Do you wonder what are the best investment options in the USA for tax saving beyond 401k?If yes, then keep reading, here I have discussed strategies used by the wealthy to save taxes.
401K is good but
401k is a great option to save taxes but one has to keep a few things in mind.
- Your money is locked till you are 59.5 yr. As you might know, you cannot withdraw money from these accounts without heavy penalties.
- When you withdraw money from 401K account at that time you will end up paying taxes. For example, if you have $1 million in your 401K account and the tax rate for you is 30% then you will be paying $300K in taxes.
Now investing some amount in 401K is good especially because many employers provide matching. This employer match can help you in compensating for some of the taxes which you will have to pay later during withdrawal. For example, if your employer has a 5% match then invest till that amount in 401K but going anything beyond that does not make sense because of the challenges mentioned above.
Some have a lot of money and even after maxing out the 401K contributions they want to save tax beyond 401K.
Basic concept for saving taxes
One concept that many wealthy use to save taxes is taking out loans from assets rather than selling them. So if you have an asset worth $1 million dollar then instead of selling that asset you can take a loan by having this asset as collateral.
You will pay some interest on this loan but if you are able to use this amount to generate a return that cancels out this interest then you are effectively taking out money tax-free.
Let’s discuss some of the options where you can apply this concept. If you have some other options in mind then please feel free to leave a comment and share with us.
What are the best investment options in USA for tax saving beyond 401?
- Investing in real estate
Some of the most successful entrepreneurs in the world have built their wealth through real estate. In fact, it’s estimated that 90% of all millionaires invest in some form of real estate.
How does it work?
So if you buy a rental property say for $300k and you are using rent that you receive to pay for the mortgage and getting some cash flow. Now, in 10year say the property is having equity of $150k.
In this case, if you sell the property then you will pay taxes. But if you refinance your mortgage or use a HELOC then you are able to take out this equity tax-free. You don’t pay any taxes when you take out a loan.
- Growing money inside the permanent life insurance policy
Permanent life insurance provides you coverage throughout your life and it builds cash value over a period of time which if planned properly can be taken out tax-free. There are many types of permanent life insurance products but one of the best to save on taxes and grow money is Indexed Universal Life or IUL. We will use IUL to understand how to save taxes in this article.
IUL, or indexed universal life insurance, is a type of permanent life insurance that offers the potential for cash value growth linked to the performance of an index, such as the S&P 500. The main benefit of IUL is the potential for cash value growth that can outpace the performance of traditional fixed interest-earning life insurance policies. This growth is tax-deferred, which means that policyholders do not have to pay taxes on any earnings until they withdraw the funds. Additionally, IUL policies often have death benefit guarantees and flexible premium payment options, making them a potentially attractive option for people looking for a permanent life insurance policy with the potential for cash value growth.
It is one of the best investment options in USA for tax saving beyond 401k.
Case study for IUL:
At 30yr if someone starts investing $500 per month in IUL(assuming 5.97% annual growth) then at 65 they will have $1.1 million in death benefit and can take out $914K , if planned properly tax-free.
At 50yr age they will have $470k in death benefit and $238K in cash value.
So at any stage in life, you can take out money from this policy. Instead of doing regular withdrawals what people do is that they take out loan out of policy where cash value is used as collateral. This way they are taking money out tax-free as you are not withdrawing but taking a loan.
Your actual cash value will keep on growing in this example say at ~6% and it will help in offsetting interest charged by the company say 7-8% rate.
When you pass away insurance company will deduct the remaining loan amount from the death benefit and pay the rest to your beneficiary tax-free.
Floor and Ceiling: One of the best features of IUL is that there is a floor that guarantees that your money will not decrease but it also comes with a tradeoff where you can claim growth at a certain level.
For example, if the floor is 0% and the ceiling is 8% it means that you will not have a negative return. If the stock market tanks by 30% or 50% your money will remain the same due to 0% floor. At the same time if the market goes up by 10% then you get only 8% gain due to the ceiling.
Imagine you are planning to retire next year and you have $1million dollar in your 401k account or brokerage account. If the market goes down by 30% then your savings will reduce to $700k and if you start withdrawing then you are incurring losses.
But if you have $1million dollar in your IUL policy and the market goes down by 30% then you still will have $1million in your account due to floor and you can retire peacefully.
Effectively what you are doing here is
- Growing your money at low risk
- Getting life insurance effectively for free as cash value will be multiple of premium paid over period of time.
- Passing wealth to the next generation tax-free.
- Having a nest egg that you can use while you live for anything you want like purchasing a house, education, buying car etc.
Why wealthy use IUL (index universal life) to save taxes?
If you have a lot of wealth then there are few options to save taxes. You can invest 20k per year in 401k, you may not be eligible for investing in Roth IRA which is limited to $6k. A real estate is a great option but not everyone may want to deal with the overhead that comes with these investments.
But you can invest as much amount you want in IUL. Wealthy can put $50k or $100k or more every year in IUL and they built a huge portfolio that they can access tax-free and with low risk. This is like a Roth IRA for the wealthy with no limit.
But many Finance gurus say IUL is bad
Now IUL is a little complex product and you can structure it in multiple ways. Sometimes insurance agents structure in such a way that you end up paying high fees and agents get a huge commission. Hence it is important that you work with someone trustworthy who has your interest in mind.
Many financial gurus have limited knowledge on insurance and they don’t understand the benefits which were listed above. Hence one should do their own research before making up their mind.
If IUL was not a good product then many wealthy families would not be buying this and if no one buys a product then it will cease to exist.
Why not Term insurance for saving taxes:
Term life insurance has no cash value and it expires when the term is over.
For example, if a 35yr old buys 30yr term life paying $150 per month as a premium then this policy will expire at 65yr of age. You will not have any protection after this and around $54k you paid for the premium is gone.
Hope you found something valuable in this article.
If you are interested in learning more about different insurance products then please set up a call using the below link. Or you can ask for a quote online. We will compare with 50+ companies/products to get you the best rate and coverage.