The Silent Tax Mistakes Draining Millions

The average person is overfunding in the wrong tax environments and they don't even realize it. The personal environment happens to be the least efficient. Most people have been conditioned to just maximize their 401k. 30 sometimes 40 is going to be given Uncle Sam. The smallest or most underutilized environment is the tax-free.

I think about one of our clients, doctor ran a great business, but the amount chances are that he missed because he wasn't set up the right way. So often people, they think that their planners must know, but if they're not asking the right questions, believe me, things are getting missed. It's not how much you earn, it's how much you keep. Part of how you keep a lot is avoiding the tax.

Most people think that tax season is the only time that taxes matter, but the truth is your tax planning should be baked into your wealth plan long before tax season rolls around. Today, we're exposing the biggest silent killer of wealth: tax environment misalignment. You could be saving millions, but in the wrong tax environment.

Phil, you said that the average person is overfunding in the wrong tax environments and they don't even realize it. Can you explain what that means and why is it so dangerous?

Yeah, it's such a good point, and people get in the wrong environments all the time and they think that they're doing a really great job, and in a lot of cases they are in terms of savings, to your point, Spell. But we break the tax buckets or the environments into five real categories, and the first one, this is really where people get off track, is the personal environment. And the personal environment happens to be the least efficient of the five, yet that's where the majority of people's money flows.

And so because that one gets overfunded, it's the least efficient. I don't have to say much more for you to realize that means you're being robbed, because you've got all that money in the least efficient bucket. So in a simple way of saying this, we got to get more out of that environment and get it into the right environments.

Got it.

So, Spell, if I break it into the parts now so people can really understand what I mean. So the personal environment, number one, and that one is the least efficient.

Got it.

Right behind that would be tax deferred. And most people have heard the term tax deferred. Well, that's one of our environments and it's not all bad, but it is a place where embedded tax lives. So, you get to defer the tax now, but you're going to pay it at some point.

And then there's a tax-free environment. Well, that gets everybody's attention. So, tax-free, by and large, the best environment. The more you can have in that one, the better. And then we have two more. Tax advantaged. So people say, "What the heck is tax advantaged?" Well, don't worry, we'll get into it.

And then there's corporate, and that one is probably the most underused because so many people today, they have small businesses or they have the opportunity to turn whatever it is they do into a small business, but they don't use that environment. Missed opportunity. So those five, if used properly, to your point, can save people hundreds of thousands, maybe across your lifetime, millions of dollars.

When the, I think the important part too, Phil, is a lot of the folks who are listening make or have accumulated millions of dollars. The question is, where do those dollars sit? Are they in a taxable environment, or sometimes synonymous with a brokerage account, where you pay or you're subject to capital gains on earnings? Or are they in a tax deferred environment, meaning, or most commonly referred to as a 401k environment, where you've put money in pre-tax and it's fully taxable at your ordinary income rate upon distribution? Or maybe it's in a tax-free environment, which, if our picture is anything to show for anyone listening, that bucket's usually the smallest bucket.

And I guess, Phil, my question is, why is that? Is it just how things are? Is it just a general misunderstanding that I have to put everything I can into the 401k because I get a tax break today?

A lot of times when you look at a situation, an individual family, the smallest or most underutilized environment is the tax-free, and it isn't because they don't want to have more in the tax-free environment.

Yeah.

Spell, I think for the most part it's they don't have the right advice or their team is not well coordinated. So, chances are they're just missing the opportunity, or they have been misguided or misinformed at some level to think that a tax-free bucket, say for example, Roth IRAs or Roth 401ks, that that's only for young people. That's not for someone who might be 55 or 60 or 65 years old. And maybe it is, maybe it isn't, right? But to just look at it from that perspective of maybe it's just not something for me and not ask enough questions, then you could easily miss that opportunity.

So it isn't on purpose necessarily. I just think a lot of times it's lack of coordination, which we talk about a lot with other professionals, and then just not understanding the environments or knowing how to get into them and what are the right amounts.

Yeah, for sure. Phil, it's interesting that you mentioned Roth 401k. When I walked in the studio, I had just gotten off the phone with someone who is or was a part of one of our plans that we helped manage, and she said, when the 401k was established, and this was early 2000s, Roth 401k wasn't an option. And she's since moved to a different employer, and she said, "I really wish that I had the ability to take advantage of the Roth portion of a 401k."

