10 Lessons from 2024: Reflections on a Year of Financial Insights and Growth
In short, an ICHRA:
Is an employer-funded health benefit that reimburses employees for individual health insurance premiums and qualified medical expenses on a tax-free basis (& are even exempt from FICA taxes).
Employers set defined reimbursement limits, and employees choose their own health insurance plans.
The arrangement allows businesses to provide flexible, ACA-compliant health benefits without the need for a traditional group health plan.
It’s a win-win.
Creating an ICHRA can be done in 4 steps:
Plan Design
Employees pick a plan on the open marketplace
Employees submit their health insurance for reimbursement
Employer reimburses the employee
Takeaway #2: The stock market is not the economy & the economy is not the stock market.
Why is this?
Economic data is reported in arrears. Stock prices reflect investors expectation of future cash flows.
So what can you take away from this?
The economy is a leading indicator of how the market could perform in the future but doesn’t tell the full story.
Expectations of companies' future cash flows drive market returns in the present.
Takeaway #3: Expected medical costs should drive which health insurance plan you select. Gold and platinum plans offer lower out of pocket costs in the event of a health event but higher premiums. Bronze plans offer higher out of pocket costs in the event of a health event but lower premiums.
An example considered in the article:
With a platinum plan, you’re guaranteeing that you’re going to pay $45,559/yr in medical premiums.
With a bronze plan, you’re guaranteeing that you’re going to pay $24,421/yr in medical premiums.
The risk lies in your total healthcare costs.
If you have a catastrophic medical need year, the most you would have to pay in the bronze plan is $17,800.
But even if you have $17,800 in medical expenses your total medical costs will be $42,221.
Compared to the platinum plan, you’re still better off by choosing the bronze plan by $4,337/yr maximizing both plans.
For the Bronze plan to equal the platinum plan, you’d have to incur $21,138 of medical expenses.
Every year you don’t have more than $21,138 of medical expenses you get to pocket that difference as savings back in your pocket.
If you continue this for 10 years, that’s $211,380 of premium dollars saved.
If you attach a 5% growth rate to those dollars, here’s what that looks like stretched over time:
5 years = $122,640
10 years = $279,165
15 years = $478,934
The trade off lies in the acceptance of uncertainty.
Takeaway #4: Roth conversions can save hundreds of thousands of dollars in taxes over your life - but the tax savings are generated when you’re able to pay tax at a lower rate than when you pull the dollars out in the future - so there’s an explicit expectation of spending later - either by you or the next generation (if that’s your choice).
When you complete a Roth conversion, there are a couple things to be mindful of:
Having enough cash on hand to pay the tax bill associated with the conversion. If you’re converting $50,000 at an average tax rate of 18%, this could mean that you’ll need $9,000 come tax time to pay that federal tax bill (plus your state tax rates, if applicable)
Being mindful of your federal tax bracket. Tax brackets currently range from 10, 12%. 22%, 24%, 32% and 37%, if you’re looking to convert up to the max of the 24% bracket but spill over into the 32% bracket, you’ll pay an extra 10% in taxes on the dollars that exceed the 24% bracket.
Roth conversions are irreversible - so once you’ve completed the conversion you can’t rectify it on the back end. If you’re unsure on how much to convert, either work with a professional or convert less than you think you should.
Be mindful of qualified Roth distributions. For your earnings to be tax-free be mindful of the 5-year rule and attaining age 59.5.
Takeaway #5: Under Qualified Small Business Stock, you can have the greater of 10 times your adjusted basis or $10,000,000 of capital gain excluded from tax. Few businesses fit the criteria to qualify - but those who do (or can) - should, and need to know about this.
As strong of a tax incentive as this is - there’s provisions around who does & doesn't qualify, those are:
Business must be a U.S. C Corporation
Must be stock issued (common voting/non-voting, preferred voting/non-voting stock)
Corporation cannot redeem/have redeemed stock during a two year-black out period (IRS wants to avoid individuals passing around stock purely for tax savings)
Entity size must be less than or equal to $50M (which would mean the total 10x adjusted basis exclusion would be $499,999,999 of gain exclusion) this includes cash or property used to be exchanged for QSBS.
