Ways of Avoiding Taxation?

[raptix]

So you understand the nature of government, inflation, the fed, and a few other variables: yet you stare in wonder at fellow Objectivists who have implemented their plans to avoid tax when they opine "when my books balance I end up paying minimal taxes, almost zero'. When I hear another person say something like that I think "I wonder how he did it" and I presume some others reading this may also be in this camp.

The purpose of this thread is to help Enlighten myself (primarily) and others (secondarily, as this information is exoteric and not a confidential session between me and an Objectivist financial planner) as to the methods people use to claim their stolen funds back from the system legally as well as provide information pertaining to avoiding tax in the first place. You will benefit from participation in this thread in that other similar minded people will probably explain how they avoid tax, and possibly post a method you've never thought of, and then you could use that method to piss off your government

This is about minimizing tax, our goal is the closest to $0 in taxes as we can get, this thread is not about consuming more than one produces.

At 18 years of age I personally have little knowledge of the available monetary claims from the welfare state whilst employed (in my case through Australias centralized jobless claim/welfare agency 'centerlink') -- I've never been unemployed and probably never will be, my understanding is that its generally only legitimate (from the governments perspective) to claim benefits, as in monetary assitance; when you're unemployed, such as a jobless claim.

I hear some Objectivists citing that they receive Rent Assistance and have setup shelf companies in which they make sure they get payed just below X (a poverty line?) from that company so as an individual they are able to claim benefits (rent assitance and others I personally don't know of..) thus receiving more income, and having the business (who they are the only employees) pay for trips overseas etc (under the guise of liasoning etc) these people are getting the government back for expropriating their produce (that just happens to be in the form of the company, rather than individual net worth).

Most countries have this individual>company tax avoidance setup and I consider most modern welfare states as similar, I'm Australian, and you could be sure most of the tips an American would give me (such as instructing me on how to obtain rent assistance whilst employed) applies to me (as we have rent assistance as well).

What I'm trying to convey is that in explaining how you, as an Objectivist, try to get as much of that stolen money back, be mindful to point out a welfare benefit you get in your country and know doesn't exist in another countries system, other than that -- everythings quite similar -- the methods of avoiding tax (and getting your stolen money back) are virtually the same.

As you can see I only know of Rent Assitance, this really demonstrates my lack of knowledge, hopefully once this discussion gets moving I'll know of many ways to receive monetary benefits from the welfare system.

I also have an off topic question for anyone willing to quote and give their answer.

Say you earn $20,000 (in X country) in a Financial year, and since the beginning of the financial year (say you earnt $500 the first week) the Government was taking $60~ or whatever the figure was every week from your pay.

So on the last day of the Financial year your last payslip says Net Deductions for Year "$2,500" (this is how much you've paid in in taxes).

Yet after you do your Tax Return you only end up paying $100 in taxes and $2,400 is returned to you.

What about the loss of buying power during the financial year?

What about the extra float the government has in real money terms when they have thousands of your dollars?

My Off-topic Question is this: Assuming it was the first year you've ever payed taxes, when you consume (claiming money back) are you consuming more than you produce if you utilize/claim $2,500 in any form of welfare or should you only be consuming $100?

Edited July 5, 2006 by raptix

[softwareNerd]

The Objectivists I know have never boasted about paying zero-taxes, so it's difficult to say for sure. However, most such tax-avoidance schemes are implemented by people who run a small (often single-person) business. Broadly, the methodology consists of

• being able to prove that the business is spending a lot of money on all sorts of expenses and has almost no profit left, and is paying you very little in salary
  
• being able to hide business revenue -- e.g. by taking cash from customers and not declaring it
  

Firstly, these schemes probably require illegal actions.

Secondly, such schemes typically do not scale upward and cannot be applied to all professions (and rarely to salaried jobs). From a monetary point of view, it's better to focus on earning more and paying more taxes, as long as one is still earning more net of taxes.

(Edited for grammar; thx CF. - sN)

Edited July 5, 2006 by softwareNerd

[aequalsa]

[*]being able to prove that the business is spending a lot of money on all sorts of expenses and has almost no profit left, and is paying you very little in salary

Firstly, these schemes are probably require illegal.

This one, assuming that they are real expenses is not illegal.

There are certainly a number of loopholes that can lesson the the amount you pay, but anyone who says they pay no taxes is either lying, not making any money, or doing something illegal.

One example is with regard to capital gains tax(in the US). If you buy stocks and they increase in value before you sell them you have to pay capital gains on the increased amount of %33. If you do not sell the stock, but rather hold onto it for 10,20, or 50 years you do not pay tax on any of that increase until you sell it, which means you can earn the increase in value on the whole of it for all of that time.

