Tom Knows: Efficient Tax Structures are Important
Transcript:
Katie Nealis:
What is a controllable income versus an uncontrollable income?
Tom Vaughan:
Oh, wow. Okay, that’s actually a really important component, especially in tax planning area. So a controllable income versus an uncontrollable income, and you need to be able to identify those to be able to really figure out your tax planning strategy. They have a thing that I heard about years and years ago, it’s called a Rockefellers rule. And this is supposedly a quote that was attributed to john D. Rockefeller. And the concept is to do to have the most efficient tax structure, he should not have more taxes on your tax return than you spend in any one year. So again, to have the most efficient tax structure, you should not have more income on your tax return than you spend in any one year, I used to give seminars called the seven steps to retirement success. This was one of them. And so one of the things that happens there is, in order to do that, you need to be able to identify your controllable versus uncontrollable income. So an uncontrollable income be something that’s coming in that you can’t really stop, I mean, never really want to stop them. But from a tax standpoint, so security would be great example, or pension would be another example. And if I put like rent into that, for example, or if you’re getting royalties for a textbook that you wrote, those type of things. Now, rents are theoretically controllable, you can sell the property and stop the rent. But usually, that’s such a big job, and people don’t want to do it, I’ll call that uncontrollable. So let’s say that adds up to 50,000. And I’m spending 100, just make up a number.
Now I want to identify the other incomes that I have. And let’s say my total income is 150. Altogether, so I got another $100,000 worth of control income. And so these would be things like interest income from CDs, or savings accounts, dividend income capital gains, that you’re kind of consistently generating out of taxable accounts, these are things that you could handle in different ways. And try to reduce that taxable income down to the 100,000 that you’re using. And so most of the controllable incomes are incomes coming off of investment types of assets. And then you could do different things to you know, defer capital gains and buy and hold. You know, if you bought some gold coins, you can hold on to them until you know, so you don’t have to pay taxes, even though it could grow. And so really, it’s about about matching up that income source to you know, how much you’re spending. And so that’s what that’s what they’re talking about there when they’re talking about controllable versus uncontrollable incomes.
It’s a really interesting area, actually. And it’s part of tax planning. tax planning is different than tax preparation. Most people are familiar tax preparation, because you go to see your accountant, and you get, you know, taxes filed in April, or what have you. A tax planning is taking a look at all of your income sources, controllable and uncontrollable, and seeing what happens, you know, over your entire lifetime, all the way out to age 100, you get to 72, you got another uncontrollable income in that the required minimum distribution that has to come out of your IRAs. So part of tax planning is dealing with that. And then what strategies can you do today to reduce your overall tax costs throughout the rest of your life? You’d be amazed at how much difference that can make actually, hardly anybody really does tax planning. And so that is the first step is to kind of identify that controllable versus uncontrollable income.
Easan Arulanantham:
Is that why Roth is so powerful is because essentially, you can have, you can get money without actually creating any kind of income for yourself?
Tom Vaughan:
Yeah, if you have, and this is why I converted everything I have into Roth, you know, last year and this year, because it just gives you massive flexibility, I can generate whatever income I want out of my Roth accounts, and that none of it ends up on the tax return, I can get stock market rates of return for tax free. And so there’s some, you know, pros and cons to that. But it’s also part of the Roth now, and the ability to convert from an IRA, regular IRA or regular 401k into a Roth, you know, IRA is a part of tax planning. And so that’s something you have to take a look at, because let’s say somebody has a lot of money in 401k. And when they retire, all of a sudden, they’re gonna have this massive income, uncontrollable income after age 72, because of the requirement of distribution, right. And so the Roth then becomes a very powerful tool in a tax planning base to try to start moving some of that out of the IRA to control some of that income in the future. And it’s math you can we have programs that will figure out how much to move and what makes sense, what doesn’t make sense and you know, what have you there’s lots of, you know, tricks to that to make it work just right, but that’s definitely on the success path for retirement. Very important.