In most cases, someone’s biggest expense over their lifetime is taxes. The tax code can be complex, in this article we try to simplify it to help you minimize your tax liability.
Timing income:
Timing matters. By deferring or accelerating income, you can strategically manage your tax liability.
For example, waiting to sell your investments until AFTER you have held them for 1 year, can change your tax liability on the gains anywhere from 0%, 15%, or 20% depending on your income. Contrast that to selling them under 1 year, you would be taxed at your income tax rate which could be as high as 37% if you are in the top income bracket.
Roth Conversions. When you are in a lower tax bracket year, you can convert some of your pre-tax accounts to a Roth, minimizing your overall lifetime tax.
Tax-Loss Harvesting:
Tax loss harvesting is offsetting your gains with losses. For example, when your investments are down in a taxable account, you can sell them to capture the loss on paper.
You can then use these losses to offset any realized gains you have not only in the stock markets, but also the sale of a business and/or real estate.
If you do not have any realized gains that year, you can use them to deduct up to $3,000/year off of your income and the remaining losses carry forward to the next year.
Two important notes:
1.) We are not suggesting selling your investments and staying out of the market, that could end up costing you greatly if/when the markets recover. When you sell, you should consider buying back in right after you sell.
2.) When you buy back into the markets you cannot violate the IRS’ wash sale rule by selling an asset at a loss and buying a substantially identical asset within 30 days before or after that sale. Doing so will invalidate the tax loss write-off.
Investment Location:
Placing investments with higher potential tax consequences in tax-advantaged accounts can minimize your overall tax burden.
For example, a real estate mutual fund tends to carry a higher tax cost ratio than other funds. By holding this in your IRA vs in your taxable account will help save taxes.
Charitable Giving and Tax Deductions:
While I don’t suggest giving for the sole purpose of receiving tax benefits, a side advantage of giving is there are tax benefits.
By donating to qualified charitable organizations, you can potentially reduce your taxable income while making a positive impact on the causes you care about.
There are other strategies such as giving through your IRA, giving with a Donor Advised Fund, and/or giving appreciated stock from your taxable account so you do not have to sell and realize the gains.
Your Mortgage:
When you look at the payback plan on your mortgage, it can be nauseating to see how much interest you will pay overtime. This can lead one into paying extra on their mortgage to reduce the amount of interest they owe.
While in a silo, this can appear to be a good strategy. However, the unintended consequences are that the savings you incurred on interest, potentially just cost you a lot more money in taxes. Interest can be used as a tax-deduction, the lower the interest you pay, the less you have to deduct. If your interest rate is only 5%, but your tax bracket is 30%, you paid extra to save 5% but ended up costing you 30%.
Individual Retirement Accounts (IRAs):
Traditional and Roth IRAs provide different tax benefits. Traditional IRAs offer tax-deferred growth, allowing your investments to grow without immediate taxation. Roth IRAs, on the other hand, provide tax-free withdrawals during retirement. High income earners need to be careful about contributing to these plans. Once you are over a certain income limit, you do not get a tax benefit by contributing to a Traditional IRA. Roth IRAs also have income limits for direct contributions. There is a work around for still contributing to a Roth IRA if you are over the income limits.
401(k) Plans:
Employer-sponsored 401(k) plans enable you to contribute a portion of your pre-tax income, reducing your current taxable income. The beauty of these is they have no income limits for receiving the deduction.
Additionally, these contributions grow tax-deferred until withdrawal. In addition, a Roth 401k is becoming a more mainstream offering by employers and has the same tax status as a Roth IRA.
Health Savings Accounts (HSAs):
HSAs offer triple tax benefits. Contributions are tax-deductible, you can invest the funds in your HSA and the growth is tax-free, and qualified medical expenses can be withdrawn tax-free. HSAs provide a unique opportunity to save for medical expenses while minimizing taxes. If you have the ability to pay for expenses out of pocket, you could save those receipts, let your HSA funds continue to grow tax-free, and later reimburse yourself tax free by turning in your medical receipts.
529 Plans:
These education savings plans offer tax-free growth and withdrawals when funds are used for qualified educational expenses. They are a powerful tool for saving for future education costs for yourself, your children, or other beneficiaries. If you are in a state with state income tax, they could potentially offer a tax-deduction for contributing as well. Just be wary of overfunding them as distributions from the account can incur a 10% penalty + income taxes.
These tax strategies are cornerstones of sound financial management for high-net-worth individuals.
Incorporating these strategies into your financial roadmap can help you reduce tax liability, preserve wealth, and pursue your long-term financial goals.
“For a comprehensive review of your personal situation, always consult with a tax or legal advisor.
“Distributions from traditional IRAs and employer sponsored retirement plans are taxed as ordinary income and, if taken prior to reaching age 59½, may be subject to an additional 10% IRS tax penalty. A Roth retirement account offers tax free withdrawals on taxable contributions. To qualify for the tax-free and penalty-free withdrawal of earnings, a Roth account must be in place for at least five tax years, and the distribution must take place after age 59½, or due to death or disability. Depending on state law, Roth accounts distributions may be subject to state taxes.”.
“Investors should consider the investment objectives, risks, charges and expenses associated with municipal fund securities before investing. This information is found in the issuer’s official statement and should be read carefully before investing. Investors should also consider whether the investor’s or beneficiary’s home state offers any state tax or other benefits available only from that state’s 529 Plan. Any state-based benefit should be one of many appropriately weighted factors in making an investment decision. The investor should consult their financial or tax advisor before investing in any state’s 529 Plan.”.