Another related way is to put as much as you can in a 401k if your company offers one or a roth IRA on your own. That money is taken out before taxes are assessed, and will therefore reduce your liability on that % of your money.

Again, this applies to the US, and as complicated as tax law is here, you would probably do best to speak to an accountant in your area who would certainly be more knowledgable about the laws and less likely to get you into trouble. However, this will hopefully give you an idea as to what sorts of things you should find that would be legitimate ways of reducing(notice I said reducing and not eliminating) your tax liability. If something sounds to good to be true it probably is.

[raptix]

I'll just like to add my own Tax Avoidance ways, which will materialize either this or next financial year, depending on my readyness to trade the Financial Markets with real cash. Although I do not know much about claiming assistance out of the welfare system, I have done lots of research on the feasibility of Incorporating a company offshore rather than initially trading as an Individual, incurring Individual income taxes and CGT.

Just a 2 hour flight off the East coast of Australia where I live (Brisbane) the Pacific island of Vanuatu has:

* No personal income taxes

* No corporate income taxes

* No capital gains taxes

* No withholding taxes

* No estate or death duties

* No exchange treaties

* No exchange control

* Extensive confidentiality provisions

* Full international banking, insurance and other professional services

* Excellent communications

It costs roughly $800-$1000 to incorporate an International company in Vanuatu.

It is illegal in Vanuatu to give foreign law enforcement account information, furthermore the only real tax a tourist is subjected to is a VAT (sales kind of tax) of around 10%: I'm yet to discover whether foreigners can claim this tax back if they've got permanent residency/solid visa (I personally don't worry about this which ever way it goes).

If you do business in Vanuatu your corporation will be taxed, however a foreigner doing business offshore is subjected to virtually no taxes.

I'm doing further research into fund transfers into Australia (offshore credit card and under $10,000 bank transfers into Australia [so AUSTRAC (anti-money-laundering) doesn't notice]) and whether we've got wealth taxes/any side effects of my legalized money laundering.

I like Vanuatu alot, and when I'm rich I'll look at Bermuda.

I'm going to holiday there to find all this out, as the flights only something like US$500 return and all the hotels are cheap, not to mention if I ever buy/hack my residency (as it becomes a technicality) the property prices there are cheap, USD$250,000 for a 2 bedroom shack with 1 hectare of awesome beachside land, US$100,000 for a two bedroom brick house with a view akin to that of sitting on the North side of Sydney harbor (just in Vanuatu) in the middle of the capital.

Right now my demo trading (being paper trading on the FX market for months now) yields 20% losses and 90% wins a month by average, not to mention the amount of leverage available through an FX brokers credit lines when I trade real currency -- so my future looks bright (and I'm looking forward to visiting Vanuatu).

Again, this applies to the US, and as complicated as tax law is here, you would probably do best to speak to an accountant in your area who would certainly be more knowledgable about the laws and less likely to get you into trouble. However, this will hopefully give you an idea as to what sorts of things you should find that would be legitimate ways of reducing(notice I said reducing and not eliminating) your tax liability. If something sounds to good to be true it probably is.

I've spoken to an accountant over (before I thought about doing things offshore) whether the expenses would be greater or lesser if I were to begin a trading company run it at a loss (and do some legal tricks so I eventually end up paying less tax, like differing tax payments, running my life through the business, paying myself very little, etc) in contrast to trading Individually -- he said in Australia the expenses outweigh the benefits opining "especially since I'm $120 an hour, ahaha" -- and I left after 5minutes of discussion and no consultation fee

Edited July 5, 2006 by raptix

[aequalsa]

I've spoken to an accountant over (before I thought about doing things offshore) whether the expenses would be greater or lesser if I were to begin a trading company run it at a loss (and do some legal tricks so I eventually end up paying less tax, like differing tax payments, running my life through the business, paying myself very little, etc) in contrast to trading Individually -- he said in Australia the expenses outweigh the benefits opining "especially since I'm $120 an hour, ahaha" -- and I left after 5minutes of discussion and no consultation fee

Maybe we have an excess accountants here. I have a pretty good one who charges $400 for corporate taxes and $200 for personal. There is more expense if you have him do monthly bookkeeping and payroll, but it is all pretty reasonable. I gather that they farm most of the work out to assistants who are not cpa's so as to lesson costs. Yours may have been overpriced/high end or just not expecting an ongoing relationship. If he was used to working with bigger clients or whatever. I would be surprised if he was typical.

[Capitalism Forever]

Firstly, these schemes are probably require illegal.

Your grammar are probably require incorrect.

There are solutions that are unquestionably legal; there are ones that are unquestionably illegal; and there are ones (the majority) where it depends on how you interpret the law. While there is a lot of vagueness and uncertaintly involved with all tax and business law, you can be sure of two things:

• The government will not be satisfied with the amount of tax you pay.
  
