Thread by @baldridgecpa

A fundamental tax concept that many people never quite catch that can cost millions in your life (and death).

The principle of having a LIFETIME EFFECTIVE TAX RATE

LETR - total tax you pay in your life / total income you make in your life

Time to think big - 1/n

Scenario - Person A works most of their life and ends up with a substantial net worth.

Timeline:

1. Grow up
2. Go off to college
3. Work your first job
4. Go to biz school
5. Back to work
6. Start a family
7. Start making good money
8. Make great money
9. Retire
10. Turn 72

Notice this fictitious person doesn’t really start earning big bucks until step 7, and probably doesn’t pay big taxes (30%+ effective tax rate) until step 8.

Their highest earning working income years are concentrated in a narrow band of their lifetime - probably <30% in total

You start paying taxes the day you are born. The Gerber baby - that kid is a taxpayer.

You also pay taxes up through the day you die via the estate tax if you have a gross estate larger than 11.7 MM

Long term tax planning starts ASAP and factors in your entire life and death.

Childhood - this can be a missed planning opportunity for high earner business owners.

Put your kids to work. Two benefits:

1. Working kids can set up a Roth IRA. They are generally below the income threshold and have earned income.

2. Parents can offload income at a lower tax rate. In the current tax regime high earners are not receiving exemptions or deductions for their kids.

Caveat - in order to pay your kids the need to actually work. This can include modeling services (see baby Gerber) or other work.

College - this gets even better. HNW folks can hire their kids to work part or full time while they go to school. Over 18 and making more than 1/2 their own financial support, your child becomes a full fledged taxpayer, with all the tuition credits, stimmy benefits, etc.

Again - you were getting no benefit or exemption for your kid as a high earner, and now you get a deduction at the highest rate for paying them and they pay very little tax as a low earning student.

Same caveat as above - they need to do actual work to earn their comp.

First job - the most valuable advice you can give to young people entering the workforce is to pay your taxes.

What???

Generally in your 20’s as you are growing your career, you are in some of your lowest earning years.

Low earning = low tax

Utilize your Roth 401k here.

Think about front loading taxes and making long term decisions here.

I wouldn’t suggest saving in a pre tax account until you are in the 32% marginal bracket if you are going to spend a substantial time in your life in the top marginal bracket.

This is a great time in your life to build a foundation - eliminate student debt, consumer debt, house hack or buy a multi family investment, etc.

Enjoy your time w/ relatively low taxes - I meet lots people who tried to be tax efficient here that ended up paying for it 10 fold.

Mid life - you’re finally making good $$ and learning the pain of what it feels like writing big checks to the IRS.

This is the point in time where deductions become valuable - your marginal federal tax rate is in the high 30’s and the state is taking their chunk as well.

Deductions are your friend here, and there are several strategies to find them.

If you are a business owner it’s simpler - start taking ordinary expenses that exist in your life and make sure you are taking every biz expense out there.

If you are a W2 worker it gets tricky.

Strategies to find deductions

1. Everything already available - max your 401k, hsa, thrift plan, etc. It is forced savings, and it will save you taxes. You’ll most likely realize this income later in life at a lower tax rate.

2. Side hustle - find a source of income that can support expenses.

When I had my w-2 job I paid for most of my life’s expenses post tax. Becoming self employed allowed me to pull a lot of life’s expenses above the tax line.

Think cell phone, auto, subscriptions, education..

3. Deferred charitable giving - especially useful for cash windfalls, you can contribute to Donor Advised Funds to save tax while you earmark many years of charity.

4. The crazy stuff - conservation easements, historic tax credits, solar credits, etc.

Pay $1 for >$1 savings.

Retirement - these can be great years for folks to move forward income - if you are 59.5 you can start to pull cash from your IRA or elect Roth conversions. This can enable you to more effectively set your tax rate as you retire.

It is usually a waste to post a $0 tax year here.

Late life - this is where all the tax deferrals come due. You did the right thing to save, and you will be forced through RMDs to pull out your qualified savings, or those will be passed to your children.

Wealthy folks often still pay high income taxes at this stage in life.

High Net Worth - Once you get to the point where you have amassed a growing asset base, and will die with more than $10MM, it’s time to start thinking about your estate.

It’s better to start early. Easier to throw a acorn over a fence than to pick up and move an oak tree.

Beyond saving on income taxes, asset protection and estate planning are most important for high net worth folks.

There are tons of tools out there to help achieve this end.

Insurance products, trusts, entity setup etc all help to achieve this end.

Trusts - there are many different types of trusts that achieve many different objectives -

Are you looking to save on state income tax on an upcoming asset sale? Consider an ING trust.

Pass down your wealth without getting hit with estate tax?

Protect assets from creditors?

Depending on many different circumstances (resident state, are your parents living?, married?, children?, goals?) there are many different decisions you will make.

Hire competent CPAs and attorneys. Expect to pay for setup and maintenance. Weigh the lifetime cost v benefit.

As your wealth grows, so does the complexity of your financial and tax planning, and the time horizon you must consider.

Billionaires should consider how their wealth will impact their great grand children.

It’s good to begin with the end in mind, but there are many unknowns.

You don’t know what will happen with your business, the markets, the tax regimes, etc.

You can only take what you know today and what you guess the future might hold and do your best to make good business decisions.

Try your best to think in decades, and save what you can!

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