Yeah.

So, it's knowing what's available to you, I think, apart from maybe getting bad advice, but just knowing what you have available to you, knowing the tools that you have in your toolbox, super important.

It is important. And to her point, Roth was not something that people knew about, right, 10, 15, 20 years ago. 10 years ago, people were hearing about it quite a bit. 15 years ago, it was on the scene, not nearly as much as it is today. But if you go back to the '9s when Roth became a thing, nobody understood it, right? Nobody was talking about it very much. And you certainly didn't have the option to put that in a 401k.

Should have been there, but it takes our federal government a long time to get things to a place that actually makes sense. They could certainly do a better job at helping Americans save more and be more, I think, appropriately mixed across these environments.

Yeah.

As it relates to tax.

Talk to us a little bit about someone who has all of the dollars that they've ever been able to accumulate inside of a 401k. What are the primary, I don't want to call them problems, but what are some of the bumps that that person is going to feel down the road?

You bring our attention to something that's real. Most people have been conditioned, trained if you will, to just maximize their 401k, maximize tax preferred or deferred environments. And so you're right, Spell, they reach retirement and the lion share of their wealth for most Americans sits inside of a 401k.

So the first and maybe not the most obvious problem is that, we'll just use 30% because that seems to be where a lot of people land with state and federal income tax.

Yeah.

But 30% of that account belongs to the federal government, Uncle Sam, and to the states, and so Uncle Sam's got their paws out. They're ready, and so that's the first problem.

Yeah.

The second problem is required minimum distributions, and you can't get away from those, and so fortunately they've moved that number up a little bit.

Mhm.

But so now it's 73 years old, soon to be 75.

Yep.

But those are the problems, Spell, because all that money sits there. So you got 2 $3 million in an IRA or a 401k, and then you have zero control in terms of distribution. You're going to be forced to take it, and depending on your social security, depending on other income sources that you might have, right? Suddenly it can hoist you into a heavy tax bracket that you might not have planned for. Maybe you haven't given that any thought. And so all of a sudden here it is, but you can't control it, because Uncle Sam says you must take this money out.

Yeah.

So I think there's a better way to do it. People are just not getting the right advice. So they end up in this situation unnecessarily in a lot of cases.

So you mentioned advice, and I think that's a perfect segue into the next topic, and that is usually tax planning or tax advice. You think of a CPA.

Yeah, for sure.

And what we realize, and this again is not a dig at any professional, but CPAs most of the time are looking at what's already happened. They're reporting taxes. Financial advisors should be looking at what's to come. And I think a lot of times there's a divide, or maybe a lack of communication, or maybe someone's only working with the CPA, and so all of their money goes into the 401k because the tax professional is saying we need to reduce your taxable income. Reduce your taxable income. Reduce your taxable income.

Well, that might not be the best advice five years from now or 10 years from now or 20 years from now. So, talk a little bit about that. What has your experience been working with CPAs? I know we work with lots of them.

You bring up a great point. First, I want to say to all of our listeners out there, Spell is being, I think he's being, he's accurate when he says that a lot of CPAs are more looking at what's happened. So, you've already earned the income. Now, they're saying, "Okay, how do we mitigate your tax risk now?" So, that in is another way of saying we're doing your tax return. Let's see how we can reduce it.

But before I go too much further, Spell, I just want to say I'm married to a CPA. She's not a look in the rearview mirror person. She knows how to use the rear view, but she looks through the windshield and she's always thinking about forecasting for the company where she's CFO and what's to come.

Yeah.

So I think some CPAs know how to do that. They know how to do it well. A lot of the CPAs that we've experienced through the years, you are spot on. They tend to be more myopic, focused on the tax return and that's it, and they're not really looking forward. So that tends to be problematic, because what they should be doing is looking forward.

That tends to be more of what we do. So a lot of forecasting, thinking about the what-ifs. What happens if tax rates go up? What happens if your income goes up? How are we going to get money out of this box or this bucket or this more costly environment? How are we going to do that? And so we have to set ourselves up for that now, because most people aren't going to think about 15 or 20 years from now that they're going to have millions of dollars in a program or inside of an environment that you can't get it out without giving up maybe as much as half.

