Broker Check
Goldilocks Tax Shelters

Goldilocks Tax Shelters

January 10, 2022

Are you paying too much in taxes?


Pause for a moment to reflect on the fact that the institution of taxation is an 'honor system'. Things would be much easier if the government sent you a bill for what you owed each year. Instead, you have to calculate that amount on your own and send them a check! 

If you don't send the government enough it might come after you in the form of an audit, penalties and interest, tax court, or ultimately asset seizure and jail time.

There's a good deal of judgment involved in the process and the key is making a good faith effort to do the absolute best you can to get it right. Calculating that amount is as much of an art as it is a science and, in reality, it's unlikely anyone will ever notice if you make a few mistakes, because remember, there isn't a right or wrong answer set in stone.

Consider, as well, that it's not always a great idea to wipe out your tax liability to the largest extent possible.

For instance, one of the best ways to grow your personal wealth is to borrow. Most of us have done this in the form of a mortgagewe borrow other people's money to secure a home which will likely appreciate in value. Lenders keep the interest on the loan and you keep the home, which may appreciate in value at a greater rate than the loan.

When you report low income to the government, you save a lot on income taxes, but you can lose access to credit. As with most things, it's healthiest to have a nice balance.

That being said, in most cases we're looking to lessen our tax burden, and in that endeavor there's a big difference between tax evasion and tax efficiency. Tax evasion is an illegal practice of not paying taxes which are rightfully owed, but tax efficiency is a duty you owe yourself. 

One thing that will help you be more efficient is your knowledge of tax shelters. 


In finance we're typically dealing with three types of taxes.

(1) Income taxes are checks you send to the government simply for earning a cash flow the government deems as 'income', typically generated from some sort of labor. 

(2) Capital gains taxes are checks you send to the government after selling an asset for more than what you paid for it.

(3) Transfer taxes are checks you send to the government when you give an asset to someone else, whether as a gift while you're alive or a bequest at death using a will or trust.

Simply put, a tax shelter is a financial instrument, account, or technique which one can employ to grow assets and defer or diminish a tax liability. The key to tax efficiency is thinking ahead, and knowing when (and when not) to use tax shelters.


I like to categorize tax shelters as natural, government-sponsored, and synthetic. 

(A) A natural tax shelter is what I call a financial instrument which has tax benefits built in. Those benefits weren't necessarily bestowed by the government on purpose, but yet they remain. A great example would be a whole life insurance policy. 

The American income tax was first sanctioned in 1913, and by that time life insurance was already a well-established financial product. Whole life insurance accumulates tax-deferred and transfers free of taxes at death, in most cases. Every few years the idea of taxing whole life policies is floated by a few politicians, but usually doesn't get very far. The reason? It's not clear where to draw the line between life insurance and health insurance, or annuities and IRAs. The debate gets complicated quickly, and eventually the effort is dropped.

Annuities are another great example. They were originally whole life insurance policies designed less and less as insurance, and more and more as retirement savings leaning on the tax efficiency of whole life insurance policies. The government probably should have just outlawed the practice when the issue came to light, but instead came up with the awkward idea of a 'Modified Endowment Contract'. Alas, annuities are an oft-misunderstood financial product with natural tax-deferred accumulation from their days as life insurance.

(B) A government-sponsored tax shelter is a type of account invented by the government to incentivize some behavior. Examples are retirement accounts such as 401(k) plans, individual retirement accounts (IRAs), and Roth IRAs. Others are health savings accounts (HSAs), and college saving programs called 529 plans.

In each case, the government allows a taxpayer to save money on a tax-preferred basis, and withdraw the funds to that end. However, also in each case there are heavy penalties if the funds are not used for their intended purpose. If retirement accounts are withdrawn early, or HSAs are used for something other than health expenses, there's a hefty penalty in the form of a penalty tax in addition to the ordinary income taxes which might be due. 

(C) Finally, there are what I call synthetic tax shelters. These are actually techniques one can employ which mitigate or lessen a tax burden, but aren't technically tax shelters at all.

Imagine, if you will, that you own a diversified portfolio of stocks in a retail investment account, and that these stocks don't pay any dividends, yet they appreciate in value over a 10- or 20-year period of time. Since these stocks are not in a tax shelter, they aren't creditor protected. That sounds bad, but it can actually be very good.

Whenever you need money you take out a loan using your stocks as collateral and when you have extra money you pay down the loan. Under this scenario, your stocks may double or quadruple in value over a 20-year period of time, and you haven't paid a penny in taxes because (1) you didn't receive dividends which would have been taxed as income, and (2) you didn't sell anything so you didn't realize any capital gains. 

Your wealth has grown, but your tax liability has been deferred for two decades. This is an example of a synthetic tax shelter, and the type of technique often employed by more sophisticated wealth management firms for clients with larger retail portfolios.


The key is to use the right tax idea, at the right time, and in the right amounts. If you save too much in a 401(k), for instance, you might actually increase your tax liability in retirement by generating income on withdrawal and paying higher income tax rates than capital gains tax rates. If you save too much for your kids' college education, you might have to transfer their accounts into your name and go back to school yourself! (Rather than pay a penalty on withdrawal.)

When it comes to finding shelter in a tax environment wrought with pitfalls, we want to be like Goldilocks in the Tale of Three Bearsfind a wealth accumulation strategy whose associated tax liability is "just right". 



All investing involves risk including loss of principal. No strategy assures success or protects against loss.

This material contains only general descriptions and is not a solicitation to sell any insurance product or security, nor is it intended as any financial or tax advice. For information about specific insurance needs or situations, contact your insurance agent. They may not take into account your personal characteristics such as budget, assets, risk tolerance, family situation or activities which may affect the type of insurance that would be right for you. In addition, state insurance laws and insurance underwriting rules may affect available coverage and its costs. Guarantees are based on the claims paying ability of the issuing company. If you need more information or would like personal advice you should consult an insurance professional. You may also visit your state’s insurance department for more information.

Fixed and Variable annuities are suitable for long-term investing, such as retirement investing. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply. Variable annuities are subject to market risk and may lose value.

Distributions from the Modified Endowment Contracts (MECs) are subject to Federal income tax to the extent of the gain in the policy and taxable distributions are subject to a 10% additional tax prior to age 59 ½, with certain exceptions.