• Except for the most unquestionably legal situations, the government will see what you do as illegal if that's how it wants to see it.
  

Even in the perfectly legal cases, the government will often apply intimidation tactics and threaten you with legal action in the hope of extracting a settlement from you.

What is the right way to respond to this? To be "a good citizen" and pay whatever the government demands, just like a "good" cartoonist would apply whatever amount of self-censorship the Islamists require? Definitely not. You should realize that other people are trying to minimize their taxes too, and that the government is powerless against large groups of taxpayers. So the question to ask is not "Is this legal?" because that's a question the law's authors have left up to the IRS to answer. The question to ask is: "Will this raise a red flag with the IRS?"

We do not live under objective law, and we cannot afford to act as if we did. The United States is a mixed economy, consisting of about 75% pure freedom and 25% pure tyranny. When you deal with the IRS, you are dealing with the pure tyranny. It's as if a kidnapper held you captive 6 hours a day and left you free the rest of the time. How do you deal with a kidnapper? You try to get away with as much as you can while keeping him happy enough to make sure he doesn't pull the trigger.

Edited July 5, 2006 by Capitalism Forever

[bobsponge]

It's become very tough to avoid taxes in the USA, but one of the best loopholes they still allow (because all the congressmen are doing it) is: VUL (Variable Universal Life) insurance policies. Basically, it allows your company to pay you this benefit (you have to add it as a bonus to your personal income tax), which is a tax writeoff for the company but a bonus to you the individual. You can only put in so much per year (I think it's about $2500 per month). So far it sounds bad but here's where it turns good--

It works just like a 401K, where you allocate the funds inside to go towards whatever investment packages you like. Funds inside compound upon themselves (around 10% healthy rate currently). You can take out any amount you like as a return of premium, tax free, so long as you maintain a balance large enough to pay your monthly premium. You can also take out a loan on the balance at 0% interest if you want.

Money taken out of the policy is not taxed, because it is a 'return of premium'.

The premium costs per month are trivial if you keep a decent balance inside-- the compounding interest will pay the premium off. Even if the premium is not paying itself, you are saving money because the business writes off a benefit expense, and your tax liability decreases by leaps and bounds. And you launder your money through a 100% legal loophole. Congress tested, IRS approved

And, if you kick the bucket, your beneficiaries get a million bucks.

-J (lowering my taxes while staying legal has become a fargin' fulltime job!)

[raptix]

We do not live under objective law, and we cannot afford to act as if we did. The United States is a mixed economy, consisting of about 75% pure freedom and 25% pure tyranny. When you deal with the IRS, you are dealing with the pure tyranny. It's as if a kidnapper held you captive 6 hours a day and left you free the rest of the time. How do you deal with a kidnapper? You try to get away with as much as you can while keeping him happy enough to make sure he doesn't pull the trigger.

Very very well articulated.

Food for thought, I learn't something, thank you for the trigger analogy.

In regards to my interests in Vanuatu, I'm trying to find out as much as possible about safe and secure offshore money handling, do you have any practical advice as to how I'd achieve complete verification and assurance that 'what I'm doing won't ring alarm bells'?

For example, if you were looking to do business in Vanuatu, play the Financial markets, have the broker deposit funds to XYZ corp in Vanuatu, move the funds from that account to Australia, have it not ring alarm bells, etc, where would you look for complete assurance so that you feel safe to do such transfers? Would you waste your life reading 10,000 pages of some random tax code? Specifically, what would you look at/any tips?

[Toolboxnj]

It's become very tough to avoid taxes in the USA, but one of the best loopholes they still allow (because all the congressmen are doing it) is: VUL (Variable Universal Life) insurance policies.

Well, not quite. From my understanding this loophole was closed in the late 80s and that only grandfathered VULs of this kind exist. Today you need to pass the 7-year test or else it becomes a modified endowment fund that can adversly affect your taxes. Some broker-dealers have VULs that just barely skeek under the test, but they aren't benefitual because of all the costs and penalties you can pay.

From my experience, just max out your tax-deferred vehicles (401k, 403b, IRA) and you should be better off than a VUL. Agents love to sell the VUL, WL and annuities because they get a monster commissions for selling them.

Edited July 5, 2006 by Toolboxnj

[Capitalism Forever]

where would you look for complete assurance so that you feel safe to do such transfers? Would you waste your life reading 10,000 pages of some random tax code?

Of course not. The tax authorities don't read those either!

Unfortunately, there is no complete assurance, as the tax laws and the tax authorities' "areas of interest" change year by year, and differently in each jurisdiction, so what works this year might not work next year. But it helps a lot to seek advice from tax consultancies that specialize on international tax planning. These are companies whose profitability depends on providing people with just the kind of information you need. I know a good firm in Hungary, but I think you'll prefer to ask your friends if they know one in Australia.