At least 80% of the asset of the business must be used in the active conduct of 1 or more qualified trades or businesses - a qualified trade or business is anything that is not:
Health, Law, Engineering, Architecture, Accounting, Actuarial Science, Performing arts, Consulting, Athletics, Financial Services, Brokerage Services, Banking, Insurance, Financing, Leasing, Investing (or similar), Farming, Production/extraction businesses, hotels, motels, restaurants (or similar service), Any business where the principal asset is the reputation or skill or one of more employees.
Real property not used in the active business can’t be 10% or more of total assets & stock of other corporations can’t be greater than 10% of company assets unless the corporation is a subsidiary (ownership greater than 50%)
Stock acquisition must be directly from the U.S. C Corporation & stock must be acquired in exchange for:
Cash, property (where basis of QSBS would be the FMV of property), services rendered (stock must be vested)
Eligible shareholders is any person/entity that is not a C Corporation (could be individuals, trusts, partnerships, LLCs, or S Corporations)
Required holding period is 5 years beginning the date of acquisition.
Original owner must generally be the seller (exclusions would be a gift during the owner's lifetime, transferred upon the owner's death, or an in-kind distribution by a partnership to a partner).
Stock sale requirement (typically buyers like asset sales because they have a larger base to deprecation from - with a stock sale, they don’t get the same benefit of deprecation moving forward).
Consider Guyton and Klinger created a framework of spending guardrails, which they broke down into four steps:
Portfolio management rule: Depending on market conditions, where you pull your spending from can either enhance or damage your portfolio longevity. Idea being, when equity markets are performing well, pull from stocks. When equities are performing poorly, bonds are more stable, so pull from bonds because they’re performing better.
Withdrawal Rule: Increase spending by inflation except in years where the portfolio experienced a negative return.
Capital preservation rule: Spending is cut 10% if the current withdrawal rate rises 20% more than its initial level and the planning age is still more than 15 years away. Ex: if your spending initially is 4.50%, then a spending cut would take place once your withdrawal rate reaches 5.40% and you’re in the first 15 years of retirement.
Prosperity Rule: Spending is increased 10% in any year that the current withdrawal rate falls to 20% below its initial level (inverse of capital preservation rule).
Idea being - yes, you can get more out of your portfolio with a flexible approach.
The presenter was discussing a “tax-efficient wealth transfer” tool touting the benefits of using a non-qualified annuity which would allow for the beneficiaries, upon the owner’s death, to stretch the required distributions over their lifetime.
Why is this beneficial?
The SECURE Act. 2.0 eliminated the ability for beneficiaries to stretch their qualified account distributions based on their life expectancy & required them to pull out the full account value within 10 years (assuming the beneficiary is an non-eligible designated beneficiary - more on that HERE) - but this doesn’t apply to non-qualified annuities (they keep the stretch rules).
Sounds great - you preserve the stretch ability, but does that make it more beneficial than a traditional brokerage account?
That is what caused me to raise an eyebrow.
It wasn’t that this was an inherently bad idea, rather, there were no circumstances or conditions being placed around why the strategy makes sense for a specific scenario.
And being honest… It was just being talked about like we discovered gold for the first time (which further fueled my curiosity).
No strategy is great without context.
Takeaway #8: Having 10 properties in their own LLC may be overprotection but having 10 properties and no LLC may be under protection.
In splitting up real estate interest, I would split this into 3 buckets:
Amount of equity in each one of your properties
Risk involved with the type of rental
Location of your properties
The amount of equity at risk is something that’s different for everyone (& partially out of their control as market forces come into play).
I would consider having a max number of rentals being 3-5, considering how much appreciation is built in or you’d expect to build up in the rentals.
This should also be contrasted with the type of rental.
If you have a bunch of short-term rentals in a party town, this may warrant yourself to reduce the number of properties in each LLC as the risk grows based on the number and type of tenants.
This can also be considered through the nature of the real estate, be it commercial, land, apartment complexes, single family units, duplexes, etc.
Lastly, it’s more affordable and convenient to have properties in different states in their LLC by state.
When you start acquiring 10+ rentals with plans of further expansion, you may want to consider the use of a series LLC.
