Pay Attention: Insurance, Taxes and Other Boring Financial Topics

Below, you will find an unedited chapter from my new book about wealth building, investing and personal finance, The Ten Year Turnaround. To get your copy of the book, visit www.tenyearturnaround.com

“The avoidance of taxes is the only intellectual pursuit that carries any reward.” – John Maynard Keynes

While much of this book has been devoted to playing offense in the game of wealth building by increasing your income and investing for the future, we also need to play defense too. It won’t do you any good to make a bunch of money if you aren’t able to keep any of it due to a liability claim, a lawsuit settlement or a big tax bill. If you want to keep the wealth you are working hard to build, you have to learn about the tax code and take a variety of steps to legally reduce your tax burden. You also need to carry the appropriate types of insurance so that you don’t get hit with a big liability claim if you are in a car accident or someone breaks their leg on your sidewalk. Finally, you need to build your life in such a way where you won’t become the target of frivolous lawsuits from people that want a piece of your wealth.

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Insurance

Some people see paying insurance premiums as a waste of money. If you don’t have a claim during the term of your policy, you don’t get anything for your money. If you never have an insurance claim, that’s entirely true. However, you don’t buy insurance to cover what you know is going to happen. You buy it to cover things that you can’t possibly predict. In 2012, my son Micah was born 10 weeks before his expected due date. He weighed 3 pounds, 1 ounce and had to spend the first 71 days of his life in a neonatal intensive care unit. Prior to his premature birth, we thought we had what was a smooth pregnancy and had no idea that anything was wrong. If we didn’t have insurance, we would have paid more than $700,000 in medical bills for the care that Micah received in the first year of his life. Because we a good health insurance policy in place, our total out-of-pocket costs were around $15,000 when all was said and done. It was still a big bill to pay, but nothing compared to what it could have been without insurance.

It’s important to have a series of insurance policies in place to cover “black swan” events that you normally would never expect to happen and couldn’t possibly pay for without insurance. If you get in a major auto accident, if you become disabled or if your house burns down, you don’t want to be the one footing the bill. It’s much better to pay a manageable annual fee to cover the risks associated with these things than it is to get hit with a large bill that you can’t possibly pay down the line. There are several types of insurance policies that you should probably own:

Homeowner’s or Renter’s Insurance – These policies will cover your material possessions in the event that something happens to your home or the apartment that you live in. Always buy replacement-cost insurance, which will require the insurance company to pay you enough to replace your possessions and not just compensate you for the value that the insurance company decides your stuff is worth. If you are a homeowner, over insure the value of your home because it often costs more to repair a home severely damaged by fire or other disaster than it does to build a new home from the ground up. If you live in a flood zone, you should also carry a separate flood insurance policy because homeowner’s insurance policies typically do not cover damage by flood.
Car Insurance – Every state requires that automobile owners carry liability insurance, but the minimum amount of insurance required by states is often not enough to pay for the vehicle damage and medical bills that can result from a major accident. Most insurance experts recommend buying at least a “100/300” policy, which covers $100,000 in medical expenses per person involved in an accident and $300,000 total for all of the individuals involved in an accident. If you have a net worth of more than $300,000, buy the maximum available liability coverage (typically $500,000 per accident) so that your assets are protected in the event of a lawsuit stemming from an automobile accident.
Life Insurance – If you have a spouse or children, purchase a 20-year or 30-year level term life insurance policy to provide for your family in the event of your death. Purchase at least ten times your annual income in coverage so that your loved ones can invest the money and live off of the income. Avoid whole life, universal life and variable life policies because of high-cost and fees associated with those types of policies.
Health Insurance – Medical expenses are responsible for 62% of all bankruptcies in the United States (http://www.investopedia.com/financial-edge/0310/top-5-reasons-people-go-bankrupt.aspx). Because of the incredibly high cost of medical care in the United States, everyone should get a health insurance policy through their employer, through one of the state insurance exchanges or through an independent insurance agent. If you are unable to pay for health insurance, check and see if you qualify for a subsidy under the Affordable Care Act. You might also consider faith-based health insurance alternatives, such as Christian Healthcare Ministries (chministries.org), Samaritan Ministries (www.samaritanministries.org), Medi-Share (www.mychristiancare.org) or Liberty HealthShare (www.libertyhealthshare.org).
Long-Term Disability Insurance – You are four times more likely to be permanently disabled than you are to die by the age of 65 (http://www.affordableinsuranceprotection.com/death_vs_disability). A typical 35-year old adult has a 21-24% risk of becoming disabled for three months or longer during their working years (http://www.disabilitycanhappen.org/chances_disability/disability_stats.asp). Buy a policy that will cover at least 65% of your income if you become disabled. Make sure to pay for long-term disability with after-tax money so that the benefits you receive will be tax free. Also, try to get a policy that covers you if you are unable to do your own occupation. The cheapest way to buy long-term disability insurance is through an employer, but an independent insurance agent can help you buy a policy if employer-offered long-term disability insurance isn’t an option for you.
Long-Term Care Insurance – 70% of people who turn the age 65 will have a nursing home stay or need some other form of long-term care (http://longtermcare.gov/the-basics/how-much-care-will-you-need/) during their lives. Since the cost of nursing home care averages more than $6,000 per month, it’s important to cover the risk of needing to stay in a managed care facility by buying long-term care insurance. According to the American Association of Long-Term Care Insurance, the best time to purchase long-term care coverage is in your mid 50’s (http://www.aaltci.org/long-term-care-insurance/learning-center/best-age-to-buy-long-term-care-insurance.php/). If you purchase a policy before your mid 50’s, you are probably wasting money because the risk of you needing long-term care is pretty low. If you wait until your 60’s to purchase long-term care insurance, the cost of the policy will rise dramatically.
Umbrella Liability Insurance – If you have a high net worth, purchase an umbrella liability policy that will protect you from major claims and lawsuits. An umbrella policy will provide additional liability coverage above the limits of your homeowner’s and auto insurance policies. For example, your auto insurance might cover the first $500,000 of total liability. Your umbrella policy might add $1 or $2 million of extra liability coverage after your auto insurance liability caps out. Umbrella policies may also cover you from other types of liability that your other policies don’t cover, such as false arrest, libel, slander, malicious prosecution and mental anguish. Umbrella insurance is very affordable and can be purchased from every major insurance company.