This is how I would proceed:

• Contact a tax consultancy and ask them what they think is the best solution in my particular situation
  
• Do some Internet research regarding the proposed solution. While Internet sources cannot usually be trusted to confirm that a given solution works, they can still be useful to find out about potential pitfalls, plans by governments to "close the loophole," and so on.
  
• Get a second opinion from another tax consultant
  
• Talk to acquaintances who have experience with the tax authority in question
  
• Draw a conclusion from all the above
  

At least in my country, many of the local offshore-incorporation firms are rumored to be stooges of the Hungarian tax authority, so I would definitely:

• Prefer the one endorsed by my friends
  
• Not disclose sensitive information until I get to know them well
  
• Not compare the tax authority to the Nazis during our initial conversation
  

For example, if you were looking to do business in Vanuatu, play the Financial markets, have the broker deposit funds to XYZ corp in Vanuatu, move the funds from that account to Australia

The solution for my colleagues who were in a similar situation was to incorporate offshore and do everything through the offshore company--the trading and the subsequent spending of the profits. The offshore company can have a subsidiary in Hungary, which can own things like real estate and cars. I suppose it might work analogously with Australia; they key question to answer is how much your tax office will mess with a company that has a funky car, little or no profits, and a shareholder from Vanuatu.

[Mercurus]

Well, not quite. From my understanding this loophole was closed in the late 80s and that only grandfathered VULs of this kind exist. Today you need to pass the 7-year test or else it becomes a modified endowment fund that can adversly affect your taxes. Some broker-dealers have VULs that just barely skeek under the test, but they aren't benefitual because of all the costs and penalties you can pay.

From my experience, just max out your tax-deferred vehicles (401k, 403b, IRA) and you should be better off than a VUL. Agents love to sell the VUL, WL and annuities because they get a monster commissions for selling them.

If your earnings and/or assets are such that you're considering VUL's - and you do your due diligence - the 7-pay test should not be a big concern. A VUL or any financial instrument that shields asset accumulation and distribution from taxation should be looked at very, very seriously.

The biggest problem I've seen with ANY sheltered investment scheme is lack of diversification. Most provide a multitude of choices for investments in stocks, bonds and money market instruments...but when it comes to hard assets or derivatives of hard assets, few offer the choice. I'd advise that whatever a person considers, make sure you have the option to invest in all asset classes...equity, debt and precious metals.

The companies I own controlling shares of have successfully accomplished near zero federal income taxes two out of the past four years. The best way I've found to accomplish this is to make sure we pay for as much as possible out of our company pocket rather than our personal pocket. There is no hope of EVER accomplishing zero total taxes as Washington State has a gross receipts tax, sales tax, use tax, unemployment tax, blah, blah, blah. There are also federal payroll taxes (SSI, FICA, etc.) and capital gains taxes that I haven't found efficient ways to avoid. My role in the company is to divert enough resources into as many tax free or nontaxable assets as possible without attracting the wrong kind of attention...which is just about the most inefficient use of my time (which, you could argue, is itself a tax).

I'm with Capitalism Forever: consider your options using the "no red flag" standard, forget complying with the law...its impossible. And if you ever get audited, recognize that you have a gun to your head.

Edited August 11, 2006 by Mercurus

[prosperity]

From my experience, just max out your tax-deferred vehicles (401k, 403b, IRA) and you should be better off than a VUL. Agents love to sell the VUL, WL and annuities because they get a monster commissions for selling them.

This is something that most financial planners tell you to do. It's become something of an undigested slogan. The best way to accumulate wealth is still by using private contracts without Government help or favors like 401(k)s, IRAs, etc.

In fact, to test that theory, I recently ran the numbers taking into account current tax assumptions (because, I am operating on the assumption that the best case scenario is that marginal tax rates remain the same for the next 30 years).

IF, and this is a big if, IF the life insurance policy is funded so that a minimum amount of death benefit is purchased and maximum paid up additions is purchased (or in the case of a UL the contract is set to "minimum death benefit, maximum cash value"), the whole life or universal life should outperform the qualified retirement account in almost every scenario where the individual has a combined (State and Federal) marginal tax rate of 25% or more. At 15% marginal tax rate, the insurance and 401(k) are about even in net income with the difference being the insurance policy has a death benefit too.

The assumption I used was for a mutual life insurer's dividend paying whole life. The dividend rates rarely dip below 7%, and in some cases, they've never dipped below 7% in the 150 years the company has been paying dividends. That's not a guarantee, of course, but the assumption is that they know how to run a decent business and produce consistent returns for their policy holders.

