What does tax-free wealth mean? Is it a feasible option to grow your wealth? Well, the truth is growing your wealth tax-free is possible. This article explores the different ways of achieving this.
Do you want to keep more of your hard-earned money? Of course, you do! Who doesn't? Taking advantage of tax-free wealth opportunities is one way to achieve this.
But where do you start?
It's not a secret that most people in developed countries spend a good number of their working life (25-35%), making money for the government. Now, when you think of it this way, you undoubtedly want to get some of this money back.
Today, we will discuss tax-free wealth and how you can take advantage of it. We will also provide some tips on how to get started to help ensure that you retain more money than before.
But, before we get any deeper, let's understand the main concepts.
What is Tax-Free Wealth?
Generally, if you ask many people if it's possible to make more money but pay fewer taxes, they would say no. Most would think that the only way to pay fewer taxes is through tax evasion or earning less income.
But, I'm here to tell you that it's possible. You can make more money, grow your wealth, and still pay fewer taxes.
By definition, tax-free wealth is simply, as the name suggests – growing your wealth while paying less or no taxes.
If you don't want to continue spending a lot of your time and money paying for those hefty taxes, there is a way out. While tax laws are meant to ensure that you pay taxes like any other law-abiding citizen, you can also take advantage of the same laws.
If you can't use these tax laws to your benefit, the increased inflation coupled with the high taxes will take a toll on your purchasing power. And this will only mean fewer opportunities for getting rich or building more wealth.
Tax and Wealth Management
If there is something you don't want to outsource, it's issues concerning taxes. Fully understanding the concept of taxes and how it works gives you an upper hand in managing your finances. It will even help you in growing your wealth.
If you want to grow your wealth, you certainly can't avoid taxes. This means that you must learn and understand the basics of how taxes work – at least the basics.
While most people look at taxes as a plague or something to be feared, scholars like Tom Wheelwright view it from a different angle. To them, the tax code is a series of incentives for taxpayers and investors. And, they urge you to use these incentives to reduce your tax burden.
Generally, most people think that they have no choice when it comes to paying taxes and the amounts they should pay. The notion is everyone pays taxes, and so should you.
Well, that's where most of us go wrong. The hard fact is millions of people pay little or no tax – legally. Meaning their wealth continues to grow tax-free.
So, how do they do it? Are there some loopholes in the tax system that we don't know? Not really! The secret is in understanding how tax laws work.
These people take their time to learn and understand the tax law. They have realized that tax laws are not instruments by the government to raise taxes. Instead, they are tools that governments use to shape the economy by promoting social, energy, and agricultural policies.
For these reasons, these people take the tax law for what it is – stimulus packages and incentives for investors and entrepreneurs. But, how can the tax law work in your favor?
How to Build Wealth by Lowering your Taxes
In developed countries like the US, about 95% of the tax code is designed not to increase the amount of taxes you pay but rather encourage economic, energy, and agricultural activities.
The tax law is simply a guide or map to enormous wealth if well-understood. Through the tax code, you learn both how to reduce the taxes you pay, as well as how to amass vast amounts of money and wealth.
However, before you start building your wealth by lowering those taxes, there are a few things you should note.
- If you are still employed, you might not have a good chance of enjoying the said tax incentives (although you still can). To fully take advantage of the tax stimulus and incentives, you need to have a business or be a real estate expert.
- You must understand why it’s important to track hours for the real estate professionals.
- Learn how to view audits in a positive light.
- Learn what millionaire real estate investors do differently from the average investors.
With these few tips, you'll understand why some people or investors seem to make money more easily than others. And this can be your turning point to start amassing incredible amounts of wealth.
Generally, your government wants you to grow. When citizens grow, so does the economy. This means that the government offers incentives for you to invest in the economy, local agriculture, or local energy production activities.
These are three major areas where you'll be able to lower your taxes and start growing tax-free wealth.
Best Strategies to Grow Tax-Free Wealth
If you want to grow tax-free wealth, the following strategies will help you do just that. They give you the basic principles of making enormous amounts of money.