Well, it can be really difficult for people to understand what it's going to be, what their financial situation is going to be in 15 or 20 years, unless you have a team or software that is showing you, okay, based on this set of criteria and the things that you're doing today, here's where you're headed. It's very difficult for folks to picture this.

Such a great point. So as you know, Spell, and some of our listeners, maybe they've been afforded this kind of planning, right? But we tend to build our models, are not one model, they're multiple models. So here is a what-if, here's a what-if, and here's a what-if. And if we plan based on multiple scenarios, we're going to get it right at some level, right? Which means forward thinking is going to give us the best result, and likely we're going to be able to save our client a lot of unnecessary tax costs now and down the road, right? But it takes a lot of forecasting and a lot of scenarios being looked at before you could make those decisions.

If all we're doing is looking at a tax return for, say, 2025, right, and we're trying to reduce your tax for the 2025 tax year, then we're going to be thinking just like a CPA. And that is spend some money, use section 179, fully fund your 401k, think about any tax, any preferential treatment on the tax side that can reduce that adjusted gross income, HSA, HSAs, IRA, anything right now.

Yeah.

That can reduce your taxable income.

Yeah.

And I think that's good. There is absolutely a need for that. But there's so much more. So I think CPAs, they serve a wonderful purpose. I enjoy working with them, but there are some certainly that I think they could do a better job. I'm excited that we're going to bring accounting into our firm over the course of the next year, just to have them inside with us where we can build better plans.

For sure. Having their knowledge, because the CPA does have incredible knowledge.

Yeah, I just believe there's, that goes back to coordination. If we're properly coordinated, then I think you take all that knowledge and, man, the client really prevails. They become the winner in that case.

Absolutely.

And I don't want to be misconstrued in saying that CPAs are backwards looking, if you will. In fact, you and I had a conversation in a show about the importance of a CPA. Yeah, for sure. And an estate planning attorney and a financial adviser. Got to have it. So, they're extremely important. Yeah. Your point, coordination is key.

We'll get right back to today's show, but first, I'd like to ask you a quick favor. If you're enjoying this episode, hit that like button and make sure that you're subscribed to our channel so you don't miss what's coming next. And hey, if something in today's episode has you wondering about your own financial plan, why not get a second opinion? Visit omnistarfinancial.com to schedule a consultation with one of our team members. It's quick, it's easy, and it could make a huge difference in your financial future. Now, let's get back to the show.

Yeah, that brings us back to, Spell, the five environments. And so, I just want to talk about those again. So taxable, tax deferred, tax-free. Mhm. Those environments are important and those are the ones that so many people think about, right? What they don't think about are tax advantaged and they don't think about the corporate environment. True.

And so if we could pull those things into the conversation, then if you're a 1099 person, Yep, and you're not set up the right way with your business, you're missing a tremendous opportunity.

When you say you're not set up the right way, are you talking about LLC filing as an S corp?

Could be. Y. Yeah. If the dollars and cents are there, if it makes sense, then you got to do that. But I think about one of our clients for years. He worked in a self-employment environment. He ran a great business, doctor, but he was a sole proprietorship for a long time.

How much money was he making?

He was making about 350 to 400,000 a year and that grew over, he made a lot of money. Yeah. Yeah. But the amount that chances are that he missed because he wasn't set up the right way, not to mention there was tremendous liability. Yeah. That he exposed himself to because he was a sole proprietorship. It's not the end of the world. It's not the worst thing, but boy, there's a better way to do it. So the corporate environment is huge.

And then tax advantage. Now, tax advantage, when I talk about that, I'm referring to things like home mortgage, charitable planning, those things, donor advised funds. Yep. So now there's sort of a push and a pull in that environment because on the one hand you want to push for those deductions. You want to itemize, right? But Uncle Sam changed things in 2017 when Trump enacted the first version of his bill which now was just passed again and basically kept everything in place as it was, right? But he raised way back then or created this standard exemption or standard deduction that was a lot higher. Today it goes up a little more. Well, at least starting in 2026, we get a nice bump to 30,000. Yeah.

So for most people, the tax advantaged environment isn't going to be what it maybe could have been or once was. Right. However, for the next several years, we at least have this up to $40,000 of SALT or state and local tax deductions, right? That some of that could come into play. And so, if you're an itemizer along with those things, that could push you over that 30,000 threshold. So, that could be tremendous, big time. So, tax advantage could come back into play.

