BiggerPockets Money Podcast 54: 6 Ways to Reduce Your Taxable Income with Eric Brotman

by | BiggerPockets.com

In today’s episode, we chat with Eric Brotman, CEO of BFG Financial Advisors, who discusses his top 6 ways to reduce taxable income.

Eric dives deep into each of these 6 methods, taking time to explain the ins and outs of each one and sharing how to maximize their benefits—both now and for your future.

It’s a new year, and “get my finances in order” is one of the most common resolutions people make. This episode will give you a leg up on the steps you need to take to make this happen in 2019.

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Listen to the Podcast Here

Read the Transcript Here

Welcome to the BiggerPockets Money Podcast Show #54 where we interview Eric  Brotman.

It’s time for a new American dream that doesn’t involve working in a cubicle for forty years barely scraping by. Whether you’re looking to get your financial house in order, invest the money you already have, or discover new paths for wealth creation, you’re in the right place. This show is for anyone who has money or wants more. This is the BiggerPockets Money Podcast.

Scott: How’s it going everybody? I’m Scott Trench. I’m here with my co-host Ms. Mindy Jensen. How are you doing today Mindy?

Mindy: Scott, I am fantastic. It’s a brand new year and I’m so excited for everything that’s coming around this year. What is going on with you?

Scott: I am doing great. I got new goals, all that kind of stuff. I’m one of those guys who, around the new year, gets everything ready for the new with my goals and all that kind of stuff. So a huge nerd about it, but excited.

Mindy: You’re a huge nerd about it, Scott and I am learning from you, taking some tips from you. I have a goal this year to run a half marathon and I am going to participate in a bicycle ride called Rag Ride which goes around the state of Iowa. If you’ve never been, might sound boring. It is the most fun bicycle ride you will ever do in your whole life. And just trying to, you know, get my physical self in shape now that my financial house is in order.

Scott: Sounds like a pain in the rear.

Mindy: Oh my goodness.

Scott: Let’s talk about Eric Brotman, though. Eric is a financial adviser who has a pretty large financial advisory firm and he’s come on today giving us a boat load of information about how to shelter money from the government, how to set up a tax diversification system and really think through some things and their consequences, both over the course of your wealth accumulation lifetime and as that pertains to passing money to the next generation. So, very excited for this show.

Mindy: Yes. I will give it a caveat. He legally shelters money from the government through taxes and tax planning. When you said how to shelter money from the government I want to make sure that everybody knows before they listen, this is all legal methods.

So we did actually record this episode at the end of last year. There are a couple of guidelines that weren’t released yet at the time of recording. But we will update all of the show notes which can be found at BiggerPockets.com/MoneyShow54. That’s Money Show 54.

Eric Brotman, welcome to the BiggerPockets Money Podcast. How’s it going today?

Eric: It’s going great. Thank you so much for having me.

Mindy: Well thank you for making the time to talk to us today.

Eric: Absolutely.

Scott: So you have a lot of experience working with people who have built a large amount of wealth and then maintain that wealth throughout a couple of generations. So I thought, you know, that’s a pretty common goal amongst people that are listening to the Money Podcast so we have a lot to talk about there.

let’s start off with this. Can you define what you mean by retirement and what the concept people should have in mind when thinking about that term?

Eric: Absolutely. Retirement is a terrible idea in its traditional sense. In fact when retirement was created, it’s created as a way to put old people out of pasture and have them essentially recognise that they are no longer useful. It sounds terrible. So to retire is to withdraw or retreat or to disappear and I don’t know anybody willing to sign up for that. So to me, the idea of retirement is not the absence of work. It’s the absence of needing to work. You’re in that moment of financial independence where you are working for yourself, you are working for fun. You’re doing things that move the needles and that matter to you.

And so I see retirement as a graduation from punching a clock for a check to doing things that empower you, that are important to you.

Scott: What needs to happen in that? How do you, kind of, define that numerically? There’s a combination of numbers and probably mental, how you feel about those numbers. But what’s that definition to you?

Eric: Well, the numbers are going to be different. I heard Chris Rock joke one time that if Bill Gates woke up with Oprah’s net worth he’d want to jump out a window. So wealth is pretty relative. I would say that financial independence is really about perpetuating the income that you’ve enjoyed, adjust it for inflation forever. And so if your income is $100,000 a year, it will require 2 to 2 and a half million dollars or some other income sources to do that. And that’s just with a reasonable withdrawal rate and that is simple math.

You’re right, there are a lot of non-quantifiable things to go with that but in terms of building a nest egg and figuring out your number, somewhere between 20 and 25 times your income, gross income, is the right number. And you can adjust that gross income by whatever you are saving. So in other words, if you live on a $100,000 a year and you’re putting away 20, then what you really need to replace is the 80. Because you don’t really need to replace that which you were saving or investing. You only need to replace that which you were consuming or paying taxes on.

So that’s really the math that is the back of the envelop calculation that can be done by anyone in a matter of minutes and then the question is, how do we get there? And then the harder question is, how do we stay there?

Scott: So you’re talking about the absence of needing to work, right?

Eric: Yup.

Scott: It’s the key thing there. You know I have polled a couple of people in the financial independence community and a remarkably small sliver of the community has actually achieved their fire number, you know, achieved this 20-25 times their income and stopped working at the capacity that produces this income, right?

So your situation is going to be exaggerated because you’re working with people who have a higher net worth maybe even just bare bones financial independence. What do you see a lot of people doing after they’ve retired professionally? From a business of wealth building perspective.

Eric: Sure. Once you’ve gotten to that level, it allows you to chase what really means the most to you. And sometimes that means consulting, sometimes that means entrepreneurship, sometimes it means supporting or being an angel investor or venture capital or crowd funding or all these other kinds of things where you could participate in other people’s opportunities. I see very few people who retire and you know, put their feet up and play shuffle board. It’s not good for you. So for the most part, I think the most successful people have that mindset and that attitude. And when you’re earning because you’re producing something or you’re moving the needle, you’re making a difference for people, you’re going to earn by accident.

It’s not even income that you need at that point it’s going to happen. And then you have a tax problem instead of an income problem and you complain about taxes instead of income. Typically there’s always one or the other, you either have an income problem or a tax problem.

Scott: I love it when people complain about their high tax bills. Like a million dollar tax bill. Hey, good problems are happening from those, right?

Eric: Well, listen. For anyone who thinks, oh my gosh if you’re paying a million dollars in taxes, imagine what you must have earned? There’s still that guy or gal who happens to pay a million in taxes who lives next door to somebody paying half that because they better planning. And so they’re irritated not necessarily at the number but at what the number could have been.

Scott: So is that an essential kind of consideration in one’s financial picture after financial independence, in your opinion? Is tax managing changing income streams in a way. Are there different ways to become tax advantaged?

Eric: Absolutely. In fact anytime you can take some of your assets and put them in a place where they’ll never be taxed again, you have done yourself an incredible service and at some point there is an opportunity to put money where there’ll never be taxed again based under current rules. And usually, there is what I refer to as the TANSTAAFL premise. Have you heard of Tanstaafl? If you spell it out, it spells “There Ain’t No Such Thing As A Free Lunch”. It is never, it is never free. However, there are ways to defer or delay  or eliminate taxes, income taxes, or capital gains taxes. There are really creative ways and legal ways. We’re not talking about pushing the envelop and moving money off shore or something. For almost any American tax payer, there are ways to save future taxes by doing smart things today.

Scott: So what are examples, what’s something that maybe someone can relate to? They’re trying to approach that 1-2 million dollar net worth, 20-25 times their spending, getting ready to just…what should they be thinking of for a typical situation or something they can relate to?

Eric: I’ll give you a perfect of something folks either don’t know or aren’t doing to the best of their ability and that’s health savings account. HSA’s are the greatest tax invention ever. To the extent that, number one, you can put money away and it is deductible at any income level. Number two, you can grow that money indefinitely. So unlike a flexible spending account where it’s use or lose it, you wind up with four pairs of glasses in December you didn’t need because you were going to throw the money away. With the Health Savings Account, it can go forever.

