This blog aims to explain how business owners and real estate investors can and should protect and grow their wealth (nearly) tax free in the effort of becoming a “Capitalist” as soon as possible.
Which Do You Want to Be?
Laborer: A person who is employed/self-employed and works for income that is used for living expenses.
Capitalist: A person who manages and invests capital for profit that is used for living expenses.
If you choose Laborer, this blog is not for you. If you answered Capitalist, please read on!
A Place to Begin
Before we get to the 3 secrets you need to know to grow your wealth (nearly) tax free to become a Capitalist more quickly, let’s start with one of my favorite acronyms.
KISS … Keep It Simple, Stupid!
This is my approach to life and to investing. This does not mean there is no complexity involved. To the contrary, investing is very complex. But with so much information available, and so many laws on the books, we need to break all that complexity down into a simple system that we can easily execute in the little time we have left after our family, business, health, and faith.
This is the challenge I pondered for years. Compounding this challenge, while they taught me business in business school and law in law school, I have never been taught how to invest. This is simply not taught as part of the general education we get in the United States.
So, after I worked 40+ hours a week for an entire year and was in complete control of my business and its profits, how was I to invest the money that remained after paying my taxes and my family’s living expenses?
Was I supposed to just hand over control of this and my family’s fate to a financial advisor who had only handled my liquid investments, such as stocks and bonds, but gave me no advice on real estate?
Well, that is exactly what I did and after 3 years I had only half of the money I had given him.
This was definitely not going to work!
Let me be clear, I am not saying financial advisors are not a valuable resource. To the contrary, they are extremely valuable. But for me to hand over my money with little to no understanding of what stocks were being purchased or how it was being held or managed was just reckless on my part.
It turns out he had nearly all of my money in dot com companies and then the dot com bubble burst. Had I been a more astute client, AND MORE INVOLVED WITH MY FINANCIAL ADVISOR, all of my money would not have been in dot coms.
Of course, I implemented other investment “strategies” after that, but none of them worked so well either, again, because I had no idea what I was doing. I’ll save you the pain of my many failed attempts at investing. Instead, let me just say that my plans to become a Capitalist were in serious jeopardy.
It was at this time the “light” went on, and I came to my first really good investment decision. I was no longer willing to work an entire year only to then entrust my family’s future, my retirement, and my desire to be a Capitalist, to someone else. I had to be involved with my financial advisor, CPA, attorney, and other advisors. I had to learn how to invest. I had to give myself the education that the American school system never provided. I needed to invest time in the investment of my money.
My Primary Focus
This newfound commitment to gaining an investment education sounded great in theory, but how was I to find the time for this education? My business was much bigger than my investment portfolio, and certainly produced more income than my investments. How was I to take time away from my business to spend on my investments?
I struggled with this for quite a number of years, too. I did not have the time to do everything I needed to do with my business, so how was I actually going to take time away from that to spend on learning about investing?
I must admit, it was very frustrating. I was earning good money but without a plan to multiply that money into more money by investing, it seemed like all my hard work at my office was going to waste. How was I ever going to get my investments to produce as much income as my business so I could become a true Capitalist? It was around this time that I started playing around with the math.
If you average 10% return on your investments, you will double your money every 7 years.
So, if I put aside $100,000 per year for investment and I could average a 10% annual return, that $100,000 would be worth $200,000 in year 7, $400,000 in year 14, $800,000 in year 21 and $1,600,000 in year 28. So, if I put aside $100,000 per year now and did that every year, then beginning 28 years from now I would have $1,600,000 every year for 28 straight years.
While not much time went into this computation, it certainly gave me some clarity and hope.
If all I had to do was manage and invest my capital, and I could average 10% per year, I could become a Capitalist and this certainly seemed better than spending 40+ hours a week working inside my business. I felt like I was starting to get somewhere, so I kept going.
I remember reading in several places that you can reasonably expect to live off of 4% of your total investment portfolio without decreasing the value of your portfolio. I thought it would be great to have $1,000,000 per year coming in and $1,000,000 is 4% of $25,000,000, so I started thinking about what it would take to get to a $25,000,000 investment portfolio.
To figure this out, I started with $25,000,000 and worked backwards. 7 years before I had $25,000,000, I would have to have $12,500,000 and 7 years before that I should be at $6,250,000 and 7 years before that I should be at $3,125,000.