The mutual funds that 401(k)s invest in, however, according to DALBARinc show that the average investor earns less than 5%...still, even with a 7% after fees in the 401(k) and 7% illustrated rate in the whole life policy (which is usually before fees), the life insurance policy does much better assuming the above tax implications.

The second issue is that of frictional costs. The investments in a 401(k) endure a consistent fee for the life of the investment, whereas the life insurance policy (whole life) guarantees that the contract will become more efficient over time, thus reducing frictional costs.

These two components offer probably the greatest advantages. A third could be a life insurance policy's non-direct recognition loan offering. You just can't do that kind of thing with any investment.

That being said, I think whole life insurance properly belongs under the category of "savings", not "investment".

I'm with Capitalism Forever: consider your options using the "no red flag" standard, forget complying with the law...its impossible. And if you ever get audited, recognize that you have a gun to your head.

The magic word(s) for business owners is "executive bonus plan". Or "double bonus plan". It takes a while to get to a point where your taxes will consistently be zero but I think it's worth it.

[brian0918]

IF, and this is a big if, IF the life insurance policy is funded so that a minimum amount of death benefit is purchased and maximum paid up additions is purchased (or in the case of a UL the contract is set to "minimum death benefit, maximum cash value"), the whole life or universal life should outperform the qualified retirement account in almost every scenario where the individual has a combined (State and Federal) marginal tax rate of 25% or more. At 15% marginal tax rate, the insurance and 401(k) are about even in net income with the difference being the insurance policy has a death benefit too.

Interesting. I'm getting my first retirement investment from my company this year (equivalent to 25% of salary I believe), and I am supposed to be able to choose how it is invested - by default it's just handed over to Morgan Stanley and they do with it as they please, I guess. I am supposed to sit down and talk with the company's accountant sometime soon about this. Is cash value insurance a possibility I could/should consider talking to him about?

(I am clueless when it comes to savings/investment, so I wouldn't be surprised if my question doesn't even make sense )

Edited December 26, 2008 by brian0918

[softwareNerd]

IF, and this is a big if, IF the life insurance policy is funded so that a minimum amount of death benefit is purchased and maximum paid up additions is purchased (or in the case of a UL the contract is set to "minimum death benefit, maximum cash value"), the whole life or universal life should outperform the qualified retirement account in almost every scenario where the individual has a combined (State and Federal) marginal tax rate of 25% or more. At 15% marginal tax rate, the insurance and 401(k) are about even in net income with the difference being the insurance policy has a death benefit too.

What pre-tax annual rate of return did you assume on the 401(k)? The main reason advisers recommend 401(k) plans is that they are comparing them against a stock+bond portfolio that is taxable. The major assumption underlying this is that a stock+bond portfolio will return more than an insurance policy (which appears to have a CD-like return). Are you challenging this underlying assumption? Edited December 26, 2008 by softwareNerd

[gags]

Interesting. I'm getting my first retirement investment from my company this year (equivalent to 25% of salary I believe), and I am supposed to be able to choose how it is invested - by default it's just handed over to Morgan Stanley and they do with it as they please, I guess. I am supposed to sit down and talk with the company's accountant sometime soon about this. Is cash value insurance a possibility I could/should consider talking to him about?

Of course you should ask, but I would be very surprised if that is an option. You probably have the choice of a few different MS funds to pick and that's the extent of your "choice".

[Juxtys]

I live in Lithuania, and businessmen avoid taxes by:

*reusing tickets or not giving them at all(bus, taxi drivers);

*not printing cheques(bar, restaurant, club owners);

*making a company, taking loans in it's name and dissapearing. later, someone known to you opens another company and buys everything remaining of that bankrupt company at a much lower price.

[SD26]

Ah, taxes. Well, the heart of the matter is pretty broad. Taxes are levied in many ways and forms. Fuels are taxed. It's inside the retail cost. When I travel, I usually get a "gasoline temperature map" so that I recognize what my costs/benefits are going from state to state. Often, the cost of fuels are related to two specific things: state and/or local taxes and special fuel blends. As an example, I don't fuel up in Chicago as they have a special refomulated fuel blend and local taxes above and beyond federal and Illinois state taxes.

Does anyone have a favorite charity? I give a pretty good amount to a couple of pediatric cancer programs. Their administrative loads are low so the money really does go toward research and scholarships for pediatric cancer survivors. That money is an expense for my corporation, reducing my overall taxable profit, but it also counts on my personal income tax return as a charitable contribution, reducing out tax load. I would prefer not to be taxed, but giving to a charitable program can allow one some kind of freedome to direct your earnings toward something of personal value rather than public or social good.

Cash works well if both sides can do so. Company to company operations make things harder in cash as one might have real accountability for that cash while the other does not.

