Blood is a Big Expense – But So are Taxes
If I asked you what your biggest expense is for your business you would probably say people or products. But what about for you personally? For most successful business owners, taxes are probably your biggest expense, unless you are actively planning and working to reduce or eliminate your taxes.
This is true for your income but also for your wealth as you build more valuable businesses and even if you are squirreling money away in tax deferred vehicles like 401Ks and IRAs. As it relates to your wealth, while you may not be paying taxes each year, you may be growing a huge future tax liability.
There are four basic ways to hold and build your wealth from a tax perspective:
- Cash or Cash Equivalents
- Taxable Investments
- Tax Deferred Investments
- Tax Free Investments
For most business owners, their business assets would fall into the Taxable Investment category. The most underutilized strategy to hold and build wealth is as a tax free investment.
Other than for the most civic minded of you, maximizing your tax free assets makes the most sense particularly as it relates to your wealth. I understand one of the beauties of our humanity is we don’t need to be logical, however, developing Tax Free Strategies can help you get more benefit with little extra effort from the wealth you have developed as a business owner.
Before you can benefit from Tax Free Strategies, you need to position your assets in a tax free vehicle: either a Roth 401K or a Roth IRA. The two basic positioning strategies are Contributions and Conversions.
On an Annual basis everyone can contribute up to $18,000 after tax dollars in a Roth 401K provided that you make at least $18,000. Additionally for those of you over 50, you can contribute up to $24,000 after tax dollars into a Roth 401K. Plus your employer (you if it is a single owner company) can also contribute up to 25% of your earned income each year up to a combined $53,000 combined between your contributions and your employers contributions. There are some special calculation rules for single owner companies so your maximum number may be lower depending on how much you make. For more information, see https://www.irs.gov/Retirement-Plans/One-Participant-401(k)-Plans
Another bonus for those of us over 50, we can contribute $6500 per year and the rest of you under 50 can contribute $5500 per year after tax dollars into a Roth IRA. By combining these strategies over a four to five year period you can position over $100,000 to be used for your Tax Free Strategies and even more for your Tax Deferred Strategies.
If you don’t meet the income limits for direct contribution to a Roth IRA, you can contribute these amounts to a traditional IRA with after tax dollars and build up your basis in this strategy. You can then convert your traditional IRA into a Roth IRA at a later date.
There is currently no restriction on converting tax deferred assets into tax free assets. The reason is that this conversion is a taxable event to the extent that your converted assets exceed your basis in the tax deferred assets. If you have been building up tax deferred assets with after tax dollars, there is not tax on what you have contributed – only on the gains that you have made in the meantime.
Once you have your wealth positioned in a tax free basis you can start developing your Tax Free Strategies. I understand that there are many analyses that demonstrate if you use a passive, low-yield strategy used by traditional financial services you will net out about the same amount. But our goal as business owners is not to use Tax Free assets in passive, low-yield strategies but in finding high yield wealth and income strategies
Our next post will outline some high-yield, Tax Free Strategies.