PRIVATE EQUITY

ARTICLES​

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Tax Efficient Retirement Planning Strategies

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As of this summer, Millennials (those born between 1981 and 1996) comprise the largest generation in the United States, having just recently supplanted the Baby Boomers. This key generation numbers roughly 73 million strong and makes up the largest portion of the US labor force, at 35%, according to the Pew Research Center.

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Millennials have matured into a powerful economic force. Accenture estimates that Americans aged 23 to 38 will spend approximately $1.4trillion beginning in 2020 and will comprise 30% of all retail sales domestically. The statistics surrounding this group are abundant, but the point is that this tech-savvy, disenchanted, oft-entitled generation is making real money. Adjusted for inflation, their salaries are higher than just about any other period over the past 50 years, according to the Pew Research Center, with a median income of $69,000.

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The obstacles this generation faces have been publicized for years; they are mired in student debt, they can’t afford to move out of their parents’ home, at a time when healthcare and childcare cost more than ever and the US Bureau of Labor Statistics reports that purchasing power today is comparable to what it was 40 years ago. Surveys have shown that by and large this group is skeptical of its ability to become debt-free or ever afford to buy a home. Meanwhile, the clock keeps ticking and retirement is getting closer by the day. Retirement won’t pay for itself and this group likely won’t have a company sponsored pension or defined benefit plan on which to rely.

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The common solutions to retirement planning are company sponsored defined contribution plans, also known as 401(k) or 403(b) plans or individual retirement accounts (IRA) – of the traditional or Roth variety. Each of these account types has its own merits and can and should be used in concert with the others, to the degree that is allowed. Defined contribution plans are funded with pretax money and often come with employer matching contributions. The maximum that can be put into an IRA this year is $6,000, or $7,000 if you are over 50 years old. Traditional IRAs are funded with pretax money and Roth IRAs use after-tax income. The difference between the two mainly has to do with taxation on withdrawals after age 59 1⁄2.

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Enter a new solution, the Qualified Opportunity Zone fund, or QOF, as they are colloquially known. Created as part of the 2017 Tax Cuts and Jobs Act, Opportunity Zones are census tracts that have been identified as undercapitalized areas in need of investment. By following certain rules and allocating capital to properties or businesses in the defined Opportunity Zones investors can reap a series of tax incentives. The most compelling attribute for Millennial retirement planners is the permanent tax exclusion of capital gains derived from QOF investments so long as the investment is held for at least ten years. What this means is that if an individual invests in a QOF and the QOF earns investment profits after 10 years the investor can withdraw her investment and pay no taxes on the gains. Further, the Opportunity Zone program is scheduled to run through 2047 which allows investors to continue to make tax exempt

investments even after the initial fund is retired. The program’s duration offers Millennials the flexibility to invest for as short as ten years or all the way to retirement age.

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The QOF tax profile is similar to a Roth IRA, but without the contribution limit or income eligibility restrictions. There is no maximum investment into Opportunity Zone funds, nor are potential investors disqualified from participating if their income is above a certain threshold. Additionally, QOFs invest in either real estate development projects or engage in private equity-style investing strategies. Both of these investment techniques offer diversification benefits from a strategy standpoint relative to traditional equity and fixed income portfolios. Finally, direct real estate and private equity investing are not easily accomplished in an IRA.

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Qualified Opportunity Zone funds offer several attractive investment characteristics that will likely appeal to Millennials investing for retirement. Used in concert with other available retirement investment vehicles, a QOF can be a powerful tool in the Millennial retirement planning arsenal.

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