1. Make Tax Planning Part of your Wealth Strategy
All too often, many investors ignore taxes when investing or formulating their wealth growth strategy. In most cases, considering their ROI (return on investment) as the money earned before paying taxes.
This is absolutely wrong!
The fact is, taxes are the biggest expense in your investment income. For this reason, the most prudent way to go about it is to look at your ROI after paying taxes.
When you do this for all your investments, you might even realize that the investments you thought were making money are making less than others, and vice versa.
Let's take a classic example of two investors in the US. One invests in real estate and the other one in the stock market.
Let's assume that the first investor bought a rental property worth $500,000. The investor uses $100,000 from his savings and the rest $400,000 from bank financing. Now, assume that the investor's annual ROI ends up being 7% of the $100,000 before taxes.
On the other hand, the second investor puts the same $100,000 in the stock market. But as for the ROI, this investor gets a whopping 10% return on the $100,000 before taxes.
Looking at these two investors, the second investor seems to have made a better return. However, this is quite far from the truth.
Now, let's include the tax aspect in these two investments:
The second investor pays around 20% in capital gains, leaving them with $8,000 from the $10,000 annual return. On the other hand, the first investor pays zero tax on their $7000 return on investment due to the depreciation effect.
In addition, real estate investments lower the payable taxes on salary and business. This way, with the $7,000 positive cash flow, the depreciation deduction will be around $27,000, resulting in a tax deduction of around $20,000 in the other income. And, for a normal 30% tax bracket, the extra $20,000 deduction is worth around $6,000.
This means that the real estate investor has an ROI of $7000 plus $6000, adding up to $13000. The second investor only has a total of $8000. This means that considering taxes even before you start investing is quite important.
2. Invest Where You Travel
One may wonder how traveling, investing, and taxes can relate. Well, I have a shocker for you. Travel can become one of your biggest tax-deductible expenses.
How does this work?
If you love traveling, you certainly have a favorite travel destination. This means you travel to the place quite often. If you invest in this place, it means that you can go check on your investments during your frequent travels.
When it comes to taxes, you can include travel expenses into your deductible expenses. That's right! Any travel expense can become a deductible expense, adding more money to your pocket.
As long as your primary reason for travel is business, your travel expenses become part of your business expenses. This means while you'll still enjoy your time there, as you usually do, those expenses won't hurt your pockets.
And to make things even better, the option doesn't discriminate any expense. You can include all expenses right from air tickets, accommodation, meals, etc.
However, for this strategy to work, there is a catch. The IRS requires you to allocate more time for the said business than the time you spend having fun there. This is the only way you can turn your primary reason for travel to be business.
So, if you love traveling to the Caribbean, why not travel for both business and pleasure? And, you'll be amassing tax-free wealth while at it.
3. Decide how the Government Taxes Your Limited Liability Company
If you didn't know, you could make your company whatever you want for tax purposes. Generally, limited liability companies have become quite popular for entrepreneurs seeking asset protection. And you can also manipulate it when it comes to taxes.
Fortunately, LLCs offer flexibility, allowing you to decide what you want it to be. You can make it a sole proprietorship, a C, or an S Corporation. With this choice, you have a better chance of protecting your assets and taking advantage of the tax law.
If your country doesn't have LLCs, the LLPs (limited liability partnerships) might offer you similar advantages. In essence, understanding the LLCs helps you to lower your taxes while still enjoying asset protection.
After deciding which type of company you want, always ensure that you select the proper tax entity. You do this by ensuring that you check the right box on the entity election form from IRS. Failure to do so prompts the IRS to make a choice for you.
The choice you make will have a significant effect on the amount of taxes you pay.
4. Meals are a Deductible Expense
As I mentioned earlier, almost any expense can be turned into a deductible expense. This includes travel, entertainment, accommodation, and even food. In fact, even your house can fit among these expenses.
All you need to do is to make those expenses become business expenses. For instance, the US tax law demands any business expense to pass three main tests.
The first one is that the expense in question must be intended for the business. For example, any cost incurred must primarily be intended for the business.