As a company, certainly, keeping records of all your actual expenses can help. It's good for recognizing what you really do and spend to accomplish your task of business, and it can help increase your accountability for expenses/cost of goods sold against taxing "authorities".

Additionally, if you put money into your business, pay yourself back. It's not income.

There was a post before me about the cost of an accountant, and I'll agree with those numbers. It's money better spend in the hands of my accountant doing actual work for me vs going to the public good.

[prosperity]

What pre-tax annual rate of return did you assume on the 401(k)? The main reason advisers recommend 401(k) plans is that they are comparing them against a stock+bond portfolio that is taxable. The major assumption underlying this is that a stock+bond portfolio will return more than an insurance policy (which appears to have a CD-like return). Are you challenging this underlying assumption?

From my post above:

The mutual funds that 401(k)s invest in, however, according to DALBARinc show that the average investor earns less than 5%...still, even with a 7% after fees in the 401(k) and 7% illustrated rate in the whole life policy (which is usually before fees), the life insurance policy does much better assuming the above tax implications.

Yes, I am challenging that assumption if you are putting the money with a mutual life insurance company and it's a dividend paying whole life policy that is funded up to MEC guidelines. The dividend rates, which are not guaranteed, demonstrate that these companies are fairly well run, and well run for the last 100 to 150 years...think the Guardian, Mass Mutual, Mutual Trust Life, NY Life. None of those companies have had to pay their guaranteed rate ever in some cases and in others for most of their operation.

...the guaranteed rate though, like you said, is more like a CD rate. Typically, 2-3%, though on the mutual insurers, it's more like 4-5%.

...then again, I'm not advocating all of one's money in these...just a good percent. Instead of trying to make 100% of your money earn 10% or more I go at it from the perspective of getting 80-90% of your money to earn 6-7% and then the remaining 10-20% earning 50% or more. About the same return...much less risk.

Interesting. I'm getting my first retirement investment from my company this year (equivalent to 25% of salary I believe), and I am supposed to be able to choose how it is invested - by default it's just handed over to Morgan Stanley and they do with it as they please, I guess. I am supposed to sit down and talk with the company's accountant sometime soon about this. Is cash value insurance a possibility I could/should consider talking to him about?

(I am clueless when it comes to savings/investment, so I wouldn't be surprised if my question doesn't even make sense )

[soapbox]

I'm not a big fan of qualified plans. ...keep in mind that these were created as a direct response to the onerous tax rates in the 70's...you are basically saving by permission. Probably the most irritating (at least in my view) is that even if you get beyond the taxes in the traditional qualified plans, the Government has made it a habit to change the rules on qualified plans. In the 90's you were discouraged (through caps and excise taxes) from accumulating to much money and from contributing too much...now you are just discouraged from saving too much...

[/soapbox]

But in response to your question:

Cash value insurance is probably not an option. And, inside of a Government sponsored plan, it's not something I would ever do anyway, even if the life insurance company offered it (and some do). The lure of Government plans is the tax deferral. The trap is that it is simply delaying your tax liability.

I wrote an article about it (in my sig) and have a few other ideas concerning qualified plans. In plain English it works like this: If you plan to do well in your 401(k), you are guaranteeing a bigger tax bill (unless the tax code gets thrown out when you are ready to get at that money). Also, most of the time - and definitely if you are not getting a match, you will pay back more money in taxes than you actually saved...usually within 7-10 years, sometimes less. If you don't plan on doing well, don't worry about the taxes, but you will have to worry about what you're going to live on if you need your savings.

Of course the alternative is the Roth or Roth 401(k)...but at that point, you are getting the same tax advantages as a life insurance policy except the life insurance is a private contract, has no caps, mandates on withdrawals, or restrictions on the use of the money.

If you do consider the insurance option, I'd educate yourself as most advisors either aren't familiar with how to use them for cash accumulation or would rather just forgo the concept of savings and use all investments instead.

[softwareNerd]

From my post above:

The mutual funds that 401(k)s invest in, however, according to DALBARinc show that the average investor earns less than 5%...still, even with a 7% after fees in the 401(k) and 7% illustrated rate in the whole life policy (which is usually before fees), the life insurance policy does much better assuming the above tax implications.

Sorry, I missed that. So, you're comparing a 401(k)/IRA with a 7% return (after fees) against an insurance policy with a 7% return (before fees). Is that correct?

What is the 4-5% you mention? Is that the net return on the policy after fees have been accounted for? In other words, is it a comparison of 7% net from a 401(k) mutual fund versus a 4-5% net from an insurance policy?

Another question, how does the insurance calc work in adding in the benefit that comes from having insurance coverage? For instance, if I'm paying (say) $1000 for a policy, then a part of it is buying me the benefit of true insurance, and the balance is like "pure" savings. Is only the "pure" savings component (say, total premium minus the amount that would be required to buy term insurance) treated as an outflow?