Use the acronym WENT for purchasing a real estate rental:
Which is short for:
Why: do you want to own real estate?
Experience: of repair/maintenance of property &/or working with a network of professionals who can
Numbers: Do they make sense?
Time: commitment/bandwidth available for working on the property
When it comes to tax planning strategies to minimize the cost of education, you could consider gifting appreciated securities to your child to sell.
When your child has taxable income remaining in the 12% bracket $47,150, their capital gains rate is 0%.
Meaning, you could gift appreciated securities to your child, the cost-basis carry’s over, they can sell the securities and provided they’re under $47,150 of taxable income, they pay 0% in tax on the gain.
Considering an example, if you own $50,000 of apple stock and your basis is $10,000, that’s a $40,000 gain, at 15% capital gains tax rate that’s $6,000 in tax. When you gift that to your child (assuming they make $7,125 or less) they can realize that entire gain at 0% (note, the gift over $18,000 reduces the parents lifetime state exemption - no tax due for them immediately but provided when they pass they have an estate over the estate exemption they could owe estate taxes).
Also - this assumes your child is not a dependent for tax purposes.
If they are, then this sale is subject to Kiddie tax and any value over $2,600 is taxed at the parents marginal income tax rate.
You could however realize this $2,600 of 0% capital gain in your child’s name & if you have multiple children, this is something you could realize for multiple children.
Something to keep in mind is that if you do this every year then your child will have a small accumulation of unearned income which would eat into their $2,600 exemption that any dollar amount above is taxed at your parent marginal tax rate, so this ability would decrease slightly for each year you try to deploy this.
Provided your child is above the age of majority and lives away from you for more than half the year and financially supports more than half of their own living expenses then they may be able to qualify as independent on their tax return instead of a dependent and the kiddie tax rules no longer apply to them.
Being a child that is independent for tax purposes & is paying for school is now eligible for the American Opportunity Tax Credit (AOTC) which is a $2,500 max credit designed to help offset the cost of higher education.
The credit covers 100% of the first $2,000 of qualified education expenses and 25% of the next $2,000.
Further, up to 40% of this credit (or $1,000) is refundable. Meaning, that even if the taxpayer (the child) has no tax liability (more likely than not), they can receive a portion of the credit as a refund.
Don’t plan for your child to pay for school?
No problem.
You and your spouse each have the ability to give your child $17,000 as a gift, of which the child can then use to pay for qualified education expenses, which can be used for the AOTC tax credit, which have the potential to offer a refundable $1k at the end of the year.
If you’re a business owner, you would consider hiring your child (provided they’re doing legitimate work in your business) & income they earn that’s $14,600 or less, they pay 0% tax on (as this is the standard deduction for a single filer).
In action, this could mean that if you’re in the 37% marginal bracket with a 6.60% state tax for one child who earns $14,600 and pays 0%, this is $6,365 in tax savings.
When unplanned events turn sideways, we have two options:
Option 1 = Choose to not accept the event and exercise whatever emotion we experience.
Option 2 = Seize an opportunity to exercise good character.
Which option is going to allow us to maintain a good flow in life (or be more welcomed by peers)?
I like to think about this approach as a model to live by.
This model of accepting what is, instead of what I want it to be… doesn't always work (I’m human).
But more often than not, puts external events into context so that I can reason through them without losing my mind.
In the world of investing, uncertainty is the price you pay for higher returns.
Uncertainty meaning, your portfolio could go down in value (gasp).
Uncertainty meaning, your portfolio could also go up in value (yay).
That range of uncertainty you’re willing to accept is commensurate with the long-term return you can reasonably expect to receive.
In short:
Looking at history, you get rewarded with higher realized returns for taking on more uncertainty (risk) in your portfolio.
But just because we expect positive equity returns, doesn’t mean that we will receive them.
We accept what is instead of what we want it to be.
So when markets don’t work in your favor, that’s not a good reason to take risk off the table.
Risk management happens before the risk, not after.
So the only thing you’re doing when you’re taking risk off the table in down markets is hurting your prospects of positive long-term returns
So whether we are voluntarily or involuntarily subjecting ourselves to uncertainty, we might as well value it, because life without uncertainty is like a static, unchallenging existence absent of growth and discovery.