And once you’re 59 and a half, you can choose to take that income, just like an IRA which would be taxable, or you can save it, invest it and grow it for the rest of your life and eventually use it for medical costs when you’re 85 or 90 years old. Half of the medical expenses that happen in our lifetime happen at the last six months of our lives. So you know you’re going to use it. Build it, grow it and if you’re blessed to be healthy and playing tennis at 93, use it like a IRA.

Scott: Question about that. Relative to the size of, I guess the HSA, it seems to me like a great tactic. A no brainer, if you’ve got one and that’s your plan, it’s a high deductible plan that qualifies for an HSA, go ahead and contribute and obviously invest it because you know you’re going to at some point in your life. Right?

Eric: Of course.

Scott: But, it seems like the upper bound there is that there’s only a couple of thousand dollars a year in tax deferred saving, right?

Eric: Today, it is. And so you take the HSA and you latter on Roth IRA’s or Roth 401K or other places where you can put potentially more money  that will never be taxed again. And then you throw on a 529 plan and for other money whether it be for your kids or your grand kids, or your great grandkids who you might never meet. You build money that’s tax free forever so long as it’s used at some point for education.

And oh, by the way, it’s still under your control but it’s not in your estate so there are other ways that you can save taxes. And then you throw on things like life insurance or other things where you can have a complete tax saving. And by the time you’ve done all of those things, it really adds up and you could wind up putting 20, 30, 40 thousand dollars a year away or more in a place where it will never be taxed again.

Scott: Ok. We got to go into detail into a lot of these things in a minute. And I’m trying to think of what’s kind of the next helpful way to think through this situation. So maybe let’s start with this. So what’s a story, one, two or three stories of someone you have worked with who’s gone on to create a large amount of wealth and then retire in some sense,  at least stop or move away from what they’re working on and begin to employ these strategies. Can you think of a story of that person? Who is this person? What do they look like? How did they get into that situation? And then how did they begin to take advantage of all of these things? Maybe that’s a way that will help me at least think things through.

Eric: Sure. I think everybody should be using tax diversification which is something people don’t think about. And so as you get closer to retiring, we’ve had clients who are 50 or 55 or 60, have started positioning themselves to transition significant wealth to the next generation and start doing things that are for income but aren’t necessarily for need. And they start doing it in a way that allows them to maintain control. No one likes to give up control.

I know some really wealthy people who think they’re going to run out of money. They’re not. But they think they are and it’s an incredible fear because I think as you get older, you have to remember, when you’re young and you’re hungry and you can go make more, it’s a little less scary than when maybe you’re not in a position to make more the way you could. And so having losses at that point is very scary.

So who are these people? These are sandwich generation folks. These are folks who are working 50 to 60 hours a week and sometimes side hustle. They’ve got their parents getting older and they’re worried about them. They’ve got kids to educate. And they’d like to retire themselves before they die. And ultimately, they’re being pulled in lots of different directions. So how can you leverage those generational opportunities?

Well one way is you fund a Roth IRA for your kids as soon as they’re old enough to get a W2. You know you can buy insurance on your parents and create tax free income, income tax free, or estate tax free dollars down the road. It’s creepy but it’s an investment. I mean, there’s lots of different ways to do that. So I think perpetuating wealth means using all the strategies at your disposal and starting early.

You start at 50. It may not be early for your typical listener, but in the grand scheme of things, hopefully you’re only on the 50-yard line.

Scott: Love it.

Mindy: Ok. So we just unpacked a bunch of stuff. The HSA plan, the Roth IRA, 529 plan, whole life insurance is not something we’ve talked about on this show before. I’ve heard the concept but I don’t actually know what that, like there’s term life, there’s whole life, I don’t know what exactly is better and why. So this is the first episode of 2019. Let’s look at the HSA plans, the high deductible insurance plan, the savings plan. What are the 2019 contribution limits?

Eric: Actually, 2019 limits have not been established by the IRS yet. The limit currently is $6,900 for a family. If someone is over the age of 55, if they’re 55 or older it goes up to $7,900. And that’s for a family plan. If you’re an individual plan, the limits are cut by 50% so it’s cut in half. There will be a potential 2019 increase. It had not been announced as of this recording.

Mindy: Ok. So $6,900 a year for a family plan, that’s $575 a month that you could contribute to your HSA plan and over the course of the year, you get your $6,900 and you don’t have to use that in 2019, is that correct?

Eric: That’s correct. You get a tax deduction for the contribution regardless of your income level, there’s no phase out. And you don’t have to use the money. You can grow the money indefinitely through HSA accounts which you can set up at any bank basically or any financial institution, also allow you to invest the funds over certain limits. Most of them have a threshold where you have to keep at least 1 or 2, $3,000 in cash and they’re in basic savings accounts. But everything beyond that, you can put in mutual funds or other investments in them and you continue to grow them in such that there’s capital gain.

Mindy: Ok. And our friend, the mad scientist shared this on show 18 of the BiggerPockets Money Podcast. He calls this the best retirement plan there is. The HSA plan.

Eric: I would agree. It is dangerously close to perfect. Almost bordering on accidental.

Mindy: Ok. We’re going to have to quote that. “Dangerously close to perfect.” The Roth IRA has a limit of 5,500 is that correct?

Eric: It is 5,500 in 2018. It is 6,000 in 2019. So in 2019, the Roth limit is 6,000 and for anybody aged 50 or older or is turning 50 in 2019, it’s 7,000.

Mindy: Ok. And that is $500 a month that you’re putting away into your Roth IRA. Now that’s after tax?

Eric: Correct. That is not deductible. But it will grow tax deferred. You don’t get 10.99’s on it every year. And then when you make withdrawals so long as you’re more than 59 1/2 at that time, it’s not taxable. Well the beauty of non-taxable income is it doesn’t go on your 1040, it doesn’t go on your FAFSA, it doesn’t go to create increases on your taxable income. I mean I don’t know about you guys but the federal government and just about every state you can name is borderline broke. Income tax rates are unlikely to go down and if they’re higher later, even if your income’s a little lower, you could be paying a higher percentage.

So the Roth IRA is a panacea and what the government’s done with Roth IRA’s is they would set up, originally, to be saving plans for relatively modest earners. They weren’t supposed to be playgrounds for the so-called rich. However, there were some mistakes with the way this law was drafted. In order to not admit those mistakes, the government now said, oh no that’s what we planned, it’s ok. And this is what I mean. Have you heard of the back door Roth IRA?

Scott & Mindy: Yes.

Eric: Ok. The backdoor Roth IRA is the greatest tax accident ever and what that says is that while you’re not allowed to contribute to a Roth IRA if you have an income over a set threshold, and that’s set whether you’re individual, how you’re filing. But let’s say, you’re making an income of a quarter million dollars a year, you’re not allowed to contribute to a Roth IRA. However, you can contribute to a traditional IRA regardless of your income level.

Now some people say well wait, but I can’t deduct my IRA contribution if I’m over an income level and that’s true. But you can make what are called non-deductible contributions to traditional IRA’s. And when you do that, you then have the ability to do Roth IRA conversions which is to convert a traditional IRA to a Roth IRA, regardless of your income level.    So essentially, what the IRS has said is, yes you can put $6,000 into your Roth IRA, and once you’ve done that, you’re allowed to convert it. And so by converting it, would pay taxes on your full IRA except that to the extent that you have bases that is non-taxable.

So on your tax return, something called the form 8606. The form 8606 is an IRS tax form that goes with federal funding that allows you to declare bases in your IRA such that that amount is not taxable when you convert. And so right on, the 2019 tax returns are going to be different. In fact, the 2018 tax returns are going to be different. But in 2017, it was line 15 and 15a of the 1040 that said declare what’s going to come out of your IRA’s, now declare what portion of that is taxable. And it had to be pro-rata.

So if you don’t have an IRA, and you make a non-deductible IRA contribution, and then you convert it, 100% of the account with basis is non-taxable. You just made a Roth contribution legally.