But then taxable, tax deferred, and tax-free. You've got to get those aligned properly. And you got to start filling them as soon as you can in the right amounts. And that's where people go astray.

So we talk about coordination all the time here, Phil. And with a taxable bucket of money, a tax deferred bucket of money, and a tax-free bucket of money, what's the best way for someone to coordinate those to get them most effectively to where they're headed?

Well, that's a loaded question for you. It is, but you know what? I'm going to go to a simple place. Okay. Simplest answer I can give. The first thing is you have to know where you're trying to go. True. Right. So it starts with planning. Starts with building a plan, knowing what it is that you're trying to accomplish. So, what are your goals? Yeah. What do you need now and what will you need then?

So, what does that forecast look like once you build that model and you start to determine what you're going to need? And then if you can forecast what you're likely to have based on what you're willing to do today, right? If you put all that together, you can start to in some ways visualize or see it in the planning. Here's what my wealth picture is likely to look like then. And from that, we can begin to determine what is the tax likely to look like. Even if it goes up or stays about where it is or goes down a little bit, you can at least start to forecast.

That's far better than the wait and see game which seems to catch a lot of people with their guard down, right? And they end up with these huge, which is great, these huge 401k plans or these huge qualified plans knowing that 30, sometimes 40, 45% is going to be given Uncle Sam. And what else do we have to worry about, Spell?

There's one more thing in that they get to that point, all of a sudden there's millions in those plans, right? If they've done a good job with everything else like real estate or other asset classes that have really helped them accumulate a lot of wealth. Mhm. If they are fortunate enough to have an estate tax problem, yeah, then those 401ks, IRAs, etc., they're going to potentially be double taxed. Y. Because they count towards your estate, you're going to get taxed at the estate level and your kids or whoever you leave that money to is going to pay, they're going to pay ordinary income on all the money inside of those qualified plans. Yeah. So, a double taxation.

Now, you do get some credit for that. There is a slight offset there or a fairly good offset. Nevertheless, you could end up seeing 70 cents on every dollar from those qualified plans go to Uncle Sam. So, getting in the right environment as early as possible. So important.

And it's not just a conversation that we're having about taxes. We're talking about allowing you to control taxation in the future, which is extremely powerful. I want to make sure that everybody's understanding that when you have everything in a tax deferred environment, you mentioned it earlier, you have no control. 30% on average is going to Uncle Sam whether you like it or not. And depending on your wealth picture, it could potentially be significantly more than that. But with appropriate planning, you can take control of your tax situation, which is super important.

Well, it is, it's one of the most important parts to building good wealth, right, and efficient wealth. So we say around here, it's not how much you earn, it's how much you keep. Well, part of how you keep a lot is avoiding the tax. Yeah. So, of course, you want to earn as much as you can. You want to get maximum growth. So, maximum performance or return. But if you can mitigate the tax exposure or that risk, man, it's a game changer, big time. And so many people fail to do that.

So in the accumulation phase, it feels right to use 401k only. But there are other things that can help you be in a much better position when you get to that point of retirement, early retirement or whenever you choose to do it. So I would say, Spell, people have to elevate their, the tax environment ratios. They've got to figure out what theirs happen to look like, whatever that is. And everybody's will be a little different.

But what is your ratio for tax-free, for tax deferred, tax advantaged, which sort of happens on its own, right? But the corporate environment and then what does your tax-free look like? All those things, or rather the personal. So, and hopefully we're getting that personal down as much as we can. As much as we can. So, getting rid of that one to fund the other ones is usually going to turn out pretty well. That's how you take control. That's how you take control.

So, then building those amounts based on what you're trying to accomplish, where you're headed, that's what makes the biggest difference. But it really goes back to what I said, or we go back to what I said a few minutes ago. You got to plan. Yeah. And if people are not planning, then you're going to fall short in what you could have done or what you could have accumulated.

So I would say the last piece to getting this thing dialed in, so to speak, it's really having an integrated team. So, back to what you said, the attorney, the tax preparer, or the CPA, and the wealth advisory team. Yeah. Having those three well-coordinated or if they're all under one roof, whatever it happens to be, right? Just knowing that you've got that knowledge, talking to one another on your behalf. Yeah. Thinking about your outcome, listening to what you want to achieve, asking the right questions so they can better understand what your vision is for your life and where you want to land.