The seven types of insurance listed above are must haves in most situations, but there are also many other types of insurance that you just don’t need. Never buy an insurance policy or an extended warranty for anything that you can easily cover with an emergency fund. That means you shouldn’t ever buy an extended warranty on things like TVs, computers and appliances. Never buy an insurance policy when there is no insurable need. For example, children do not need life insurance because no one depends on their income to live. There are also many types of duplicative insurance policies that replicate what your existing insurance policies already cover, such as cancer insurance, accidental death insurance, hospital insurance and mortgage protection insurance. These things are already covered by your health insurance and life insurance and do not need to be double insured.

While it’s incredibly easy to shop for insurance online these days, I think it’s best to work with an independent insurance agent that can shop for policies among many different insurers on your behalf. A good independent agent will be able to educate you on exactly what policies that you need, what features you need in each policy and what coverage levels to get for each type of policy. Working with an independent agent will also give you someone you know to call in the event that you have to file a claim or have a dispute with an insurance company. The best way to find an independent insurance agent is to ask for recommendations from friends and family members. If no one has a recommendation, it’s very easy to find a local independent agent through Google or the local Yellow Pages.

My Insurance Action Plan

Which of the seven key types of insurance are you missing? What policies do you have that you haven’t reviewed in a while? Do you need to change your coverage limits on any of your policies? Do you have any gimmick policies that you need to cancel? Write down what action steps you need to take in order to get the appropriate policies with the appropriate level of coverage in place.

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Taxes

Taxes are a reality of life in every country in the world. Whether you agree with your country’s tax system or not, you have to pay whatever tax code says is your fair share. If you plan on becoming wealthy, you should expect that your fair share of the nation’s tax bill will be larger than everyone else’s fair share. 45.3% of American families pay no federal income tax (http://www.cnbc.com/2015/10/09/775-million-households-are-not-paying-federal-income-taxes.html) and the top 10% of income earners pay 68% of all federal income taxes (http://www.heritage.org/federalbudget/top10-percent-income-earners). Most countries place a disproportionately large tax burden on the wealthy and the United States is no exception. I personally paid more than $650,000 in taxes in 2015 and spent five times more on my tax bill than all of my other living expenses combined. If you plan on becoming wealthy during your ten-year turnaround, learn to use the tax code to your advantage to limit your federal tax liability each year. You should never evade paying taxes by filing a fraudulent return or not filing a return at all, but you should do whatever you can within the bounds of the tax code to minimize your tax burden.