Mindy: Ok. This is where the backdoor gets a little bit confusing. I know that the Roth IRA, you can only contribute up to a certain income level. What is that income level?

Eric: You know what at the top of my head I don’t know. It’s around $190,000 or a married couple.

Mindy: Ok so that’s a nice…

Eric: It’s a significant income level.

Mindy: Yes. So let’s say that I get a raise and I make $200,000 a year. I can contribute to my, I can have a regular IRA. I can contribute $6,000 to my regular IRA. Then I tell the government, this is non-deductible. Then I pay no taxes when I convert it to the backdoor Roth. Now I did pay taxes on it when I earned it.

Eric: Just as you would have with a Roth. You functionally use after-tax dollars into your traditional IRA so that you can move it to your Roth.

Mindy: So this is still after tax but now it’s in the Roth.

Eric: Absolutely.

Mindy: It will grow tax free. When it grows really, really big I pay no taxes additionally.

Eric: Correct. You don’t pay taxes every year as it grows. You don’t pay taxes for transactions or capital gains along the way. And you don’t pay income taxes when you withdraw.

Scott: Both of our minds were blown but I think Mindy…

Eric: Now here’s the caveat and it’s an important one. If you already have an IRA, with balances that you’ve deducted. Let’s say you have a former employer’s retirement plan. You have $60,000 in your IRA and you roll it. I’m sorry on your 401K and you roll it on a traditional IRA. If you have that account and you convert it, you have to pay taxes on the full $60,000. If you make a non-deductible contribution to any IRA, let’s say it was $6,000 just to round numbers. Now  you have a $66,000 balance and 6 of it is basis. When you convert, you can’t just convert the non-deductible. You have to convert it pro-rata.

So if you already have an IRA, the backdoor doesn’t work very well because you would only be able to deduct 10%. essentially, to wave 10% of that piece, you’d have to pay taxes on the rest.

Scott: But if you’re looking to retire for example, let’s say you’re making $150,000 a year in household income and you stopped working that year, you’d have very low income if you haven’t taken out any contributions. So you can roll that over in that year if you have a year where you’re planning to have low income or a loss at a business or something like that, that’s a good year to potentially roll all this stuff over into the Roth. 

Eric: Absolutely. Sometimes it’s advantageous to get your last formal pay check before you elect social security and before you’re subject to the required distribution rules on IRA’s which is 7 and a half.  There’s strategic reasons to take year or two off.

Mindy: Can you have more than one IRA?

Eric: Yes. But for the purposes of this, they aggregate in terms of that process. You can’t open a separate one and then just move it. All of your balances are aggragated. But here’s what you can do. Let’s say you have $60,000 on a traditional IRA but say you’re now working for a different company, most 401K’s will let you take your IRA money and put it on to your 401K at your new job. If you move your money into your 401K, now you have no IRA. Now you can do backdoors.

Mindy: Ok. So I take my old IRA, I put it my new company’s 401K. What if my new company doesn’t have a 401K, I take my old IRA and put it into a self-directed 401K or some other option?

Eric: No. Unfortunately that doesn’t work. You’d have to work with an employer that had a plan.

Mindy: Ok. That’s good. I’m just asking because when I’m listening to podcasts while I’m driving out on the road, I’d be, wait ask this question. And they don’t. So I want to ask all these questions.

Eric: Fair enough. Ok now that’s fair.

Scott: What’s the limit on a backdoor Roth?

Eric: It’s the same as a traditional Roth.

Scott: So 18K.

Mindy:   No that’s a 401K.

Eric: The 401K limit in 2019 is 19,000. And if you’re over 50, it’s 25,000. That’s an increase also over 2018. That’s the 401K. And by the way the Roth 401K allows that same limit and doesn’t have an income barrier. Now the thing about doing that is if you’re waiving a tax deduction a year, you might need it. So we don’t see a lot of people with high incomes do Roth 401K’s exactly because they really do wan the deduction. Especially since that tax bill that was passed on Jan 1st of 18, it left a lot of people scratching their heads and trying to figure out where their deductions went because most of them are gone.

So the limits for the Roth, what we see people do is we’ll see somebody in January make, and it’s January now, so you have an opportunity in January to make a backdoor contribution or a non-deductible IRA contribution for 2018 and for 2019 simultaneously and then do the conversion. You just doubled your contribution to a Roth instantly.

Scott: So if I want to go and take action based on what we’re talking about here, right? It might be a good idea now or come January to go in and talk to my financial adviser and put together a situation where I max out my 401K at work.

Eric: Yup.

Scott: Great. Then I make non-deductible after tax dollar contribution to my IRA outside of that and ask to backdoor that into a Roth.

Eric: Correct.

Scott: And I can do that for both 2018 and 2019 at those two limits. Perhaps early on in the year, you know if ever I contribute to an IRA, I’d like to do it at the beginning of the year so it has all the year to compound. And I never understand why there’s not a huge line outside of Scott Trade or whatever, wherever you hold your IRA, on January 2nd, you know, out the door for everybody to try to deposit the maximum into their IRA right on day 1. But that’s the other back side of the story.

Eric: Was that rhetorical? No that’s procrastination. The oh my gosh it’s the deadline, can I still do this?

Scott: Why isn’t there a huge line of people doing it? If you try to do this, that should be your plan right? You max it out from day 1, at 8am.

Eric: Because it feels like a bill. And it’s on the heels of the holiday and people have just gone overboard. So, it just doesn’t work that way.

Scott: Fair enough.

Mindy: I have a question really quick. So I have my IRA, I put my $6,000 into it, my 5,500 for 2018. And then I turn it into a Roth. I backdoor it into a Roth. What happens to that IRA?

Eric: It’s closed.

Mindy: It’s closed. So then the next year, I can do the same thing.

Eric: Correct. Every year, you open an IRA. You have no IRA’s. You open an IRA, you fund it, non-deductibly, convert it to the Roth and you close it. Every single year. And in most cases, as long as you’re with the same custodian, as long as you’re with the same firm, converting an IRA does not cost like an account closure fee or any of the nonsense that you’d have to deal with if you were closing an account. In most cases, if you’re with Fidelity and move a Fidelity IRA to a Roth IRA, they don’t charge you to do that typically.

Mindy: Ok. Another question is I’m trying to reduce my taxable income, this is a personal one. I am trying to reduce my taxable income so I can sell some stock without hitting the capital gains, I would prefer not to pay that. Can I do any of this without it making the non-deductible IRA’s so that’s not going to help me at all.

Eric: No.

Mindy: Is it better to make the deductible IRA or I wonder, this year I’m kind of not going to be able to hit that limit, so…

Scott: Well I think, sorry to dive in here real quick, but it sounds like the question is how would you defer more income and not paying taxes on it right? And that brings us to the third point that you’re going to talk about which is the 529 plans.

Eric: Yeah. Actually, 529 plans are truly amazing in terms of ways to use them.

Scott: Is that a reasonable transition in there? Are you asking other ways to shelter your income because you don’t want to pay taxes this year?

Eric: I think Mindy is looking for tax deductions. And this is not a deduction.

Mindy: The 529 plan is not a deduction.

Eric: It can be, depending on your state of residence at the state level but it’s not at the federal level.

Mindy: Ok. Then yes, we’ll get to that in a minute. Is it better to fund your Roth or is it better to reduce your taxable income? And if you can’t,  I mean there’s only so much to reduce it to. I think I’m not going to be able to reduce it enough to hit that so I would be able to sell stock without paying capital gains taxes on it, in which case doing the backdoor Roth would be better. Well I don’t have to make a backdoor Roth I don’t make a $199,000.

Eric: Well let me ask you this, since now I’m providing personal financial advice. Are you in a position where you’re charitably inclined?

Mindy: I am charitably inclined.

Eric: Do you give money away every year?

Mindy: I’d like to. Let’s say yes.

Eric: Ok. Have you ever considered holding onto that stock and giving the stock to charity, in such that there is no capital gain? Instead of writing a check out of your check book, instead of selling the stock and paying taxes, why not gift the stock because then the charity can sell it, it can carry over bases but they are 501c3, they pay no taxes at all and the capital gain goes away.