So, if I could get to $3,125,000, I would be just 21 years away from $25,000,000, right? But what if I got to $3,125,000 and then, in addition to growing my portfolio by 10% annually, I also contributed more money each year from my business to my investment portfolio? Wouldn’t this speed up the process? Would I be able to get to $25,000,000 even quicker?
I played around with these figures, the math, and many spreadsheets when I wasn’t busy running my business. I plugged in many different scenarios that took into consideration many different uncertainties and “what if’s.” In the end, after about 3 months of being totally obsessed, I came to one very simple conclusion:
I absolutely had to immediately make investments a part of every work day. From now on, it would be the amount of my invested assets, not my business profits, that would be my primary focus, and my business profits would no longer be viewed as the goal, but as a means to achieve the goal.
So, it was at this point that I made investments not just a part of my business, but my primary focus. There had to be time for my investments that was scheduled on my calendar just like everything else in my life. After delegating some tasks to others, and making other to-dos more efficient, I carved out 1 hour for investments each day and spent the rest of my time on everything else.
Carrots and Sticks
While it was certainly a good start, with only one hour per day, I did not have a whole lot of time to figure out this “investment” thing so I had to definitely keep it simple. All of my math and calculations and spreadsheets were great, but there were two HUGE questions that needed to be resolved.
First – How was I going to average a 10% annual return?
Second – Even if I averaged a 10% return, wouldn’t I only have about 7% after the government takes its cut?
The remainder of this blog will focus on addressing the second question.
(Nearly) Eliminating the Government’s Cut
The government uses two kinds of tools to get us to do what they want: carrots and sticks. If you are not sure what the stick is, go on a robbing spree and when you land yourself in jail you will know. The government does not want you robbing other people and they will hit you with a stick if they catch you doing it.
With that out of the way, let’s talk about the carrots.
First (Nearly) Tax Free Secret – Retirement Plans
The first (nearly) tax free secret that you need to know about is retirement plans. The government wants you to put money away for retirement so you will not be a burden on society in your retirement years. To advance this agenda, they have enacted laws that allow you to “defer” taxes on income you earn from your business, and on the growth of that income when invested, so long as you earmark that income and its growth for your retirement, which you can do by putting it into a qualified retirement plan.
By investing your excess business income through a retirement plan, your money can grow tax deferred. So, using my above example, if you realize an average annual return of 10%, your investment will actually grow at 10%, not the 7% figure I estimated if you had to pay taxes on the growth each year.
Of course, when you pull money out of your retirement plan many years from now, called a “distribution”, you will have to recognize those distributions as taxable income which is the trade-off for not paying taxes on the business income you used to fund your retirement plan in the first place. But despite the taxes due on the distributions, you still want to maximize the use of retirement plans because the tax benefits of doing so are too good to pass up, and will help you become a Capitalist much quicker.
Unfortunately, there is a limit as to how much income you can put into retirement plans each year and also some rules that restrict your use of retirement plans, and for these reasons, you will only put a portion of your excess business income into your retirement plans.
Second (Nearly) Tax Free Secret – Real Estate
The second (nearly) tax free secret that you need to know about is real estate. The government wants you to invest in our country’s land which provides stability for our country’s economy. There are two types of economic benefit when you invest in real estate: growth and income.
1. Growth
To advance the government’s agenda, laws have been enacted that allow you to “defer” taxes on investment real estate growth, referred to by the government as “capital gain,” so long as you keep that money invested in real estate. For this reason, I frequently tell my clients:
“If you are going to put a dollar into real estate, put it in forever.”
Suppose you want to sell that property and use the proceeds to buy a different property or perhaps two properties? This is referred to by the government as an “exchange” and so long as you comply with the rules, you still do not have to pay any taxes on the growth. Stated in a more CPA friendly way, you do not have to pay taxes on the unrealized gain.
You can continue to hold and grow your real estate portfolio and defer the payment of taxes on the growth until you sell the real estate and pocket the money, which I encourage you to avoid if at all possible. I do not describe the “growth” part of the Second Secret as “tax free” because you could decide to sell the property, take the money out, and pay the tax. Instead, I call it “tax deferred,” but by now you should understand that the tax can be deferred indefinitely.
2. Income
So, how does your real estate portfolio produce income for you? How are you going to get the income you need from your real estate each year after you become a Capitalist?
Again, to advance the government’s agenda, laws have been enacted that allow you to “shelter” taxes on real estate income.
