By Jeffrey Meenes, CFP® (Published Date July 21, 2022)
When markets turn down, preparing a strategy that is both advantageous and tax-efficient might feel daunting at first, but there are some investment strategies that you may consider using this year:
Backdoor Roth IRA
If you are a high earner with an income above the IRS’s income limit for Roth IRA accounts, you still have the option to create a backdoor Roth IRA. Just as it sounds, this option allows high earners to bypass the income limits and still utilize the tax advantages of a Roth IRA account.
To create a backdoor Roth IRA, you’ll need to:
- Open and contribute to a traditional IRA.
- Convert your traditional IRA to a Roth IRA account (your account administrator will provide the necessary paperwork and instructions to do this).
- Once tax season rolls around, pay taxes on the contributions (if your traditional IRA was tax-deductible you’ll pay back the tax deduction you received when initially contributing to the traditional IRA).
- Pay taxes on any additional gains your traditional IRA account may have made over time.
When considering a backdoor IRA, evaluate the tax obligations you might pay today versus the tax benefits you may realize toward retirement. Your team of planning professionals can help you determine when the tax break will benefit you most.
Smart moves can help you manage your taxable income and taxable estate. For instance, if you’re making a charitable gift, giving appreciated securities that you have held for at least a year is one choice to consider. In addition to a potential tax deduction for the fair market value of the asset in the year of the donation, the charity may be able to sell the stock later without triggering capital gains.
This discussion of tax-focused giving is for informational purposes only and is not a replacement for real-life advice, so make sure to consult your financial, tax, and legal professionals before modifying your gifting strategy.
The annual gift tax exclusion gives you a way to remove assets from your taxable estate. You may give up to $16,000 ($32,000 if you are married) to as many individuals as you wish without paying federal gift tax, so long as your total gifts keep you within the lifetime estate and gift tax exemption of $12.06 million for 2022.1 Managing through the annual gift tax exclusion can involve a complex set of tax rules and regulations. Before adjusting your strategy, consider working with a professional who is familiar with the rules and regulations.
Tax-loss harvesting refers to the practice of taking capital losses (you sell securities worth less than what you first paid for them) to help offset the capital gains you may have realized. Keep in mind that the return and principal value of securities will fluctuate as market conditions change and past performance is no guarantee of future returns. While this doesn’t eliminate your losses, it can be an approach to managing your tax liability.
Up to $3,000 of capital losses in excess of capital gains can be deducted annually, and any remaining capital losses above that can be carried forward to, potentially, offset capital gains next year.2 But remember, tax rules are constantly changing, and there is no guarantee that the treatment of capital gains and losses will remain the same in the coming years. By taking losses this year and carrying over the excess losses into the next, you can potentially offset some (or maybe all) of your capital gains next year. Before moving ahead with a trade, it’s important to understand the role each investment plays in your portfolio.
If you’re looking into this strategy, familiarize yourself with the IRS’s “wash-sale rule.” This rule indicates that investors can’t claim a loss on a security if they buy the same or a “substantially identical” security within 30 days before or after the sale.2
Build Your Team of Professionals
You might build a team for any number of pursuits, from organizing a sports team to putting together people to run a business. Any team is not only an organization of people, it’s also an amalgamation of talents.
In much the same way, building a financial team to tackle your taxes may often mean talking to more than one person. Your trusted financial professional can speak to a wide range of financial issues, but they may want to consult others who have specialized training in tax preparation.
High-earning professionals, in particular, have special tax planning considerations to work into their annual strategy due to the nature of their compensation structures. How can you best position your salary, bonuses, and equity compensation to mitigate your tax burden?
Ask your financial professional if they have worked with a CPA who would be helpful in this situation. They know someone who fits your needs.
Tax Planning is Wealth Planning
For high-income earners, tax planning is about so much more than lowering an annual liability. It’s about providing for the longevity of your wealth. You’ll need to coordinate planning across your entire asset base to protect and keep as much of your wealth as you can.
Whether you are building, accessing, or transferring wealth, taxes should always remain a high priority for high-income earners.
To learn more about integrating a sound tax strategy with you financial plan, schedule a complimentary Discovery Call for a chance to speak with us directly. We look forward to speaking with you.