Over the years, we have had the privilege to develop tax-efficient plans for clients from all walks of life. With this year’s tax season still fresh in the rear-view mirror, clients often ask us after the fact of how they can do better next year to optimize their personal and professional income tax picture. Like many other things in life, preparing and implementing these structures in advance is key to taking full advantage of the opportunities that are available. Many of these ideas can be implemented by almost anyone who is looking to trim their tax bill. Read on for some tax tips that are accessible, but can have game-changing impact that will put a spring in your step.
1. Asset Location
Don’t just think about asset allocation, think about asset location. Many investment advisors invest their client’s assets with the same allocation across all account types, without taking the tax characteristics of those accounts into consideration. Take, for example, the client whose assets are divided into a typical balanced portfolio, allocated 60% to equities, and 40% to fixed income. If a client employs the same strategy across both tax-deferred and taxable accounts, the tax-deferred account will miss out on a step-up in basis at the death of the taxpayer, while converting capital gains into ordinary income. Conversely, a client who owns fixed income securities in a taxable account will not benefit from a step-up in basis or perhaps a small one at best. Thus, when clients reach retirement age, we counsel them to hold their fixed income investments in their retirement accounts and keep their equity allocation in taxable accounts. With a potential basis step-up and a 0% capital gains tax rate for up to $94,050 for couples without significant other income, this could result in a substantial tax savings, for them and their families.
2. ROTH IRAs
Harnessing the power of tax-free compounded growth is perhaps one of the seven wonders of the financial world. The best gift you can give your child or grandchild is not a 529 college savings account but help funding a Roth IRA early in their career. A parent or grandparent who helps a child or grandchild contribute to a Roth IRA for four years from age 18–22, can expect him or her to have a retirement account worth over $3 million at age 72 without any further contributions. The only catch: the grandchildren must have earned income. Unlike a 529 plan, retirement savings are not considered an available asset to the student for financial aid purposes. The downside to Roth retirement accounts is that contribution levels are often limited. It is therefore important to start early, for example when young people are still in the process of training and earning degrees, and are in a relatively low income tax bracket. 529 accounts still have their place for those who do not expect to receive financial aid. Also, up to $35,000 of unused funds in a 529 plan can be converted to a Roth IRA under certain conditions.
If you want other creative ideas on paying for higher education, check out our booklet, “Solving the Higher Education Puzzle”.
3. health savings accounts
Health Savings Accounts can be leveraged into additional retirement savings. Nowadays, even people who have good quality health insurance can be eligible for contributions to a Health Savings Account. For a family, the 2025 deduction is $8,300. After age 55, a taxpayer can contribute an additional $1,000 dollars per year. Individual contributions are set at half that amount. These funds can be used tax-free at any time for qualified healthcare expenditures, making those expenditures deductible even if a taxpayer does not itemize. After age 65 they can be withdrawn much like a traditional IRA. A couple who contributes the maximum amount and invests the underlying funds in a broad-based index fund starting at age 50 would have over $1 million of HSA dollars at age 75. This could also be used as an alternative form of long-term care insurance and can fund nursing home care tax-free.
4. domicile
How your income is taxed in retirement can greatly affect your quality of life, so choose your retirement tax domicile wisely. Retirees should consider their own lifestyle choices and how this can impact retirement savings. For example, those who expect to buy big ticket items, such as cars and boats should look to jurisdictions with low or no sales tax. Conversely, those who have substantial amounts stored in a pre-tax retirement account should instead look to states that have low levels of income tax. Finally, for those of modest means, finding a state with low property taxes, where essentials such as food and clothing are not taxed in retirement, may prove the best
route possible.
5. business ownership
If you don’t own your own business, consider starting one. While this may not be possible for everyone, the tax advantages to business owners are undeniable. By providing the ability to deduct expenses prior to the imposition of taxation, business owners have the ability to reduce their taxes through a number of means, including renting property they own to their business, writing off vehicles that are used in connection with the production of income, employing their children, and more. They can also setup retirement and profit-sharing accounts for themselves, their spouses and children.
6. charitable giving
Lifetime charitable giving gives the donor both an income and estate tax deduction at once, and along with the financial benefit, the donor receives the joy of seeing his or her charitable contribution go to work. If you have more money in your retirement account than you need, you can make a direct gift of up to $100,000 a year to a qualified charity without declaring the income from the retirement plan or needing to itemize deductions. For those in the top federal income tax bracket of about 40%, and with the estate tax bracket at 40%, this means that 80% of your charitable giving (or maybe more if you live in a state that assesses income and/or estate taxes) will be offset by tax savings. It’s a great way to redirect funds that would otherwise be mostly consumed by taxes to a worthy cause.