This means if a meal is to qualify as a business expense, it must be during a business meeting. Also, if you are on a business trip, the meals taken then can be part of your business expenses.
The second test considers the nature of the expense. If a meal is to be considered a business expense, it must be usual or ordinary. Meaning it should be a typical expense like what any other person in your industry can spend.
Therefore, don't go overspending and trying to make this a business expense. It might not work.
For example, you must first identify the typical cost of a meal in your industry. A lunch with a business associate for a driver will certainly cost less than a lunch for two movie stars. Therefore, be sure you are traveling in the right lane.
Lastly, not every expense should be categorized as a business expense. You should ensure that the expense was necessary. In other words, the intention of this expense should be to generate more money for the business.
If an expense doesn't fulfill these three requirements, then it doesn't qualify to be a business one. But if it does, it means fewer taxes and more tax-free wealth.
Best Tax-Free Investments You Should Consider
To create tax-free wealth, you must know the best investments to help you do it. In addition, you must identify the best tax-free wealth tools and vehicles to help you reach your goals.
Here are some incredible tax-free investment options that anyone can try:
1. 401(k) / 403(b) Retirement Plans
If you are employed, retirement plans are an excellent way of achieving tax-free wealth over a long period. For instance, a traditional 401 (k) retirement plan allows you to contribute towards your retirement, deducting your contributions before tax. This means that your AGI (adjusted gross income) will be lower, and so will be the payable taxes.
However, while the contributions are not taxed, the withdrawals will be taxable. Generally, employers match the contributions you make up to a specified amount. The earnings in this plan grow tax-deferred.
You can also opt for a Roth 401 (k) plan. Here, the contributions are made after taxes. But, unlike in the traditional 401 (k), the withdrawals are not taxed.
For those employed by non-profit companies, the 403 (b) retirement plan is a great option. Like the 401 (k), this plan uses pre-tax contributions with tax-deferred earnings. However, employers here may not match your contributions.
These plans are excellent options for those looking to grow tax-free wealth by lowering taxes.
2. Traditional IRA / Roth IRA
For tax-conscious investors, an Individual Retirement Account is also a great option in growing tax-free wealth.
In these two retirement accounts, the maximum annual contribution is $5,500 if you are under 50 years. If you are above 50 years, both accounts allow contributions of up to $6,500.
The only challenge is that company retirement plans and income limits can influence your eligibility and deductions. For the traditional IRA account, pre-tax money is invested tax-free, and you'll withdraw it at a lower rate.
On the other hand, in Roth IRAs, post-tax money is invested tax-free. But, withdrawals here will be tax-free.
While high-income earners might have a challenge investing with Roth IRA, there's a way out. It is possible for them to first invest with the traditional IRA but later convert this to Roth IRA.
3. Municipal Bonds
Usually referred to as “muni,” these are state, city, or county-issued bonds that help finance their spending.
Investing in such kinds of bonds isn't a bad idea. Generally, these bonds are guaranteed by government entities, making them safer for the investors. The only drawback is that they offer lower returns.
Some of these municipal bonds help you avoid taxes from the federal, state, and city governments. Although this depends on where you live!
But before you invest in these bonds, thorough research is necessary. This helps you determine the rate of returns and related taxes, to establish whether they are worth your money.
4. Tax-Free ETFs
The goal here is to identify the best tax-efficient investments to help you grow tax-free wealth. Exchange-Traded Funds are an excellent option. Usually, ETFs attract fewer costs and are quite flexible compared to mutual funds.
As for the tax benefits, they are dependent on the types of bonds an ETF holds. In the US, government bond ETFs are sometimes state and city tax-exempt. But they are usually taxed by the federal government.
This is unlike in municipal bonds, which are federal, state, and city tax-exempt.
When choosing the best tax-free ETFs, make sure you consider factors such as your age, retirement goals, income levels, and risk. Do thorough research and also consult to ensure that you make the best investment decision. Remember, you want to take advantage of the tax law to grow a tax-free wealth.