And, if you're willing, another question: Would it follow that an insurance policy is even better when compared against a non tax-preferred account: like a mutual fund outside a 401(k), or a regular taxable brokerage account where one is trading stocks/bonds etc. ?

[JMeganSnow]

Personally, I'd rather pay the standard taxes if I could find a good way NOT TO BE AUDITED AND HAVE TO FILL OUT MIND-BOGGLING FORMS OF DOOM. It is MUCH more valuable, to me, to avoid dealing with and drawing the attention of government officials than to save a few bucks.

[EC]

The three ways I do it. 1) If you do legitimate work--do it under the table. 2) Online poker. 3) Street-level pharmacutical sales.

[prosperity]

Sorry, I missed that. So, you're comparing a 401(k)/IRA with a 7% return (after fees) against an insurance policy with a 7% return (before fees). Is that correct?

What is the 4-5% you mention? Is that the net return on the policy after fees have been accounted for? In other words, is it a comparison of 7% net from a 401(k) mutual fund versus a 4-5% net from an insurance policy?

Another question, how does the insurance calc work in adding in the benefit that comes from having insurance coverage? For instance, if I'm paying (say) $1000 for a policy, then a part of it is buying me the benefit of true insurance, and the balance is like "pure" savings. Is only the "pure" savings component (say, total premium minus the amount that would be required to buy term insurance) treated as an outflow?

And, if you're willing, another question: Would it follow that an insurance policy is even better when compared against a non tax-preferred account: like a mutual fund outside a 401(k), or a regular taxable brokerage account where one is trading stocks/bonds etc. ?

I'll try to give as best an answer as I can to your questions. Please keep in mind that these are conditional answers (obviously noted as such by the word "if").

I'm working on an objective theory of financial planning, but it's not complete yet so I'd hesitate to go too far into details about what role these contracts play in one's comprehensive planning...other than to say that in practice, I know that the 80/20 and 90/10 "rule" I alluded to earlier works very well at reducing risk while not eliminating the potential returns found under the more traditional "invest it all and diversify" or the accumulation theory of planning.

Sorry, I missed that. So, you're comparing a 401(k)/IRA with a 7% return (after fees) against an insurance policy with a 7% return (before fees). Is that correct?

The short answer is "yes". This is taking into account that the average 401(k) fees range from between 2-3% total (by the time you are done paying for admin fees, mutual fund fees, etc.). They create a lot of drag. I find, many times, that when someone says they are consistently getting 10% returns in their 401(k), they are getting that news from their adviser.

The net return before taxes is usually a bit lower, say 8-9% and assuming that their allocations are spit exactly even and IF they are getting 10% gross. The reality is, the blended rate of return for most folks at least according to DALBAR, is much much less than that. My personal experience has told me that if people are diversified well (like they are taught to be), then they are really chugging along at maybe 7-8% before fees and maybe 5-6% after fees...and before taxes. Obviously this is an average.

What is the 4-5% you mention? Is that the net return on the policy after fees have been accounted for? In other words, is it a comparison of 7% net from a 401(k) mutual fund versus a 4-5% net from an insurance policy?

The 4-5% is the illustrated rate. Cash value insurance rates are always quoted as an illustrated rate. The net rate after fees varies depending on the company's mortality experience, how efficient they are in managing assets and paying claims, etc. However, it is easy to calculate the real rate of return based on net cash value vs. premiums paid. In most cases, if you are funding the contract up to MEC guidelines, you will see a real rate of return in the guaranteed column of 3-4% if the illustrated rate is 4-5%. This only applicable for dividend paying whole life policies from a mutual company. The rules are a bit different for other types of whole life and can vary significantly if you are looking at an offering from a stock company.

The comparison I made was 7% net of fees for 401(k) and 7% illustrated rate for the whole life. Actually I ran two illustrations: 7% net of fees (for accumulation purposes) and then I also figured it after taxes when illustrating income in retirement. The 401(k) produced slightly more accumulated value than the life insurance policy over a period of 25 years, but produced less income suggesting that the drag of taxation is significant.

I assumed the life insurance policy's dividend rate at 7%. This is not the guaranteed rate. This is the rate that is non-guaranteed and assumes that the company is well run and remains well run. Dividends have historically been higher than 7% every year for the last 100-150+ years for the mutual life insurers that I mentioned earlier indicating that these companies have been run very efficiently for the last 100-150+ years depending on the company. However there is no guarantee that the companies will remain so (obviously).

Another question, how does the insurance calc work in adding in the benefit that comes from having insurance coverage? For instance, if I'm paying (say) $1000 for a policy, then a part of it is buying me the benefit of true insurance, and the balance is like "pure" savings. Is only the "pure" savings component (say, total premium minus the amount that would be required to buy term insurance) treated as an outflow?

