It’s All About What You Keep

Death & Taxes

As Benjamin Franklin famously stated, “In this world, nothing can be said to be certain, except death and taxes.”

Taxes come in all different shapes and sizes: federal income tax, state income tax, capital gains tax, tax on interest and dividends, real estate income tax, tax for taking my dog for a walk, and the list goes on…

Uncle Sam is the silent business partner in all of your endeavors; again, death and taxes.

Duck, Duck, Shoot!

This conversation about taxes reminds me a lot of the first time I went duck hunting.

There we were, shoulder to shoulder in a pit, in the middle of a flooded field, just waiting for everything to come to life.  I was with some of my best friends; we were all cracking jokes and having some good laughs while we waited for the sun to rise over the water. I can still picture the scene.

The funny thing is when you are sitting there at the crack of dawn, barely able to see, sometimes the ducks will fly right overhead, just mocking you as you have to wait for shooting hours to officially begin.  A lesson in patience, for sure.

Playing by the Rules

As a rookie duck hunter, my friend had to walk me through some of the rules.  “There is a six-man limit,” he told me.  Meaning, that during the course of our hunt, we could only shoot six ducks per man. This six-man limit may not sound like much of a limitation when the ducks aren’t flying… but on the good days… six ducks per man can potentially happen before the sun rises and breakfast is served. That’s a good morning!

One of the most comical parts of duck hunting is the claiming of the ducks. Just imagine the scene where two ducks fly in, four men shoot, and then the chatter of who actually shot the duck begins.  There is always that one friend, the one who claims every trophy and every duck. Only two ducks may have flown in, but he claims to have shot both and another one that no one else saw.  Duck hunters and investors aren’t too dissimilar, their story of their “greatest catch” gets embellished more and more as they continue to tell the tale.

So, what does all this have to do with taxes?

We All Have Our Limits

Just like the limits I experienced as a duck hunter, the amount of income/gains we are able to keep as investors are also limited.  At times, you can be a victim of your own success, especially if you are a high earner. My colleague Blaine Carver recently wrote a Thoughts on Money titled, Financial Aerodynamics which hit on some key concepts for eliminating tax drag.  I thought I would dive deeper into one of the concepts he mentioned: municipal bonds.

The Whole Enchilada

The subject of after-tax returns is rarely a topic of discussion.  Yet, this is what you actually keep.  With a six-man limit, a professional hunter and a rookie (like myself) can very well walk away with the same spoils on any given day.  Again, it’s all about what you keep.

With municipal bonds, investors have the opportunity to receive income that is potentially federal and state tax-free.  This means you get to keep the whole enchilada – all of it!

This is a classic case of there is more than meets the eye when it comes to the yield someone sees from an investment.  Often, improving tax efficiency can be the lowest hanging fruit for improving on what you keep.

Running the Numbers…

If someone’s marginal tax rate – the tax paid on the next dollar earned – is in the highest federal bracket (37%) and they are evaluating two bonds, how do you know which one to choose? Let’s imagine the options are a municipal bond paying 5% or a corporate bond paying 7.5%.

Here’s the formula to help us find the best solution:

Tax Free Yield / (1-Marginal Tax Rate)

That is 5 divided by 0.63, which equals 7.94%.  This means that my taxable bond would need to yield nearly 8% to make the what-I-keep amount the same.  In this case, the municipal bond at a lower yield is MORE attractive than the higher-yielding taxable bond.

You can imagine the difference this makes as we increase the dollar amounts invested and time periods.  A marginal difference compounds over time to make a significant difference in what you keep in the long run.  Note that including a state tax figure for a resident of a high-tax state (e.g., California, New York, etc.) would just amplify the benefits even further.

As a high-income earner, there are only so many levers that you can pull that will allow your tax situation to improve from year to year, and this may be one to consider.

Having a Guide

I appreciate this wisdom from David Bahnsen, “Never let the tax tail wag the investment dog.” Essentially, reminding us that gains in a portfolio are a great thing and that fulfilling the needs of your financial plan should be the north star when it comes to navigating your financial plans from year to year.

Said another way, taxes aren’t everything, but they are something.  Again, managing to what you keep is important and often overlooked.

Going back to my time in the duck-blind, there are a few things that I was thankful for. At times, you will have a guide who calls the ducks in close, helps determine when the optimal time is to shoot, and, if you’re really lucky – a dog to jump out and go retrieve the ducks.  All the while you are sitting back and spending good quality time with friends or family.

This is not dissimilar to what an experience could be like with a wealth management team. Whether you are preparing for retirement or deciding between taxable and non-taxable bonds, you can have someone helping to guide you.

Experience and wisdom go a long way – whether we are talking about investing or hunting.

As I said, it’s all about what you keep.

Until next time, and best of luck shootin’…

Sean Ullrich
Private Wealth Advisor

Trevor Cummings
PWA Group Director, Partner

The Bahnsen Group is registered with Hightower Advisors, LLC, an SEC registered investment adviser. Registration as an investment adviser does not imply a certain level of skill or training. Securities are offered through Hightower Securities, LLC, member FINRA and SIPC. Advisory services are offered through Hightower Advisors, LLC.

This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.

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About the Authors

Trevor Cummings

Private Wealth Advisor, Partner

Trevor is a Partner and Director of our Private Wealth Advisor Group.

As the author of TOM [Thoughts On Money], Trevor endeavors to write and speak about financial concepts and principles in a kind of “straight” talk demeanor and posture.

He received his Bachelor’s degree in Organizational Leadership from Biola University and his MBA from California State University, Fullerton.

James Andrews - CFP®

Private Wealth Advisor

James is a Private Wealth Advisor based out of TBG headquarters in Newport Beach, CA.

As an author of TOM [Thoughts On Money], James seeks to share core principles in decision-making that bring clarity to managing life and wealth.

He received his Bachelor of Science degree in Entrepreneurial Finance from Cal Poly Pomona and is a CERTIFIED FINANCIAL PLANNER®.

Blaine Carver, CFP®, CKA®

Private Wealth Advisor

Desiring to be a financial advisor since high school, Blaine has continued this passion by stewarding client capital for over a decade. A patient educator, he enjoys aligning clients’ financial resources with their values, particularly through creative charitable gifting strategies.

Blaine holds a Bachelor of Business Administration in Finance from Seattle Pacific University, where he also led the soccer team as captain.


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