Mindy: So do I get as a loss or do I get that as a deduction?

Eric: Neither. Well, you may get a deduction if in fact you deduct your charitable contributions which now as of 2018 tax filings, a lot of people, 95% of Americans are not going to deduct anymore. It means charitable contributions won’t be deductible  for 19 out of 20 people. Ok? And there’s some strategies involved in that. If you’re giving away a lot of money, there’s a lot of strategies involved in that. If you’re just trying to be thoughtful and you’re giving away modest amounts of money, anyway there are different definitions for that, but if it’s a modest amount of money, you may deduct it anyway but at least you can avoid the capital gain.

Why pay taxes? Give it to the charity. If you have $5,000 worth of stock, but your basis is a thousand, you’re going to pay taxes on $4,000 of it and you make $2,500 annual gifts to charity, I’m making these numbers up, give some of it in December, some if it in January, two different tax years. It would satisfy your charitable itch and you would have paid no taxes on the $4,000 gain and neither will they.

Mindy: Ok. That is certainly something to think about. And yes, I can ask you personal questions the whole time we’re here but…

Eric: I’m going to send you a bill, Mindy.

Mindy: I think we should teach other people things too.

Eric: Fair enough.

Mindy: Let’s move on to the 529 plan. A brief description and then how can I use that to benefit me?

Eric: Sure. 529 plans were set up under IRC or Internal Revenue Code Section 529 to be a college savings vehicle. It’s mostly for parents or grandparents to save for their kids for higher education, which you know is an extremely expensive thing. I don’t know if you have children but it’s an extremely expensive thing to consider. The way 529’s have evolved however, is they have become an estate planning strategy. They have become a tax saving strategy. And they have become even a strategy for things like private schools where as this year, up to $10,000 of private school tuition K through 12 can be paid through these plans.

The plans have the same annual limit for contributions as the limit for gifting without gift tax which right now is $15,000 a year per donor, per donee. So a married couple can give $30,000 each to any human being they want including each of their kids. Right?

If you put money on a 529, depending where you live, your area of residence, you may be able to deduct your contribution from your state tax. You can’t do that from federal. however, the accounts can be invested and they can grow forever. There’s no requirement to ever pull this money out. And as it grows, and it grows tax deferred, so long as the money is later used for higher education of some kind, it can be K through 12 or college or grad school, it’s non-taxable. You don’t pay capital gains, you don’t pay income tax.

It is also for very wealthy people. This is outside of your taxable estate. Even though you still control it and you can still say my great grandkids are rotten and I want my money back, it’s still not in your taxable estate that you can alleviate some of that from your tax burden as well. So if you don’t have children, this may not be practical unless you’re still coveting that Phd you were thinking of going back for. But if you have children and grandchildren or great grandchildren, this is a way to perpetuate wealth even if it’s not used for a hundred years.

Scott: I love this. Let’s talk about this. Let’s go into the concept of you’re listening to the show, you’re listening to BiggerPockets Money, you are attempting to build a significant personal wealth portfolio earlier in life in order to sustain earlier retirement, right? Not stopping work but the absence of needing to work as we talked about. That means, a good chunk of you listening will have reasonable odds of producing pretty much a large estate throughout your lives. Right?

So if that’s the play, to retire with a couple million dollars net worth when you’re 30’s or 40’s, right? How do I go about, and let’s say my goal is to pass that on to the next generation, how do I go about using these things to pass along a large estate in an effective way to potential heirs. Is that something we could talk about here?

Eric: Of course. Absolutely. You’re talking about, in each of these cases, each of these four cases, you are creating opportunities for the next generation. HSA’s pass by beneficiary, 529’s are passed by successor owner, you never want to name the kid as a successor owner, you always want your house or another adult to be the successor owner because if the kids ever own it, it becomes custodial, it becomes an irrevocable gift. It creates tax issues for them.

So you never want your kids to own their own plans, even when they’re of majority age. If they are 25 and you have a plan for them, it’s still not their money, it’s never their money until and unless you die and want them to have it. And you can change the beneficiary once a year so you can name your grandkids and then leave it to your kids for their kids type of thing. So the Roth IRA’s will be inherited and the next generation that receives them won’t have to pay income taxes on withdrawals.

See, if you leave your kids an IRA, the whole darn thing is still subject to income tax. And if your kids are on a higher tax bracket than you are, you just cost your family money. If you’ve got a kid who’s a plastic surgeon, don’t leave him or her an IRA because they’re going to be taxed at 50%.

Scott: Leave them a Roth.

Eric: Leave them a Roth or don’t leave them anything those rotten kids. No. So you have that and the same thing’s true on the life insurance side which we haven’t  gotten into which Mindy is very curious. And we’re going to have some fun with that one too. But there are ways to perpetuate wealth and not to perpetuate tax bills for sure. 

Scott: Now what about real estate and all of this?

Eric:  Real estate is an interesting hot potato. I know you do a lot of real estate investing on your show and have a lot of guests who are fond of real estate. To me, real estate is something you either decide you’re doing or decide you’re not doing. You should not dabble. To me, having two rental properties is like owning two stocks. You’re diversified and you’re subject to one really bad tenant. So either decide whether you’re going to be in the real estate business, whether it’s commercial or residential, and buy properties every year, and leverage them appropriately and make it a part of what you do for a living or don’t. Don’t dabble. Don’t have one random real estate property in Virginia somewhere.

And it’s for the same diversification reasons that we would talk about with any other asset class, ok? That said, because real estate qualifies like other assets, where you get a step up and basis upon death. If you leave the real estate to the next generation, they no longer are subject to capital gains if they sell something. So it actually creates a very nice gift if it’s appreciated, which we all know prior to 2007 it always goes up, it can only go up. Once ’08 hit, we learned that that’s not always true. But real estate can be a very helpful thing.

And if you decide that you want to be in the business, with the cap rates and the cash flow and the rental income and so forth, it can be a very good business to be in. But to me, it’s not a hobby, it’s a business.

Scott: I think that’s great. And I think that many of the people that are listening to BiggerPockets Money will at least want real estate as one significant part of their portfolios in a course of a lifetime. So I believe that’s the intent.   

Eric: Just remember, if you live in it, it’s not an investment. It’s a nest. Your personal resident is not an investment. It will never ever make money. I know there are folks in San Francisco who would argue with me right now because they’ve made $2,000,000 in two years on a townhouse somewhere. That’s not normal.

Scott: I like where you’re going with that thought. Mindy actually has a way of producing wealth from your personal situation. So there are exceptions. Mindy do you want to tell him what you did?

Eric: Are you renting rooms or running a bed and breakfast?

Mindy: No, I live and flip. So I buy an ugly house, I live in it as my private residence, personal residence, primary residence. I make it worth a lot more money. I sell it for a lot more money and I pay no capital gains taxes on it because it was my primary residence.

Eric: That is brilliant from a tax perspective if you don’t mind living in squaller.

Mindy: That is a very good statement. An excellent quote. I make a lot of money. Month three is though.

Eric: Oh yeah. I mean if you don’t mind dust in your kitchen 24/7, then go for it. It’s a great strategy. I don’t know that that’s a lifestyle choice that everyone would choose. But it’s a great strategy from a tax perspective.

Mindy: Yes. Most people don’t choose it and that’s fine. That makes those ugly houses for me. But yes, it can be overwhelming. My first one was in this gutted to the studs house. And now I move in and I gut it to the studs. I’m washing dishes in the tub. If you don’t want to wash dishes in the tub, maybe this isn’t for you. I make crockpot meals for a month solid.

Scott: But it’s temporary right?

Mindy: It’s temporary.

Scott: Now you live in a beautiful house that is wonderful and you have a couple of years to live in it right? Before you…

Mindy: You know what else is permanent? That big fat check that the government gives me. Well that I get when I sell the house that the government takes no part of. But, again, not a strategy for everybody.

Eric: There you go. I like where you’re coming from. That takes ingenuity and some drive as well. But you got to have a good eye for porcelain and finishes and what not. I don’t have that.

