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Keep It Simple When It Comes to Complex Tax Concepts

By Crucial Clips     August 26, 2014
The following text is a transcript of a portion of a speaker's presentation made at an industry conference or during an interview. This transcript solely represents the view of the individual who spoke, and not the view of Financial Advisor IQ or any other group.
Source: FA-IQ, Aug. 15, 2014 

CHRIS LATHAM, REPORTER, FINANCIAL ADVISOR IQ: This is Chris Latham with Financial Advisor IQ. I’m speaking with Pete Lang, president of Lang Capital, which has offices in the Carolinas. Hi, Pete, thanks for coming.

PETE LANG, PRESIDENT, LANG CAPITAL: Thanks for having us, Chris.

CHRIS LATHAM: Now you’re going to talk about several tax-related issues that advisors should be aware of, the first of which is dealing with tax-deferred situations. Can you explain how advisors can add value here?

PETE LANG: Absolutely. I want advisors to understand that they really need to keep the concepts very simple. And one of those concepts is tax deferral. For example, putting money into an IRA or a 401(k) — any kind of matching program. And the solution — or the answer — is that you really want to maximize tax deferral.

Let me give you a quick example: If we had $1, and we grew it at 100% internal rate of return per year for 20 years, the result would be $1 million in that account. Now, if we deduct taxes, and we take $1 at 67%, a 33% tax rate, for 20 years, Chris, what do you think the answer would be?

CHRIS LATHAM: I’m going to go with 670,000.

PETE LANG: That’s a great gut reaction. But the truth is the account would only grow by about $28,000. And we’re not trying to mislead anybody. We’ve stretched this to extremes, to show that tax deferral is a very strong fundamental concept for investors.

CHRIS LATHAM: Excellent. Now what’s the second point that you think advisors should be aware of?

PETE LANG: The second point I’d like to talk about is living off of the principal as opposed to the interest, dividends and capital gains. For example, think about having a marginal tax rate. In the United States, we have something called a progressive tax rate. The more you make, the more you pay.

So we want to control our income at higher marginal tax rates. So — hence, we want to live off the principal as much as possible, as opposed to allowing interest, dividends and capital gains to flow on our returns.

CHRIS LATHAM: And, Pete, you have a view on Roth IRAs that advisors should be aware of. What’s your take on them?

PETE LANG: Absolutely. I just gave you an example that you want to be able to counsel a client on how to live off of the principal, for example. You can do this with a line of credit on your home. You can do it with universal life insurance. You can do it with an immediate annuity. All of these are great ways to live off the principal.

Now imagine taking a preretiree or a retiree who’s got limited income, extending their Social Security, and then living off the principal. What you’ll have is a number of years where you can do what I would term a Roth-rollout conversion — that is taking IRA accounts and fundamentally converting them to an IRA over a limited period of time when you live off the principal.

CHRIS LATHAM: Inventive. Do you have any other tips for advisors, when it comes to helping clients and stretching out their income?

PETE LANG: If we look at taxpayers that make under $73,000 in income per year, essentially the capital gains rate is zero. So a wonderful time, when you have low income — under $73,000 — is to harvest those capital gains, because you can do so for free. So sell those appreciated stocks. Those capital gains will be free, essentially. You won’t pay taxes on ’em, and you’ll start with a higher base of stock.

CHRIS LATHAM: Pete, thank you very much. Very interesting insights.

PETE LANG: Thank you for having us.