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Tax Planning for High-Net-Worth Individuals


If you have at least $1 million in investable assets like cash, stocks or mutual fund shares, congratulations: you’re a high-net-worth individual. This distinction not only means that you’re wealthy, but also that you may qualify for certain perks within the financial services industry. However, having a high net worth also comes with the unique responsibility of protecting your wealth. Below, we’ll explore tax planning strategies to protect your assets and minimize the taxes you may face as a high-net-worth individual. A financial advisor can be especially helpful when it comes to implementing these strategies and optimizing your tax strategy.

Max Out Your Retirement Accounts

A couple looks at their tax return on their laptop. High-net-worth individuals can use a number of strategies to minimize taxes, including investing in tax-advantaged investments and accounts.

Maxing out your retirement account(s) is the first step to limiting your tax liability. Contributions made to traditional 401(k) come out of an employee’s paycheck before taxes are taken out, lowering their taxable income. Similarly, traditional IRA contributions are tax deductible and lower a person’s tax liability.

In 2022, the IRS allows employees to contribute up to $20,500 to their 401(k)s, plus an extra $6,500 catch-up contribution for employees who are 50 and older. In total, the IRS permits employee contributions and employer matches to reach up to $61,000 ($67,500 for people 50 and older).

Additionally, you may contribute another $6,000 to an IRA, plus an extra $1,000 catch-up contribution is you’re 50 or older. But beware: the IRS does not let you deduct these contributions if your modified adjusted gross income (MAGI) is $78,000 or more, you’re single and are covered by a retirement plan at work. The IRA tax deduction similarly phases out for married couples who file jointly and have a combined MAGI of $129,000 in 2022.

Beyond the amount of money you contribute to your 401(k) and IRA, consider the types of investments you hold within these tax-advantaged accounts. It may be worth it to consider keeping actively managed funds that engage in lots of transactions in your retirement accounts and defer the taxes owed on these trades.

Backdoor Roth IRA

Roth IRAs can be valuable savings vehicles, especially for high earners who expect their income to drop in retirement, because they’re funded with after-tax dollars that can then grow tax free within the account. However, chances are that you earn a considerable salary and are not eligible to contribute to a Roth IRA if you’re considered a high-net-worth individual. Taxpayers with a modified adjusted gross income of $140,000 in tax year 2021 and $144,000 in 2022 cannot make Roth IRA contributions.

But using a maneuver known as the “backdoor Roth IRA,” high earners can convert their traditional IRA into a Roth. While this requires paying taxes on the money in the year that you make the conversion, future earnings will grow tax free. As a result, you won’t owe any taxes when you begin making withdrawals in retirement. Additionally, Roth IRAs are not subject to required minimum distributions (RMDs), meaning your money can remain invested indefinitely.

Down markets are an especially good time for backdoor Roth IRA conversions. Since the value of your portfolio will likely be less than it would be during a bull market, your tax bill will also presumably be less. However, it’s important to note that Democrats had sought to end this legal tax loophole as part of President Biden’s Build Back Better plan, but the $1.75 trillion spending package stalled in the Senate. It’s possible that the future of the tax provision is debated again if BBB is revisited.

Tax-Loss Harvesting

A financial advisor talks with a pair of clients about their tax situation. High-net-worth individuals can use a number of strategies to minimize taxes, including investing in tax-advantaged investments and accounts.

Tax-loss harvesting, the process of using investment losses to lower or offset capital gains, is a powerful tax-saving tool. When you sell securities and realize losses on those investments, you can subtract those losses from your capital gains. Any leftover losses can be used to offset taxes on wages and other income by up to $3,000. If you have any additional losses at that point, they can be carried forward and applied to future tax returns.

Imagine selling an investment that has appreciated $100,000 from the time you acquired it 10 years earlier. Since you’re a high-net-worth individual with a high income, you’ll pay a long-term capital gains tax of 20% on the gain, meaning you’ll owe the IRS $20,000 for cashing out the investment.

Had you opted to harvest your investment losses and sell assets that lost value during the time you owned them, you could deduct those losses from your $100,000 gain. Perhaps, you sold shares of stock that depreciated by a total of $20,000 in the years that you owned them. Those losses would effectively drop your gain to $80,000 and reduce your tax liability by $4,000 in the process.

Sell Investments Using the Specific Identification Method

Similar to tax-loss harvesting, the specific identification method is an accounting strategy that can help you limit your tax liability. It can be used when selling shares of a particular stock or mutual fund that were acquired at different times. Rather than simply selling the shares that were purchased first or most recently, it may save you money in taxes to select the shares that have appreciated the least since acquiring them.

Max Out Your HSA

Retirement accounts aren’t the only kind of tax-advantaged savings vehicles. Health savings accounts (HSAs) allow you to use pre-tax dollars to pay for qualified health expenses, and in effect, lower your taxable income. In 2022, the IRS allows individuals to contribute up to $3,650 to an HSA and $7,300 for families. Those limits are up from $3,600 for individuals and $7,200 for families in 2021. The IRS also permits HSA owners ages 55 and over to save an extra $1,000 per year.

Not only will maxing out an HSA lower your taxable income, the contributions you make grow tax free and can be carried over from year to year with no withdrawal requirement. Furthermore, there are no income limits on HSA contributions, which means high earners can take full advantage of these savings vehicles.

Contribute to a 529 Plan

While HSAs lower your taxable income and help you save for medical care, a 529 college savings plan is another way to save for a specific type of expense and limit your potential tax bill. Money invested in these accounts grows tax free and can be used to pay for your children’s college tuition and related expenses.

No, 529 plan contributions are not tax deductible federally, most states allow you to deduct contributions from your income. This will save you money compared to selling investments to pay for college for your children or another beneficiary. As an individual, you can contribute up to $16,000 to 529 plans in 2022, $1,000 more than the limit in 2021.

Donate Your RMDs to Charity

A qualified charitable distribution or QCD is money transferred directly from an IRA to a charity. The contribution is not considered part of a retiree’s taxable income but can satisfy their required minimum distributions. For example, someone who must withdraw $20,000 from their IRA in RMDs can instead simply transfer the money to a qualified charitable organization, lowering their tax bill. This strategy is especially useful for retirees who already donate regularly to charity. Instead of donating after-tax dollars, QCDs enable you to donate pre-tax dollars and lower your taxable income.

Bottom Line

If you’re fortunate enough to be a high-net-worth individual, maintaining and protecting your wealth is an important responsibility. Planning for taxes is a vital piece of that puzzle. There are a number of strategies and moves that high-net-worth individuals should consider that can have significant implications on their taxes, including contributing to retirement accounts, maxing out an HSA, harvesting investment losses and more.

Tax Planning Tips

  • A financial advisor, especially one who specializes in tax planning, can be an invaluable resource at tax time. They can help you prepare your tax return, harvest investment losses and maximize your deductions. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • While the Tax Cut and Jobs Act of 2017 increased the standard deduction, you may still choose to itemize your deductions. If so, be sure to keep all your receipts at least a few years after you file. It isn’t uncommon for the IRS to look at returns from three to six years prior to the return they are actually auditing. Here are six common tax audit triggers.
  • SmartAsset’s income tax calculator and paycheck calculator both can help you optimize your tax strategy and budget more effectively.

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