Scott: One of the things that I, you mentioned this, step up and basis is kind of central to the concept of moving wealth between generations, right? Which it seems where we’re headed in this show. There are a lot of ways to defer taxes all that stuff. Real estate, what that means basically is if I buy a property for 500K, and I put a 30-year note on it, and thirty years go by, I pay off that note, the property is worth $2,000,000 and I set things up appropriately and I pass it along to my heirs. They can go and sell the property for $2,000,000, which is what it was valued at, and pay no taxes. If I had the property previously, I’d pay tax on the $2,000,000 because I would have depreciated the property over that holding period. Right?

Eric: Well, you wouldn’t have depreciated it if you lived in it.

Scott: It’s commercial.

Eric: Yes. If this is a commercial property then absolutely you pay taxes for the full amount.

Scott: So what other assets are along those lines? This is a very effective way for example to pass large amounts of wealth to the next generation is through real estate. What are other assets that are like that, step up and basis.

Eric: Any non-qualified investment portfolio which means any investment that is not in a retirement plan, that’s not in an IRA or Roth IRA or 401K’s or 403B’s. If you own it, whether it’s individual stocks or mutual funds or bonds, or precious metals, or commodities, or other things, if you own it and it’s not in a retirement plan, it qualifies for a step up and basis when you die. You have to die to win. Not everybody loves that strategy.

Mindy: No it’s not my favorite. Ok you made a statement just a moment ago. You said my residence is not an investment. But your primary residence can still b inherited by your children at the stepped up basis. Right?

Eric: Correct.

Mindy: Right? It’s not only investment plans or investment properties. It’s any real estate that you own at the time of your death.

Eric: Anything you own that is not in a retirement plan or in any kind of entity which for one reason or another would eliminate that. So for example, you may not want to own property jointly. You may want to own it individually. So the step up is on a 100%.  Because if a married couple owns it, for example, well married couple is a bad idea. The two of you guys own a property together and one of you dies. Depending how it’s titled, if it’s titled as joint tenancy, the survivor of the two of you receives the full property and you get that half step up and basis. But it’s only half.

The survivor of the two of you can’t then go and sell it without paying taxes on the half that you would have. Does that make sense? What a lot of people do, especially people who aren’t related, is they own property as what is called tenants in common. Tenants in common is one where each of you own split, say 50% of the property. But you own it, you own each a piece outright and can will it to someone other than the other owners.

So let’s say both of you have kids. You could leave your 50% of that property to your own children. That’s called tenants in common. Now you have to be very careful because one of you becomes business partners with the other’s children. Not everybody wants that. So now as not all joint accounts are created equal, lots of different ways to title joint accounts. There’s joint tenants with rights to survivorship, tenants by the entireties, some states have community property rules for married couples. I mean it’s more complicated than just, hey, our two names are on it.

Scott: I think this could be a whole discussion as going down into how these strategies and how to figure out how to set up partnerships and all that kind of stuff. Let’s see if we can get something a little more practical here. If I’m looking to do this, if I’m working towards financial freedom a few years away, what do I need to be doing right now to start taking advantage of these things? What do I need to go set up right away? We talked about maxing out the 401K. We’ve talked about the backdoor Roth. Can I set up a 529? I assume you got to have children to set up a 529.

Eric: No. You can set up a 529 for your neighbor, or for yourself.

Mindy: Or for my children.

Eric: Or yeah, you can set it up for Mindy’s children. She appreciates that a lot.

Scott: So why would I set it up for myself when I wasn’t planning to spend it on myself? Can I pass that along somehow?

Eric: Absolutely. You can pass it to another heir or generation or someone else.

Scott: Ok. And they could use it?  

Eric: Absolutely.

Scott: So I don’t even have kids yet, right? I’m not even married. But I could set up a 529 plan for myself and then if I were to have kids, that money, I could change that so it will go, they will be the beneficiaries. So I can start this right now.

Eric: Yes. I mean you can go throw $15,000 for a 529 for yourself and it can grow until you procreate my friend.

Scott: Alright.

Eric: If that’s in fact your plan.

Mindy: Yes he’s going to have eight little Trenchlings, he said.

Eric: Oh, then you better put away more than 15 grand. Each kid would cost between 1 or 2 million dollars to raise so there went fire. People with kids don’t fire.

Scott: If I’m thinking about this from like a checklist perspective, if I’ve got an HSA and I qualify, contribute there, boom. That’s a no-brainer. We all are on the same page. I don’t think anyone we’ve talked to has recommended not maxing out an HSA as long as you’ve got reasonable situation with your other personal finances and are working towards this, right? Backdoor Roth is a great tip. 401K is another way to shelter taxes if you have it at work. The 529 plan, if you have kids or are thinking about procreating as we’ve said it.

Mindy: Or if you want to put mine through school.

Scott: Real estate could be a shelter way to go about this. What else can I be setting up? Maybe let’s talk a little bit about life insurance.

Eric: We can absolutely talk about that. There are two fundamental kinds of life insurance. Term and permanent. Term insurance is rent. It creates on equity. It creates no wealth for you unless you die and again, it’s not death insurance for a reason. It’s life insurance. Whole life insurance has a complete component to it which has guarantees in it which will create cash that you can use in your lifetime. And there are a lot of practical applications but from my own personal story, I used my life insurance to buy my first home. I also used my life insurance to start a company.

So the amount at which my life insurance has created to my own wealth building and I’m still here, alive and well, it has still contributed an enormous amount in my own wealth building and has done so completely tax free. So there are strategies involved. They are great for married couples to consider because all married couples have a pay cut ahead even if they are financially independent. That pay cut is in the form of one social security payment going away when one of you is widowed.

So now, you and Mindy are married. Congratulations, I’m happy for you both. You have to raise your children. But you’re both married and you’re both 62 years old and in the next eight years, at some point claim social security and we need to figure out when is optimal, yada yada yada. You both claim social security. At 71, you drop dead. Mindy’s still here. What happens to your social security? Well, she keeps the higher of the two and loses the lower of the two. It’s an absolute pay cut every time a married couple has a widowhood.

So you can use life insurance to offset that. And what you do is you insure both of you because neither of us know who goes first. Usually the guy goes first. We can do a whole show on why that is but I think because we get married and it kills us. But that’s a whole other story. But I digress. Nonetheless, if that’s the situation, you’re each own enough life insurance that when one of you is widowed, now Mindy is still alive. She’s collecting the larger of the two social security payments. She gets the death benefit from your life insurance. But she also has the cash value in her your own, which she can begin to draw on with no income taxes for the rest of her life if she chooses.

So she can take let’s say a 4 or 5% withdrawal, that’s $100,000 in cash. She takes $4,000-$5000 a year of that for the rest of time and that’s a non taxable income to her. Again, there’s no free lunch. There’s always flaws in any plan, but done properly, as long as you never surrender the contract it’s never taxable. And it’s like a Roth IRA  with a death benefit. And if you do it right, you can build enormous wealth and that’s why we see clients doing that for themselves and for their kids and for their grandkids.

It’s just like borrowing money from a bank. When do you borrow money from a bank? You borrow it when you don’t need it. Otherwise, they won’t lend it to you. So you get life insurance when you’re young and healthy.

Scott: Maybe I could wrap my head around this with maybe an example. Can you give me a, who’s some who started this in their 20’s or 30’s  and had a positively massive result of this? And can you kind of walk us through the story maybe anonymously?

Eric: I’d rather tell you my personal story if you’re ok with that. When I was 14 years old, my parents bought life insurance for me. Not because they were planning on my demise but because they recognised it was a good tax shelter. Ok? They bought life insurance for me and when I was about 24 years old, transferred it to me. And that is not a taxable transfer. That is a variation of the transfer for value rule so that is an exception. When they transferred it to me, it became a gift to me. It wasn’t taxable so it was kind of cool.

I then had this insurance policy which had cash in it. I then had the ability to continue this contract or to surrender it, among other things. I chose to continue it. And then when I was ready to buy my first home, it was in my relatively early 20’s, geographically speaking, I have a 2-bedroom, 2-bath condo in the Baltimore metro area for $91,000 which is ridiculous to think about. But that’s what I did and it was great. And I used my life insurance for the down payment.

