since the mark-to-market election has limits, you need to consider the election carefully.

Other issues to consider if you are thinking of making the MTM election:

  1. The MTM election must be made on a timely filed original return, without consideration for extensions, for the taxable year immediately preceding the election year. 
  2. You can attach the election to a timely filed extension.
  3. You also must attach Form 3115 (Change of Accounting Method) if you do not make the election in your first year as a trader (Rev. Proc. 2019-43).

Investors, traders and MTM traders do not pay SE tax and earnings cannot be used to fund IRA/SEP contributions. However, a dealer does pay SE tax and can use gains for IRA/SEP contributions.

Taxing Individuals Who Buy and Sell Securities

 

As you can see, this isn’t the easiest area of tax code to navigate. I strongly recommend you consult with a competent and qualified tax professional when dealing with the trader/investor classification and before you make the MTM election.

May all your trades be profitable.

 

More Wealth Building Resources

Worthy Financial offers a flat 5% on their investment. You can read my review here. 

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.