They can do some amazing things if you get the right team of people together. So long as they understand what you're trying to accomplish, right? That's a missing link, by the way, because so often people think that their planners must know, but if they're not asking the right questions, believe me, things are getting missed and those things unfortunately can lead to some inefficiency with tax.

I agree. Yeah, I totally agree. And then the most effective teams communicate from the top of the organization to the last man off the bench. For sure. Everyone is communicating and they all know which direction they're headed and that's usually, in this case we're talking about a client. They're the CEO of the team, if you will. They communicate exactly what it is they're trying to achieve and all the other players on the team coordinate and they take the field, so to speak, and go play the game in the way that the CEO sees fit.

So, Spell, you reminded me of something that I think gets missed here a lot. Certainly, it's misunderstood, and that's all the stuff that's out there. We watch a lot of YouTubers trying to see what they're saying, some of it right, some wrong, right? Everybody has an opinion. I think one of the biggest challenges that the consumer faces, they don't always know what to believe.

You have some out there purporting to be this, the end-all be-all to planning and they're saying, "Oh, don't do a Roth conversion." And another one five minutes later puts a video out that says, "Oh, you must do a Roth conversion." Right? It's the only way. And then you have some saying, "Don't put your money in the 401k. Use life insurance instead. Be your own bank." M. There's so many things and it seems like every person who is professing to be a professional, they have this panacea. Yeah.

Well, I'm here to tell you every person in earshot should understand there is no panacea. No. It takes well integrated, good integrated planning, well-built plans to get you where you're going. There's no panacea. No. There's not a one-size-fits-all. It's not a life insurance policy with all this cash value that's supposedly tax-free. It's not just a Roth IRA. It's not a 401k. There's just so many things. It's nuance. That's right.

And everybody's situation is different. And so, I just want our listeners to understand that you're going to hear all kinds of ways to fix your problem. Right? Be aware, because a lot of these people that want to fix your problem, what they really want to do is get you to subscribe or get you to buy whatever it is they're selling, life insurance or whatever it is. Y. But understand that nobody has a panacea and it all starts, every successful one out there, it begins with planning, y, coordination, and then understanding how to discern what is going to be the best fit for you.

Yeah, there is no one-size-fits-all. That's a great point. Everyone's situation is different, but keep in mind if you misalign in a tax environment, it can throw off all the other tax environments. So planning for an individual, a client, a family, that's where it all begins. There is no YouTube tutorial, watch this and you're going to have all of your problems solved.

I wish it could be that way. I wish we could just put all kinds of advice out on YouTube and, Yeah, and look at people and say, "Okay, good. Here you go. Here's the instruction manual. Go to work." Yeah. Spell, first, most people are not equipped to take that manual and put all this stuff in place for themselves, right? And secondly, most people don't have the time to do it. They don't have the inclination to do it.

And unfortunately, this isn't necessarily a good or bad thing, but most people get paralysis by analysis. Once they think they've got it, then they don't do anything because they're fearful of making the wrong decision. People make better decisions and they get more of what they want, right? They achieve their goals when they have a competent team of people helping them do it.

And in fact, we just saw a study on that. Every year, various groups do it. Vanguard just did one not long ago, and it talks about the excess value, the alpha, if you will, that an advisory team brings to a client.

Yep.

Yet, you hear so many people saying, "Oh, you can just do this yourself." Nonsense. You need a good team of people so that you get the job done.

Yeah.

And you find success.

It's true. It's true.

If your money is in the wrong bucket, it could be costing you far more than you think. Believe us, we've seen it. We've seen it a lot. We can do things to correct it. By the way, there are, if you have all of your money in a 401k, that doesn't mean that you're at a place of no return. We can certainly do things to correct, but time is of the essence.

I think once you get past a certain point, Spell, I will tell you that generally once you're past, depending on your circumstances, there are still situations where it could work, but usually when you're beyond, say, 65 years old, transitioning to a WTH probably isn't going to make the most sense, right? Occasionally it could. There are some situations where it could work, but for the most part, planning needs to start as early as possible.

The sooner the better, the right team, start early. Your chances of success go up exponentially when you start early. It's no different than investing. The more time you're in the market, the more likely you are to achieve a certain rate of return, right?

Click or tap the screen now to watch a video that we did on the biggest retirement lies and scams that you need to avoid. We'll see you next time on We're Talking Money.