So I took $15-20,000 out of that, bought the house. I later sold that condo for $225,000 and to Mindy’s point, paid no capital gains for it. It was a personal residence and so forth. So not only did I not pay capital gains on the home, I took that and I actually used some of the gains to repay the life insurance, refund it so that I will still have all that cash in it.

I then started a company in 2003. And when you start a company, you’re an entrepreneur, you’re 31 years old, I want to start a company and every bank you go to will laugh you out of there. You don’t have enough collateral. We’re not lending you money to start a company. There’s no cash flow. Show me two years of tax return. Show us two years of your P&L’s, and what’s your balance sheet look like?

This is my business plan, isn’t it fancy? I need help with this. And they say get out of our office and come back when you’ve been around two years. So you can’t borrow money. So where do you borrow money? I borrowed money from everywhere to start the company. I’ve boot-strapped 15 years ago, almost to the day. And some of it was the life insurance dollars that I could use, that I could leverage as collateral, when no bank would lend me.

Scott: How significant was this collateral? Was it $10,000, $100,000?

Eric: It was about $100,000 at that point.

Scott: Alright that’s awesome.

Eric: No, it’s real money. I have half a million dollars in cash in my insurance right now and it’s growing tax free.

Scott: So what happens to that? Can you pass that along? Is there a benefit there? How does that work?

Eric: Well, if I dropped dead, there’s a death benefit because it’s life insurance. Right? So the death benefit is reduced by any money I have already accepted. Let’s say I have $100,000 in cash in my policy but it’s worth $500,000 if I die. If I leverage the $100,000 while I’m living, my death benefit becomes $400,000. Ok? So you’re not double dipping. It’s not that you have both. But you are creating the ability to use your own funds as collateral, no questions asked. And it is a non-recourse type of thing. So you’re not making a withdrawal, you’re making a loan.

So you’ll say, why in the hell would you borrow your own money? And the answer is because you don’t actually make a withdrawal from the account to borrow this. Imagine this, Mindy you’ve got $100,000 sitting in the bank and you want to use the money but you want to ask the bank to continue to give you, say, 5% interest on the money while on deposit. Makes sense?

Mindy: They don’t do that.

Eric: Why won’t they do that, it’s still there, right?

Mindy: Until I get rid of it. Until I use it. 

Eric: Ok. So with the life insurance contract, that same $100,000, you can utilise the money and it becomes a lean against the future death benefit. So you’re using the money, there’s a note against it. But because it wasn’t actually withdrawn, it’s still earning its interest. So let’s say the loan cost you 8% but the policy is earning 5 1/2. You just got net 2 1/2 money. Now recently, interest rates have been so low that that sounds normal. Well 30-year mortgages are back to 5% now, about 4.9-4%. They’ll be back at 7,8,9%.

The house I grew up in was financed at 14 and 3/4. It’s like buying a house with a visa card. So if you think about it, it is a way to create collateral for yourself. It’s a way to never pay income tax on that money. And it’s a way to leverage it and use it and use it and use it during your lifetime. And then you leave it behind, amplified by the death benefit. It costs you nothing. There’s no tax.

Mindy: To borrow from your life insurance policy, is that similar from borrowing from a 401K?

Eric: No.

Mindy: Do you have to pay it back at a set time?

Eric: Borrowing from a 401K is one of the most expensive decisions you can ever make. And in fact I can not think of a reason to do it most of the time. Because what happens is, if you borrow money from a 401K, that money is actually withdrawn. It’s no longer growing for you. You’re paying it interest on it. You typically have 5 years to pay it back. And you’re paying to back with after-tax dollar. You have to earn the money to pay it back only to then pay taxes on that same dollar when it comes out.

To me, a 401K loan is a disaster financially. however, will life insurance, you’re not actually making a withdrawal from the policy. All you’re doing is using that policy as collateral to utilise some of the insurance company’s general fund. So no, you never have to pay it back. There’s interest every year which you can choose to either pay it or the policy to pay. But there’s no term where you must pay it back. If you die with a loan on the contract, it just comes out of the death benefit at that point. Done right it is never taxed.

Mindy: How do I get the money? I just call my life insurance company and say hey I want $100,000?

Eric: And they send it to you and it’s not taxable. And you can use it. And then if you decide you want to pay it back, you can. Even if you don’t, you’re still earning that ever-so percent on it while it’s borrowed, and you’re paying 8% typically on the loan. So it’s still got a net cost to you but the net cost is incredibly low.

Scott:   And this is all money that you’re paying that ends in the plan.

Eric: Absolutely.

Scott: You’re paying insurance as you’re doing this so the insurance company make a profit out of the premium that you pay on a regular basis. So it’s not like netting more money than the insurance company on average.

Eric: The insurance company has fountains in their lobby a reason. They know how to play this game. But the biggest reason insurance companies are profitable is the term insurance, because people outlive it and it goes away. You just paid premiums for 30 years and collected nothing. I mean term insurance is like renting an apartment, where you get a set rental rate for x number of years. You rent an apartment for 20 years. When the 20 years is over, and you never had a rent increase, that’s great. When the 20 years is over, you have to move. Even if you’re not ready to move. It is rent. Now it’s not to say that term insurance is bad. I own some. But you have to own it for the right reasons because it’s purely rent.

Scott: So let’s transition here and think about is there anything else that you want to mention  in addition to life insurance. We’ve touched on real estate, it wasn’t really a big… I loved your comment on go big or go home. We talked about 529 plans. We’ve talked about Roth, backdoor Roth. We’ve talked about HSA. Is there anything else you want to kind of cover here before we move into our famous 4 and close out?

Eric: I’m excited about the famous 5, I mean 4. Here’s what I think we ought to consider — tax diversification matters as much as income diversification matters. So that’s number one. And number 2, absolutely avoid bad debt. Under all circumstances. There’s no good reason to have consumer debt basically ever. I do not consider mortgage bad debt so long as it is favourably structured because it’s leverage. You have an asset tied to it. But if there’s something that’s either becoming less valuable, like a car, or that set of skis that you threw on your visa card that you’re going to pay for in three years until you decided that you don’t ski anymore. Those are bad and you should never ever have them for any reason.

Financial independence is hurt more, I believe, by borrowing that anything. The next big crisis in this country is student loans. Hands down. That is a non-collateralised obligation that can’t be restructured due to bankruptcy. It is a disaster waiting to happen and these young people are making huge decisions. They’re making quarter million dollar decisions before they’re not to legally have a Budweiser and it makes no sense. 

Scott: I completely agree on that. We can get down that rabbit hole. But yes, student loan situation is absurd and I think that you nailed it with what you said which is the fact that it cannot be relinquished due to bankruptcy provision is what’s really driving, I think, this enormous bubble, you know if you want to call it that. The higher education system and student loans in general.

Eric: Imagine the day when a legislative body decides to change that bankruptcy provision. 

Scott: College tuition drops by 80%.

Eric: And look how many people declare bankruptcy.

Mindy: Everybody on the planet.

Eric: And look what that does to financial lending institutions. Sally May becomes the next Fanny May. I mean really, if that every happens, first of all, if that loan forgiveness or the change in bankruptcy laws were ever to happen, the ripple effect would be massive. You’re talking like a trillion and a half dollars. It isn’t some small thing. We’ve had people come into our office with as much as half a million dollars in student loan debt.

We had a couple. They had put themselves through undergraduate and graduate schools. Completely. Both of them completely on loans. They have what is like a $3,500 a month payment for 30 years. That’s a nice house but there’s no house.

Scott: I’m completely on the same page here. I think that the question is not if it’s when you can declare bankruptcy to get rid of student loan debt because too many people are going to, you can’t have indentured servitude or slavery in America. So at some point, that will change. I don’t know how it will work  or what it will look like if you use the word bankruptcy or not or you can declare it. But somehow, a portion of that is going to get forgiven. People are going to stop lending to people that were you know. Somehow, the debt will go away and things are going to change. I think it’s going to be a very scary and interesting situation.