The government rewards certain activities and punishes other activities through the tax code. If the government wants more of something, they setup a tax deduction, tax credit or other special tax program to reward that activity. For example, the government wants people to go to college, so they have setup a variety of credits and deductions that make attending college more affordable. The government also wants people to have children, so tax filers receive a credit each year for every child that they have. Conversely, the government taxes activities that it wants less of. This is why the federal government charges an excise tax on the sale of tobacco and alcohol. In order to minimize your tax burden, you need to do more of the activities that they government wants you to do and do fewer of the activities that the government doesn’t want you to do.

Here are some activities that the government rewards in the tax system:

Running a Business – Business owners can receive a variety of tax benefits that others can’t receive, such as the home office deduction, the mileage deduction, the self-employed health insurance deduction and the deduction of any business expenses from your tax return. Business owners also are able to put away more in specialized retirement plans individual 401(k)s and SEPs. This doesn’t mean that business owners get off easy though. Most self-employed people have to pay self-employment tax to cover the employer’s side of Social Security and Medicare. Not to mention, many business owners are in much higher tax rates than almost everyone else because of their higher incomes.
Saving for Retirement – By investing money into a Roth IRA, your company’s 401(k) plan or another type of retirement plan, you can save money for retirement on a tax-deferred or a tax-free basis depending on what type of account you are investing in.
Giving to Charity – You can receive a tax deduction for 100% of the charitable gifts that you make to any 501c3 non-profit organization. This includes any gifts that you make to your local church and any other charitable organization that you might give to.
Buying a Home – You can receive a tax deduction for your mortgage interest and for property taxes that you pay. The mortgage interest deduction is often one of the biggest tax deductions on many people’s tax return. When you go to sell your home, the first $250,000 (if your single) or $500,000 (if you’re married) of capital gains are excluded from your taxes. If your house has a big run up in price, you still probably won’t have to pay any taxes on it.
Investing in Rental Real-Estate – Landlords receive a tax deduction for the depreciation of the value of the property that they buy, which often offsets any income tax liability that gets created by rental income. Landlords can also deduct any expenses related to the maintenance of their home. There are some specific rules about what you can deduct immediately and what needs to be depreciated over several years, so do additional research or talk to your tax professional before claiming these deductions.
Having Children – You can receive a tax credit of $1,000 per child as of the 2015 tax year. Each additional child also adds a dependent to your tax return, which will also reduce your tax burden.
Paying State Taxes – You can receive a deduction on your federal taxes for any state taxes that you pay, including sales tax, property tax and income tax.
Going to College – There are a variety of different tax credits and deductions available for people going to college and the parents of people going to college. If you are in college or have children going to college, research the American opportunity credit, the life-long learning credit, the tuition and fees deduction and the student loan interest deduction. There are also specialized investment accounts including the 529 college savings plan and the Coverdell education savings account that allow people to put money away for college on a tax-advantaged basis.
Investing in Stocks and Municipal Bonds – Because the government wants to encourage investment, capital gains and dividends are taxed at a lower tax rate than other types of income. Income from investing in municipal bonds is totally tax free.
Finding a Job – You can receive a deduction for any expenses related to a job search, with some limitations. If you are moving to another city for a new job, you can also deduct your moving expenses from your taxes.
Buying Health Insurance – The government allows employers to furnish health insurance to their employees without creating an income tax liability for the employee. If you are self-employed, you can deduct the cost of health insurance from your tax return.
Going Green – There are a variety of federal tax credits available that will reduce the cost of adding energy efficient features to your home, such as insulation, roofing, water heaters and new windows. Details can be found on the EnergyStar website (https://www.energystar.gov/about/federal_tax_credits).
Paying for Medical Expenses – You can deduct qualified medical expenses that are more than 10% of your adjusted gross income each year. If you make $50,000 and have $10,000 in medical expenses, you will be able to deduct $5,000 from your taxes.

The list of activities that the government encourages above is designed to give you a flavor of the types of things that can reduce your taxes. Remember that every deduction, credit and exclusion has a specific set of criteria that you must meet to claim the credit. Additionally, tax law changes every year. If you are reading this book five years after it was first published, some of the deductions and credits listed have probably changed. Don’t take a deduction or a credit on your next tax return solely based on the information in this chapter. Consult with a tax professional or do your own additional research before taking any of these deductions.

