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How to Take Advantage of Two Everyday Tax-Favored Assets

It is typical for attorneys to have anywhere from 20-50 percent of their net worth tied up in real estate.

By Jason M. O’Dell, MS, CWM and David B. Mandell, JD, MBA.

You likely want to reduce your taxes as much as legally permissible.  While most attorneys, in our experience, consider tax reduction as their #1 or #2 financial concern, few take full advantage of the two commonplace assets that have enjoyed most advantageous tax treatment under our tax code for decades – real estate and permanent life insurance.

In our books and lectures, we discuss the similarity of real estate and cash value life insurance from a tax perspective.  While our tax code may change under a new president, both have enjoyed superior tax treatment over recent decades.

With real estate, you can write off depreciation on business real estate, deduct interest payments on home mortgages within limits, write off local property taxes against your federal taxes, and enjoy up to a $500,000 capital gains exemption on the sale of the primary home (for a married couple filing jointly), among other benefits.  

With permanent life insurance (also called “cash value” insurance), you can enjoy tax-deferred growth of gains within the policy, and if managed correctly, access such value tax-free in retirement.  In addition, policy death benefits generally pay to beneficiaries income tax free and -- for those focused on estate planning -- you can even structure the death benefits to pay estate tax free within certain types of trusts.  

Further, both asset classes have enjoyed a very powerful tax benefit that few others are afforded: the ability to move from one piece of real estate/life policy to another using a tax-free like-kind exchange.  For real estate, these exchanges are controlled under tax code section 1031; for life insurance, 1035.  

Tax-wise similarities

Interestingly, from an investment and asset class perspective, these two assets are also relatively long term.  You may have heard that, in order not to get burned by having to sell real estate in a down market cycle, you should expect to hold a property at least ten years, as a rule of thumb.  The same time period would also apply well to cash value insurance, as that is around the time where the tax benefits begin to far outweigh the upfront costs.  

Many attorneys have utilized real estate as a significant part of their balance sheet. This is not surprising, as nearly all attorneys own a home and it is often one of the most valuable assets they own.  Further, many attorneys purchase real estate to house their law practices, rather than renting for years on end.  Moreover, some attorneys own second homes, rental properties, and even raw land.  It is typical for attorneys to have anywhere from 20-50 percent of their net worth tied up in real estate.  Over the years, they have taken full advantage of some real estate tax benefits – most notably the interest deductions and property tax write-offs.  Fewer utilized depreciation benefits and, still fewer, the like-kind exchange tax opportunities.

However, relatively few attorneys have taken significant advantage of the tax benefits of cash value insurance -- despite their interest in building tax-favored wealth for retirement. This is too bad, as the tax-free growth and access of such an asset class fits well within a long-term “tax diversification” strategy for most high net worth attorneys.  Let’s look at an example of how this can work.

Case Study: Cash Value Insurance

Attorney Andrew is a 45-year-old in good health who wants to invest in either a taxable mutual fund or a cash value insurance policy for his retirement.  Keeping rates of return equal at 6.45 percent annually, Dan wants to see what relative advantages the life policy will produce due to its favorable tax treatment.  

Let’s assume Dan were to invest $25,000 per year for 10 years before retirement and then withdraw funds from ages 65 to 84.  Let’s also assume Dan’s tax rate on investments is 31 percent (50 percent coming from long-term gains and dividends, 50 percent from short-term gains, plus 6 percent state tax).

With these assumptions, if Dan invests in mutual funds on a taxable basis, he will be able to withdraw $28,477 per year after taxes. If he invests in cash value life insurance, he will withdraw $48,343 per year (no taxes on policy withdrawals of basis and loans), and will still have over $525,000 of life insurance death benefit protection. This is a substantial difference based primarily on the tax treatment of the cash value policy.  

Real estate and cash value life insurance are two everyday asset classes that every attorney can leverage in their long-term tax planning.  We encourage you to explore both and see how they may help you achieve your long-term financial goals.

SPECIAL OFFERS:  Please call 877-656-4362 to receive a free hardcopy of Wealth Management Made Simple. Visit www.ojmbookstore.com and enter promotional code NTL02 for a free ebook download for your Kindle or iPad.

David B. Mandell, JD, MBA, is an attorney, consultant and author of more than a dozen books, including Wealth Management Made Simple. He is a principal of the wealth management firm OJM Group www.ojmgroup.com, along with Jason M. O'Dell, MS, CWM, who is also a principal and author. They can be reached at 877-656-4362 or .

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