Eric: Yes. And the fact that is we all see it coming and none of us know what’s going to happen. Or how or exactly when. But we know it’s big.

Mindy: Yes. So until that happens though, we have to deal with these student loans the way they are. And we have an episode coming up in a few weeks where I interview a guy named Zac Gaultier. I really hope I said that right. It’s a French last time. I’d call him Gaultier but I know he doesn’t pronounce it that way. He is going to tell us all the things you could do with the different levels of your child’s education and start planning for student loans and student scholarships to help reduce that burden to begin with. But that’s not this show.

Scott: And one more plug there as well. We also interviewed on Episode 41, Kyle Mast and he had some great tips about how to navigate very, very large amounts of student loan debts. So if you are a doctor with hundreds of thousands of dollars of student debt, just clearly have a situation where you cannot really recover from it. It’s not like 30 grand. That would be a good one to listen to. He’s got a lot of great tips around that.

Mindy: Yup. And all of these links will be on the show at BiggerPockets.com/MoneyShow54. But now, it is time for the Famous Four questions. These are the same five questions or four questions and a demand that we ask all of our guests.

Eric, what is your favorite finance book?

Eric: My favorite finance book is called The New Financial Adviser by Nick Murray. And the reason that I love it so much is because it is not only a blueprint for financial success, it’s a blueprint for financial success for financial advisers. And it became a really interesting read for me when I started my career 25 years ago and to me it’s still as practical as it ever was.

Mindy: Awesome. That’s not one that we’ve had before. But I don’t know, Scott, have you read that book The New Financial Adviser?

Scott: No I haven’t read that book.

Mindy: It sounds like it could help anybody even if they were not a financial adviser.

Scott: Yeah.

Eric: Yeah. In any business, particularly if you’re building a business that has the potential for recurring income, incurring revenue, it’s a model for that. And it’s a great model for it.

Scott:  Love it. What was your personal biggest money mistake?

Eric: Wow. There have been so darn many, how do I pick one? No. I think the biggest financial mistake I ever made was divorce. It’s one of the big ugly’s. When you go through a divorce, and you lose half or more of your assets to start over, that’s hard to recover from. And I think a divorce is a little like a death in the family but they keep dying.

Mindy: What is your best advise for people who are just starting out?

Eric: Best piece of advise for people who are just starting out is to immediately start putting away at least 15 cents on the dollar you make and avoid adverse debt and stick to it. And don’t ever listen to the financial news or financial media, traditional media at all because you will be on a roller coaster you don’t need. It’s not good for you. 

Mindy: Yeah.

Scott:  Love it. I think that’s fundamental. Start saving a bunch of it.

Eric: I mean it’s boring but it works. And time value money is on your side when you’re in your 20’s so why not. That and avoiding knee-jerk reactions, understanding the behavioral finance portions of it and monitoring your own behavior and emotional time is real, real important.

Mindy: I was just going to say. Don’t listen to the financial media is a very, very important part of that. So on Facebook, you scroll through and people are like, oh I’m buying, I’m buying, and then when the market dips, just this massive catastrophe, oh my goodness what am I going to do? Leave it.

Eric: And unfortunately, we are wired, we are hard-wired to do exactly the wrong thing at exactly the wrong time. Some of it is biological basis of behavior which is a show in itself and you ought to have somebody on for that. Daniel Crosby would be a great guest for you. A Phd and writes about Behavioral Finance. Amazing guy. in fact a great finance book is anything he’s written. It will help you understand why people do what they do, not just what they do. But in my opinion, we are our own worst enemies when it comes to this. And the world deserves better than Jim Kramer and Suzy Norman. And I think I’d like to participate in that.

Mindy: Oh my god. I have nothing further to say about that. Scott, you’re up.

Scott: What is your favorite joke to tell at parties?

Eric: I try not to tell jokes at parties because I’m profane and offensive to people very, very quickly. And I actually heard your last episode, if you had to tell the joke for somebody, and it was like a parent joke, so clean. I actually don’t have one. I try not to tell jokes because somebody is going to get upset about it.

Mindy: Ok, my friend.

Eric: Truly, you cannot not offend somebody anymore so I try not to.

Mindy: My friend Eric Otto has a joke for you. What do you call a deer with no eyes?

Eric: What?

Mindy:  No ideer.

Eric: Ok. See, you can tell that at a party but I encourage you not to. Not if you want to be invited back to those parties.

Mindy: I wouldn’t tell that at a party. That was my friend Eric’s joke.

Eric: Ok. Fair enough. And he’s not at the party anymore. I get it. That’s fine. I see.

Scott: It was a birthday party.

Eric: For a three year old.

Mindy: Eric, where can p people find more about you?

  

Eric: Two spots. One is at our company website which is at BrotmanFinancial.com and one is, if you want more information about these tax deferral strategies, I published an e-book, it’s a free resource. And the website for that is lowtaxbook.com. and you can download it and it has all kinds of information about those strategies including personal stories and always to lower your tax bill in a way.

Mindy: Awesome. We will put link to those on the show notes. You can find those at BiggerPockets.com/MoneyShow54. Eric, thank you so much for your time today. Happy New Year! And we will, I’m sure, talk to you again.

Eric: Also a happy new year to you. This was a ton of fun.

Scott: Awesome, thank you.

Eric: Alright. Yup. Buh-bye.

Scott: Alright, that was Eric Brotman. What do you think Mindy?

Mindy: Oh my goodness. Knowledge bomb after knowledge bomb after knowledge bomb. I really enjoyed this episode. And I love the energy he brings. Clearly, he’s passionate about his topic. And you know, just breaking down all of those ways to shelter your income from taxes to defer your taxes, completely eliminate your taxes, it’s just very, very helpful. I called Brandon Turner and asked for advise but that’s why I have my own podcast.

Scott: Yes. If you want to ask personal advise, go have your own podcast. I thought it was great. I thought you can leave here with a couple of steps you can make to really maximise the benefits in terms of your tax strategy and your overall wealth building plan. Again, HSA. We’ve talked about how you should max that out if you have one. And you know obviously, this is if you have all the bases covered, right? You’ve got to have a strong financial position and you’re scaling towards financial freedom. Then start doing this. Take care of business ahead of time. Pay off bad debt, all that kind of stuff.

But if you’re there, consider maxing out that HSA, consider maxing out that 401K, consider making a backdoor Roth contribution which I got to look into. I really haven’t thought about that. Really need to take advantage of that. Seems like a no-brainer at this point for me. The 529 plan, not sure I’m going to do that entirely in advance of what we call procreation for future Trenchlings that are unborn, unconceived. But that is a great way to talk about it.

And also real estate, a lot of advantages there. I liked what he said about don’t dabble in real estate investing. I think there’s some wisdom behind that. You know, if you’re going to buy one property in your lifetime. Or one or two duplexes, get $400 a month in cash flow and your plan is to earn six figures in your career, that portfolio is going to be much more of an annoyance to you than a real contributor to your long term financial position.

So you know, I buy consistently and aggressively. I think that there needs to be some thought put into that statement. I have to look more into life insurances tuff.  I thought that was really interesting. I never thought of that angle before.

Mindy: Yes I haven’t either and back to the real estate thing really quickly before we jump into the whole life. I really do think that what he’s talking about, real estate in little piddly amounts can just be a distraction. Because when you have one property, you still have to deal with the tenant that’s terrible, if you’ve got a tenant in there. Where as if you’ve got a whole mess of properties, one terrible tenant doesn’t just ruin your whole day. So I really think that’s a really great piece of advise that we don’t hear very often here at BiggerPockets Money. But you know, it doesn’t make it less valid just because it’s not the most popular opinion. If you want to, you know, invest in real estate, jump in with both feet.