Deductions and credits are the primary way that you’ll be able to reduce your tax burden, but those aren’t the only things that you can do to reduce your taxes. Here some additional tips related to taxes that might help reduce your overall tax burden:

Hire a Professional – The tax code is incredibly complex and is too difficult for someone that doesn’t specialize in taxes to understand. If you have a very basic return and make less than $50,000 per year, go ahead and use TurboTax. If you’re an entrepreneur, make more than $50,000 per year or otherwise have a complicated return, have a tax professional do your taxes. A good tax person can often find deductions and credits that you missed and make far fewer mistakes than you would doing your own taxes. Also, if the IRS has a question about your return or audits your taxes, your tax person will be the one that gets to deal with them.
Review a “Deduction Checklist” – There are a variety of tools, checklists and questionnaires online that will help you find deductions and credits that you might have otherwise missed. A good place to start is to do a web-search for keywords like “tax deduction checklist” and “commonly missed tax deductions,” which will yield dozens of different lists that you can check to make sure that you didn’t miss out on any deductions, credits or exclusions.
Move to a Low Tax State – Your tax burden will vary dramatically by the state you live in. In New York, there’s a 4%-8.875% sales tax depending on what municipality you’re in, a minimum state income tax of 6.65%, a state capital gains tax of 8.8%, a corporate income tax of 7.1% and an average state-wide property tax of 1.5% (https://smartasset.com/taxes/new-york-property-tax-calculator). Compare this to states like South Dakota that have a 4.5-6.5% sales tax depending on what city you’re in, no state income tax, no corporate income tax, no capital gains tax and an average property tax rate of 1.36%. If you make a high income, consider moving across a state line if you can benefit from a dramatically lower tax burden.
Delay Income and Accelerate Expenses – If it’s near the end of the year, consider speeding up any tax deductible expenses you plan on making before the end of the year ar. If you’re an entrepreneur and have money coming in, maybe wait until after the first of the year to send out invoices. While this won’t eliminate your tax burden, it will make it so that you won’t have to pay taxes on the income you push forward for more than a year.
Don’t Try to Get a Tax Refund – If you receive a large tax refund each year because you overpaid in taxes, adjust your withholding so that you aren’t giving the government an interest-free loan every year. You are better off putting that money immediately to work toward your financial goals than to let the government hold onto it until you file your tax return.

While it’s impossible to completely avoid paying taxes without breaking the law, there are lots of actionable steps that you can take to reduce your total tax burden. By doing the things that the government rewards in the tax system and by following some of the other recommendations above, you should be able to find significant tax savings each year.

A Note to Christians about Paying Taxes

The Bible plainly states that Christians should submit to governing authorities and pay the taxes imposed on them. In Matthew’s Gospel, a group of Pharisees challenged Jesus and asked him whether or not it was right to pay taxes to Rome (Matthew 22:16-22). Jesus slyly responded that they should “give to Caesar what belongs to Caesar; and give to God what belongs to God.” In his response. Jesus acknowledged that the government makes lawful requests of its citizens and that we must be obedient to the government in political and civil matters.

The Apostle Paul elaborates this matter in the book of Romans:

Let everyone be subject to the governing authorities, for there is no authority except that which God has established. The authorities that exist have been established by God. Consequently, whoever rebels against the authority is rebelling against what God has instituted, and those who do so will bring judgment on themselves. For rulers hold no terror for those who do right, but for those who do wrong. Do you want to be free from fear of the one in authority? Then do what is right and you will be commended. For the one in authority is God’s servant for your good. But if you do wrong, be afraid, for rulers do not bear the sword for no reason. They are God’s servants, agents of wrath to bring punishment on the wrongdoer. Therefore, it is necessary to submit to the authorities, not only because of possible punishment but also as a matter of conscience. This is also why you pay taxes, for the authorities are God’s servants, who give their full time to governing. Give to everyone what you owe them: If you owe taxes, pay taxes; if revenue, then revenue; if respect, then respect; if honor, then honor (Romans 13:1-7).

Some Christians may argue that they should avoid paying taxes because the government does things that are sinful or are otherwise un-Christian. Those familiar with the practices of the Roman government during the time Jesus was alive immediately recognize that this isn’t a valid excuse for Christians not to pay taxes. Tiberius Caesar, who was the emperor of Rome from 14 to 37 A.D., summarily executed his political opponents without trial, appointed corrupt governors and had a reputation for severe sexual perversion. His line of successors, including Caligula, Claudius and Nero, weren’t any better. Claudius thought he should be deified as emperor and Nero extensively persecuted Christians for their beliefs. Despite the many wrongdoings of the Roman emperors that far exceed any wrongs currently happening in any developed country in the world, both Jesus and Paul both told Christians to pay their taxes to Rome.

