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Some may consider a high tax bill as a “good problem to have”—meaning, you made a lot of money last year. However, for the person footing that bill, it’s likely they would want to make every effort to minimize their taxes. In fact, an apathetic approach to tax planning could prove incredibly costly over time. Missed opportunities to lower your tax obligations can add up over the years, quietly eroding your net worth.
For high-income individuals, tax mitigation strategies should be a core component of your wealth management plan. Not only does it save you money in the short term, but the savings can be reinvested to produce greater long-term growth in your portfolio.
#1. - Balancing Qualified and Non-Qualified Savings.
Retirement plans like a 401(k) and traditional IRA are great for building long-term wealth. Your contributions reduce your taxable income (and thus reduce your tax bill)for the year, plus the earnings can compound faster thanks to tax-deferred growth. Keep in mind, however, that these accounts can trigger a large tax burden later in life when you withdraw the funds. That’s why many financial advisors recommend balancing your retirement savings across tax-deferred and taxable investments in non-qualified accounts. This strategy allows you to take advantage of some tax savings today, but not so much that you set yourself up for a “tax time bomb” when you retire.
#2. - Roth IRA Conversions.
Another way to smooth out taxes over time (and potentially pay less overall) is to transfer money from a tax-deferred savings plan to a Roth IRA. The conversion process requires you to pay income taxes on the fair market value of the assets being converted; however, after the conversion, those assets can continue to grow tax-exempt, and you’ll owe nothing further upon withdrawal. This strategy is available even to high earners who exceed the income limits for direct Roth IRA contributions.
A related strategy, called the “backdoor Roth,” involves converting after-tax IRA funds (contributions you made to a traditional IRA that were beyond the tax-deductible limits) to a Roth IRA. Even though you’ve already paid taxes on the contributions, the earnings will accumulate tax-exempt in the Roth and can be withdrawn tax-exempting retirement. Furthermore, the Roth IRA is not subject to required minimum distributions (RMDs) in retirement, allowing you to continue growing funds in the account if you don’t need the income.
#3. - Tax-Loss Harvesting.
When you have an investment portfolio outside of qualified retirement accounts, any proceeds from selling appreciated assets will be subject to either short-term or long-term capital gains taxes. However, some strategic maneuvering called “tax-loss harvesting” can help you reduce or completely eliminate those taxes. This method involves selling additional securities that have declined in value; since those losses are tax deductible, they can be used to offset capital gains taxes of the same type (short-term or long-term). If your losses exceed the gains, the remaining deduction can offset a portion of your ordinary income or be carried over to offset gains in future years.
#4. - Charitable Giving.
Giving to others can be a rewarding act in and of itself, but it can double as a savvy tax-saving strategy. Donations to qualified charitable organizations can be deducted to reduce your taxable income. And by donating property or stocks directly to an organization (rather than selling the investments and donating the proceeds), you can also avoid capital gains taxes. In a particularly high-income year, you might also consider contributing to a donor-advised fund, which allows you to claim the full charitable deduction that year, even if the funds may be disbursed to various charities over time.
Conclusion: Take Taxes Seriously
Taxes may be a certainty in life, but your actions can have a significant impact on exactly how much you pay. Over the course of your lifetime, tax-smart strategies can save enormous amounts of money and allow you to redirect those funds toward achieving your long-term financial goals. A word of warning, however: tax laws can be complex and confusing, and mistakes can be costly. We recommend always working with a financial planner and/or CPA to time transactions correctly and adhere to IRS rules.
If you'd like help navigating tax strategies and planning, please contact us here or call us at (888) 895-4797 to schedule a no-cost, no obligation consultation,
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