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Three Tax-Free Investments for Affluent Millennials

Updated: Feb 17, 2022

You have just turned 35 and already hit the major milestones! With a family you love, your forever home and a career that both invigorates and compensates you very well, you realize it is now time to focus on retirement and college for the kids. Your spouse is equally successful and agrees that these goals are urgent. Like most people with this profile, you understand that without pensions and the rising cost of education the onus falls on you and your spouse to save for these objectives. You quickly realize when you analyze your situation that you will have a significant retirement income gap. The more money someone makes, the less they can rely on maxing out their 401(k)s and social security (hopefully it will still exist). The figure below illustrates this concept. To better illustrate, if you max out your 401k and you make $200k a year you are able to save 10% of your income; if you max it out and you make $1million you are only saving 2%.

In order to maintain a similar lifestyle after retirement, you still need 80% of your current income. In order to hit that goal there will need to be additional savings elsewhere. Add that to costly education funding and something serious must be done.

Many of our retired clients hate paying taxes on their investment gains. This leads them to a place where they cannot enjoy the wealth they worked so hard to accumulate. This same problem keeps them from rebalancing their portfolios to put them in line with their current risk tolerance. With new federal tax laws being considered, a massive amount of stimulus in 2020 and 2021 plus a huge national debt, I thought it would be interesting to look at three unique strategies to eliminate or reduce future tax exposure.

1. Upstream Gifting

This is an ideal strategy for certain fact patterns because it allows large annual savings, higher distribution flexibility and more investment flexibility. It is complicated and does pose some risk; however, it can be an extremely effective planning tool. Under current tax law, individuals get a stepped up basis on assets they own in their estate. For example, if I bought apple at $1 and by the time I died, it was valued at $300 my heirs would have a cost basis of $300. To use this to your advantage you could use your 65-year old parents as proxies. Both you and your spouse could gift $15k/year to each parent giving you up to a total of $120k/year without depleting your lifetime exemption. In this scenario, your parents would then invest this $120k/year. If they lived 30 years and had a return of 6% on the assets, you would avoid paying capital gains on $5.9million dollars. Based on these assumptions this would coincide with retirement and allow you to have a large pool of federally tax-free assets to use at that point. If your time horizon for the assets was shorter, say for college, this could also be done with grandparents.

This complex planning technique should be carefully assessed. To make upstream gifting work, you must trust your parents to help you implement. You also need to make sure the correct estate planning documents are in place to insure the money will flow directly back to you and your family and not to other siblings. This strategy will be impacted if there is a change in the estate tax exemption or a change in stepped up basis.

2. In-plan Roth Conversions

Many large employers are now allowing their employees access to a powerful benefit called “in plan Roth conversion”. Most high earners think of a Roth as something they do not have access to due to income limits. The “in plan Roth conversion” is now allowing these individuals to contribute a large amount of money into a Roth 401k. The mechanics are when you max out your 401k and add your employer match, the difference between those total contributions and the 415 Limit on defined contribution plans ($61k for 2022) can be contributed to a Roth inside the plan. If you maxed out your $20,500 then your employer contributed an additional $10,500, you would have the ability to contribute $30k to a Roth in that calendar year.

Not all employers give their employees access to this strategy; however, it is one worth looking into if you want to save additional tax-free dollars. The downside is that now this money is set aside and may cause a lack of liquidity until age 59 and a half. Additionally this assumes there is no change to the current tax status of Roth’s.

3. Private Placement/Overfunded Life insurance

If the first two planning options do not work, or you have a need to save larger amounts, Private Placement or over-funded life insurance may make sense. Properly structured life insurance is a way to create tax-free income during your lifetime. When money goes into permanent life insurance, some goes to the cost associated with the policy and the rest is invested. By keeping the insurance cost as low as possible, you are able to create a bucket of money that can be accessed federally tax-free. For UHNW individuals the cost of insurance is often much lower than the tax rate on their investment income. If they are investing in high yield instruments subject to ordinary income tax, this is even more applicable. One potential pitfall is if your advisor does not have experience with the nuance of these concepts or focuses on being paid rather than building the structure correctly.

An additional benefit to this strategy as well as the in-plan Roth conversion is that you can reallocate when you want without tax consequences. This allows people to go risk on and risk off as they feel comfortable. A luxury that is not available in accounts subject to capital gains.

Overall, people can save in many ways for future expenses. For those who are nervous about future tax rates or changes in risk tolerance, these three ideas are a great place to begin.


Warren McGuire joined NFP as a Director in 2018. In this role, he works with professionals, business owners, and high net-worth individuals, advising them on strategies for asset accumulation and wealth preservation.


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