Protecting Yourself from Lawsuits

Have you heard of the lawsuit where a family living off welfare was sued for $7 million? No, of course you haven’t. Lawsuits generally don’t get filed against people with few assets because you can’t squeeze blood from a turnip. Personal liability and injury cases get filed against wealthy people, because that’s where the money is. If you are on the path to becoming wealthy, you have an increased risk of being targeted for a personal liability lawsuit. You never know when you will get in an accident with or when someone will trip on your sidewalk and decide that they need a piece of your money.

I’m not a lawyer and can’t offer actual legal advice, so consult with a good attorney before taking any steps that I recommend to reduce the likelihood of getting sued. Here are some general tips to protect yourself from lawsuits as you begin to build wealth:

Increase Your Liability Insurance – Umbrella liability insurance is your first defense against a potential liability lawsuit. You should have at least as much liability insurance to cover your personal net worth. If you are worth $3 million between your home, your investments and your business interests, you should have at least $3 million in liability coverage. At $200-$300 per year for each $1 million of coverage, having a good umbrella liability is the cheapest way to defend yourself from lawsuits.
Avoid Showing Off Lavish Wealth – If no one knows that you have a high net worth, you won’t have a target on your back for lawsuits. For this and many other reasons, I recommend against lavish displays of wealth such as high-end luxury vehicles and million dollar homes that will tip off everyone that you have a pile of money that they can go after.
Put Businesses and Rental Properties in an LLC – If you have a rental property or own a business, consider putting it in a limited liability company. That way, if someone sues your business, they can only go after the assets inside of the limited liability company and any assets that you own personally.
Put Business Partnerships on Paper – You may be at risk for the actions of any of your potential business partners. If you and your partner operate as a general partnership and your partner gets sued, your personal assets could be at risk if they get sued. Put general partnerships inside of an LLC to provide yourself with legal protection.
Nip Potential Issues in the Bud – If someone feels personally wronged by you, take action to rectify the situation before it escalates into a lawsuit. Even if you feel that you are in the right, a simple apology can stop many issues before they escalate. People get angry, hateful and litigious when they stop seeing someone as a human being and only see that person as a source of wrongdoing. A simple apology can often catch someone flat footed and cause them to remember that they are dealing with another human. Of course, a good lawyer will tell you to not admit any wrongdoing when there’s a risk of a lawsuit, so be careful what you say and what you do to try to rectify any potentially litigious situation.
Get Help from a Lawyer – If you have a personal net worth of more than $1 or $2 million, it’s worth sitting down with an asset protection lawyer and asking them what specific steps that you can take to mitigate the risk of a lawsuit and protect your assets in the event that you get sued. A good lawyer can also go over advanced strategies like setting up trusts that are beyond the scope of this book. While you might spend several hundred dollars for a consultation, it’s an incredibly affordable insurance policy to have if you do get sued.

I have personally been sued once in my life over a business dispute with a former employer. While I won’t go into detail about the suit, there was a difference of opinion on what my legal obligations were to them. I thought I was right. They thought I was wrong. While I do believe I would have ultimately prevailed in the lawsuit, I opted for a quick settlement that cost me a meaningful, but not outrageous amount of money. Another business owner in Sioux Falls once told me that if you can settle any lawsuit for less than $20,000, you probably should. Defending a lawsuit can be an incredibly expensive and time consuming exercise that can cost $30,000-$50,000 and take more than a year of your life. If there’s a possibility of a quick, reasonable and affordable settlement when you get sued, you should probably consider taking it even if you do think you will ultimately win the suit. There’s a real value in getting past a lawsuit so that you can go on with life, even if it costs you some money upfront.

Wrap-up

Playing defense is an important aspect of any wealth building effort. Increasing your income and investing your money will allow you to build wealth. Reducing your tax burden and mitigating the risk of a lawsuit or major insurance event will prevent you from losing your wealth. Many of the worst case scenarios listed in this chapter may never happen to you. It’s not very likely that your house will burn down, that you will get sued, that you will be audited by the IRS or that you will get into a major car accident. While the risk of these events happening in your life are pretty low, they do happen to some people. It’s better to be prepared for an event that may never happen to you than to take a major financial hit that you could have easily prevented. By buying the right insurance policies and taking steps to minimize the risk of a lawsuit, you can substantially mitigate the risk of facing a catastrophic financial event in your life.

Action Steps

Review your insurance policies and make sure that you carry the types of coverage recommended in this chapter.
Look for tax deductions and credits you may have missed to reduce your tax bill
Take any appropriate steps to reduce the likelihood of being sued.