I'm not sure exactly what you are asking when you ask about "outflow".

Whole life is a bundled financial product. There is technically no way to calculate how much is going to the cost of insurance, except for indirect inference. It's actually designed to be that way and though some people use that as an argument against whole life, it actually works out well for the policyholder.

Yes, some of the money is going to buy death benefit and some is going to pure savings. How much goes to which depends entirely on how the contract is set up from the very beginning.

Does that answer your question? If not, can you clarify what you mean?

And, if you're willing, another question: Would it follow that an insurance policy is even better when compared against a non tax-preferred account: like a mutual fund outside a 401(k), or a regular taxable brokerage account where one is trading stocks/bonds etc. ?

In general, yes. Mutual funds were designed to provide easy diversification from small investors. Problem is that when you reach the level of diversification that a garden variety mutual fund offers, you are earning about the same as the non-guaranteed rate in an insurance policy, at least in theory. In actuality, I think the life insurance does a little better IF the mutual fund is in a qualified account and a LOT better if it is in a non-tax preferred account, and assuming that DALBAR's research is valid about their 2-3% long-term average returns. According to their research, 90%+ mutual funds fail to outperform their respective benchmarks. In most cases, this leaves most mutual funds with long-term averages less than 10% gross.

Also, keep in mind that anything I'm saying about the life insurance is assuming it is a dividend paying whole life from a mutual life insurance company and that you are funding the contract up to MEC guidelines and all other things are equal when comparing it to an investment account (though, realize that comparing these to investments has to be a loose comparison at best because insurance - at least IMO - is a savings product whereas mutual funds etc. are investment products).

Let me know if any of that was confusing or I didn't answer your question(s).

[softwareNerd]

Let me know if any of that was confusing or I didn't answer your question(s).

I think the aspect that is most confusing to me is that multiple things are being mixed into the examples. Maybe it is just me, but I'm only happy when I see a spreadsheet showing both alternatives, with inflows and outflows listed for each year. That way, I can easily find which stream has a better IRR.

I also read a couple of your articles on your site, and they're well-written; but, once more, I didn;t find the level of detail that I would require. For instance, in your example of leasing a car, versus buying, versus cash, versus "being your own bank", my own comfort level is very low when I find high-level descriptions without a table showing the annual cash-flows (in and out) for each alternative. The same in your example about "company matching" of 401(k).

I'm guessing that the audience you're addressing would not want to see a page full of numbers. So, I'm not suggesting you're going about things the wrong way. In summary, I'd say that I don't find it confusing as much as I find it not detailed enough to allow for a judgment.

Edited December 28, 2008 by softwareNerd

[prosperity]

I think the aspect that is most confusing to me is that multiple things are being mixed into the examples. Maybe it is just me, but I'm only happy when I see a spreadsheet showing both alternatives, with inflows and outflows listed for each year. That way, I can easily find which stream has a better IRR.

I also read a couple of your articles on your site, and they're well-written; but, once more, I didn;t find the level of detail that I would require. For instance, in your example of leasing a car, versus buying, versus cash, versus "being your own bank", my own comfort level is very low when I find high-level descriptions without a table showing the annual cash-flows (in and out) for each alternative. The same in your example about "company matching" of 401(k).

I'm guessing that the audience you're addressing would not want to see a page full of numbers. So, I'm not suggesting you're going about things the wrong way. In summary, I'd say that I don't find it confusing as much as I find it not detailed enough to allow for a judgment.

I was actually toying with the idea of doing that but I was concerned that throwing numbers at folks might confuse them...but it may be easier to include it. I am so familiar with how it works, sometimes it is easy for me to leave something out that others aren't quite familiar with. If someone was interested in the general idea, I could provide more specifics.

Of course, I do have mock illustrations in PDF format showing the diff between an insurance policy and a hypothetical high yielding bank account (or some other account) showing both the effect of taxes and without. You are more than welcome to take a look if you'd like, just PM me an email addy.

[Chickenbuttlips]

I find this very interesting. Although I'm too much of a lay person to fully grasp all of these numbers, codes, etc., I am intrigued by the alternatives suggested.

I just turned forty this year. Fortunately, my husband is only thirty three, which gives us both ample time to do some financial planning. Although the initial discussion was about reducing tax liability, and I'm certainly looking to do just that, but what can you suggest for a person like myself having no experience, fore-knowledge, nor education on the subject? I know my money isn't best spent on a 401k, particularly to reduce tax liability and especially to plan a lucrative financial future, but where do I begin? I don't want gimmicks. I want solid, viable options.

Gah, what is a regular Jane to do?

Edited January 20, 2009 by Chickenbuttlips