Scott: And I think if you’re listening to this show, obviously one component of your future portfolio I think is probably going to be real estate. You know if you’re here on BiggerPockets, you’re thinking about that as one of the techniques you may use in your portfolio as you build wealth over time. But I also think, you know, hey it’s perfectly fine to not use real estate at all and build a huge fortune. There’s a lot of ways to do it that you can go about it and I think that it’s really not the best place to dip your toe in the water one time ever. I think there’s a ton of obviously huge benefits if you dive in. Otherwise, I wouldn’t be here.

Mindy: Totally agree but I also agree the real estate can and probably should be a huge portion of your portfolio. It’s about 50% of mine. And I’m ok with that.

Scott: Me too.

Mindy: Ok, Scott, shall we get out of here?

Scott: Let’s get out of here.

Mindy: Ok. Happy New Year from the BiggerPockets Money crew, Mindy and Scott, from Episode 54 of the BiggerPockets Money Podcast. We’re gone.

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They rarely do anything like this but they’re doing it just for us!

In This Episode We Cover:

  • His definition of the term “retirement”
  • What he sees a lot of people do after they retire professionally
  • A discussion on tax management
  • The advantages of a Health Savings Account (HSA)
  • Tips for tax diversification
  • The current contribution limits for HSA plans and Roth IRAs
  • What a backdoor Roth IRA is
  • How to reduce your taxable income in order to sell stocks without paying capital gains
  • His thoughts on the 529 Plan
  • The concept of moving wealth between generations
  • How to use a stepped-up basis for inherited property and other assets
  • Advice for using life insurance in building wealth
  • Two fundamental kinds of life insurance
  • A discussion about term insurance and permanent insurance
  • And SO much more!

Links from the Show

Books Mentioned in this Show

Tweetable Topics:

  • “The idea of retirement is not the absence of work; it is the absence of needing the work.” (Tweet This!)
  • “I see retirement as a graduation from punching a clock for a cheque to doing things that empower you, that are important to you.” (Tweet This!)
  • “Financial independence is really about perpetuating the income that you’ve enjoyed adjusted for inflation forever.” (Tweet This!)
  • “Real estate is not a hobby but a business.” (Tweet This!)
  • “Flipping houses is brilliant from a tax perspective if you don’t mind living in squalor.” (Tweet This!)

Connect with Eric

 

Disclaimer: Eric offers securities through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. Kestra IS and Kestra AS are not affiliated with Brotman Financial Group, BFG Financial Advisors or any entity referenced herein. Neither Kestra IS nor Kestra AS provide tax or legal advice. The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra IS or Kestra AS. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. Comments concerning the past performance are not intended to be forward looking and should not be viewed as an indication of future results. All guarantees are based on the financial strength and claims paying ability of the issuing insurance company, who is solely responsible for all obligations under its policies. Products and services may not be available in all states. The amount of benefits provided depends upon the plan selected and that the premium will vary with the amount of the benefits selected. Riders and conversion provisions are subject to additional costs.

 

 

About Author

The BiggerPockets Money Podcast is for anyone who has money… or want to have more! Join BiggerPockets Community Manager Mindy Jensen and Director of Operations Scott Trench weekly for the BiggerPockets Money Podcast! Each week, financial experts Mindy and Scott interview unique and powerful thought leaders about how to earn more, keep more, spend smarter, and grow your wealth. You'll get tips for getting your financial house in order and actionable advice from guests who have been in your shoes - and found their way out.

10 Comments

  1. Katie Rogers

    The discussion of the usefulness of whole life insurance is spot-on. My life insurance has been great over the years. It was so good I bought it for my children. Perhaps it was timing, but my policy has grown wonderfully, but my children’s policies have yet to exceed the contribution levels.

    As you mentioned, term insurance is like rent, but it does have its purposes. Term insurance is a bargain for its purposes because it is only a small fraction of the cost of whole life insurances.

  2. Jim Costa

    I must say, this is one of the best episodes I have heard. This is full of practical information. Not a lot of real estate information but great investment/strategy information for those that have rental income and looking to create generational wealth. You can tell by the way Eric speaks he is very knowledgeable about his subject matter. Could have listened for another hour of getting into the weeds.

  3. Dominic Scatto

    Great show! I’m going to be switching my term life to whole life after listening to this! I do have a question, and this may be a dumb one, but should I drop my employer’s health insurance that only offers a FSA in favor of a private health insurance where I can get a HSA?

  4. Katie Rogers

    Compare the prices of the employer’s FSA with a private HSA. Pay particular attention to the deductible. Depending on your financial situation, if the deductible is too high, you may be better off staying with your employer. Usually you can participate in the emplyer’s group policy without bothering with an FSA.

  5. james luntz

    woah woah woah. Back the truck up here. Before we all toss our term policies and buy Eric’s insurance let’s talk about this!

    This episode was great, it really caused me to stop and question a few things (had to back her down from 1.5x to 1.0 and still went over a couple areas a few times.

    – It is a bit misleading to say paying back a 401k loan with after-tax money is a bad thing. The initial balance and loan was with tax-deferred money. There is no double-taxation here. If you took a 50k 401k loan and spend the money, you are spending pre-tax dollars. Think of it as having access to 401k early and paying ordinary income taxes on it and then spending 50k. The only difference is you have to pay it back.

    – any “interest” or “fees” are paid to yourself. But that should only include the opportunity cost of what is happening in the market. If the market is netting 5% after inflation then your “cost” is the 5%. It should be the same as the example Eric gave. you’re trading an 7.5% loan for 5% opportunity cost – you net the 2.5% difference.

    – I didn’t hear any treacherous ugly reasons not to take the 401k loan here. I do believe there can be some issues if you separate from service.

    but don’t take it from me (who has never taken a 401k loan): https://www.investopedia.com/articles/retirement/08/borrow-from-401k-loan.asp

    I am, again, not an expert here, but I have never been shown any scenario where a young person pursuing FI living way below their means and, hence, typically not having a crazy high net worth, would be better off to purchase whole life insurance over term. More than once, Eric compared to term life to being a renter. I like the analogy (especially on BP), but I (as a homeowner just foolishly piddling with a single 4-family) think renting is a very good option for many people – especially those pursuing FI!

  6. Karen Young

    Always ask the insurance salesman/woman what their commission is on a product. Whole life policies pay high commissions; term does not. Make your choice when you have all the facts.
    I’m a simple person and I like to keep my insurance and investments separate.

  7. Mark Limke

    I’m a survivor of the 1980s. A big era for “buy term and invest the difference.” Back then, we caught on to the folly that is whole life, and made a big course correction. There was a major push to replace whole life policies with term and put the (substantial) savings into mutual funds. It was really catching on.

    Consumers got much more coverage, which they needed, and the potential to earn a sh*t-ton more money in the long run. You should see the comparison graphs. The concept sold itself once you just showed the facts. People were surrendering whole life policies (and stopping the commissions) right and left.

    This scared the hell out of insurance companies and agents. In the years that followed, they flooded the media and later the Internet with a flood of counter-factual and biased information making a great idea (BTID) sound bad. The original ‘fake news,’ perhaps. Now you’ll likely see “buy term and invest the difference” linked with “myth.” Righhhht. Just what the sales folks (like our esteemed guest) want you to think. But wrong.

    Go get some independent education about insurance. Whole life is not *one* of the poorest tools for your financial plan. It is THE worst. Well, maybe annuities, they dip from the same well. And yes, I’m sure there are some niche situations where a life policy will help, but not you, and not me, and not our friends and neighbors.

    I really wish Mindy and Scott had researched insurance before this so they would have known some hard questions to ask. They gave Mr. Brotman a pass, undeserved.

    Don’t let the whole life tragedy happen to you!

    • Katie Rogers

      It is possible that whole life is no longer a decent product. My whole life insurance is 40 years old, and yes, the level premium was expensive in the first years, but now the premium is cheap. My policy has served me well, paying a guaranteed 3.5% interest rate, no matter how low regular savings rates fell. The ability to borrow for less than the bank personal loan along with the flexibility to pay it back on my timeline rather than the banks has been a great feature and a wonderful safety net for my family. If I were to surrender the policy now, there would be a whole lot of taxable gain.

      I have to admit that my children’s whole life policies which they have had for twenty years, are not performing as well.

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