Have you heard of a depreciation expense? Real property is divided into two parts, the land and the improvement on the land and the government will allow you to depreciate a portion of the value of the improvement on the land each year.
If you own your real property the right way, the depreciation expense – which is not an expense you actually pay, but just a “paper” loss that the government allows you to take on your tax return – will be approximately equal to the income and therefore, you will pay very little, if any, tax. I do not describe the “income” part of the Second Secret as “tax free” because you could end up paying a small tax. Instead, I refer to this as “tax sheltered.”
So, what do you do with the tax sheltered income you receive from your real estate investments and where do you hold your excess business income while you are waiting for the next good real estate opportunity? This question is answered with the next secret.
Third (Nearly) Tax Free Secret – Index Funds
The third (nearly) tax free secret that you need to know about is index funds. The government wants you to invest in stocks of publicly traded companies which provides stability for our country’s economy. To advance this agenda, they have enacted laws that allow you to “defer” taxes on all stock growth so long as you continue to own the stock.
If you are buying and selling stocks on your own, then you have to pay taxes each time you make a profit. If you are investing in a mutual fund that buys and sells stocks, then again, you have to pay taxes each time a stock is sold for profit. But if you invest in an Index Fund, which is a mutual fund that tracks an index, there will be very little turnover and you will pay very little tax.
John Bogle, the founder of Vanguard, is generally considered the father of index funds, an idea he launched in 1976. The S&P 500 is an index of the 500 largest companies in the United States, so when you invest in one of the largest mutual funds in the world, Vanguard’s S&P 500 Index Fund, your money is invested, on a weighted basis, in the 500 largest companies in the United States.
Because index funds have very little turnover (the buying and selling of stocks), there is less taxation. For this reason, Vanguard’s S&P 500 Index Fund is likely to pay nothing or next to nothing in taxes. I do not describe this Third Secret as “tax free” because you could end up paying a very small tax. Instead, I refer to this as “tax efficient.”
Critical Insights to Become a Capitalist
First, if you want to become a Capitalist as soon as possible, you will have to spend some time learning to invest. You simply cannot delegate this responsibility to someone else just as you cannot delegate the responsibility of running your business to someone else. You will need to be involved at the very least to help establish the investment policy and/or mandate.
Second, because your time is limited, you will need to keep it simple. The purpose of this blog is to give you a simple system for investing that you can easily implement.
In this blog, I have referred to these 3 Secrets which are a combination of “tax deferred,” “tax sheltered”, and “tax efficient” as “(nearly) tax free” because you may still pay some tax, but it will be much less, unless you decide to sell your real estate investment and pocket the money (which I would advise against).
These 3 Secrets are the first step to understanding a very simple investment system I have deployed for myself and my clients, all business owners just like you who need to invest successfully to become a Capitalist, but who struggle to find the time for it. Of course, there is so much more to it. Much of the details will be in future blogs, covering how to average a 10% annual return on your investments.
Having been an asset protection attorney for many years, I have been around a lot of assets, from businesses to real estate, to stocks and bonds, gold, Bitcoin, and so many more. While there is a ton of information on each of these assets, no one is making it as simple as I’d like it, so I had to do it myself. I know that you are working hard every day to build your wealth. It is not enough for me to just help you protect your assets, I want to help you grow your wealth!
Please contact me for a private phone call if you think I may be able to help you protect and grow your wealth.
Decide and Commit to Taking Action
If protecting your assets is important to you, consult with an asset protection attorney to speak about the many aspects of your investments, trusts, and your businesses. Sollertis is a nationwide law firm with attorneys licensed in California, Florida, Michigan, New York, and Texas, with a network of attorneys helping people in other states.
Sollertis primarily helps real estate investors and business owners grow and protect their wealth. Our legal team combines superior expertise and decades of experience to plan, implement and maintain your protection. We can guide you through the intricacies of crafting a master asset protection plan and help you make informed decisions regarding the best approach to protect and preserve your assets for yourself and your future generations.
Now You Know
There are many asset protection tools available to protect your assets. But remember, asset protection is like insurance, it doesn’t work unless you have it in place BEFORE THE CLAIM. So, don’t wait until it is too late to plan or implement. You’ve been working very hard for a long time to build your wealth. Pull your winnings off the table by protecting them now.
Take the first step today and reach out to the experts in asset protection at Sollertis.
