High Earners and Successful Savers: What Is Your Tax Plan for the Future?

A successful man looks over his shoulder.

(Image credit: Getty Images)

By Jammie Avila, Registered Representative

published 24 October 2021

We saw a period of record high government spending during COVID, and this trend could continue. Considering the new administration’s proposals for raising taxes on high-net-worth individuals and the expiration of the Tax Cuts and Jobs Act at the end of 2025, you could potentially be paying more in taxes in the future than you anticipated.

Here’s how your money can be taxed and what you can do to plan for taxes in the future.

High earners or those who will have a significant amount in tax-deferred retirement accounts and taxable investments should know how their money is taxed, and thus create a tax plan. While wages, salaries and investments held for less than a year are taxed at progressive income tax brackets, investments held for over a year are not. These are considered long-term capital gains and are taxed at preferential tax rates of either 0%, 15%, or 20%, depending on the individual’s income level.

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If you own a home or rental property and ever want to sell, it’s important to understand how your tax burden will be affected and what you can do to help minimize it. If you’re a homeowner, you’re probably familiar with the mortgage interest deduction: If your mortgage originated before Dec. 15, 2017, you can deduct interest on the first $1 million of your mortgage if you itemize your taxes. If you’re close to paying off your mortgage or already have, consider how this will affect your tax burden and if you’ll continue to itemize your taxes.

Another option for deferring and or minimizing taxes is an Opportunity Zone Fund. Investors can defer capital gains tax on money from another investment by putting it into an Opportunity Zone fund within six months. Those who hold the fund for five years get a 10% tax reduction on the gains, or a 15% reduction after seven years. Investing in an Opportunity Zone fund can be complicated and there’s no guarantee that it will lead to appreciation, but the potential tax benefits are significant.

Your estate plan also should be integrated with your tax minimization strategy. Keep in mind that the rules have changed: The SECURE Act eliminated the “stretch IRA” option for all retirement accounts inherited after 2020. This means that those who inherit a traditional 401(k), IRA or other qualified retirement account must drain the account within 10 years. There are some exceptions, including the spouse of the original owner, or someone less than 10 years younger than the original owner.

If you’re passing on assets other than a retirement account, they may be available for a step-up in basis, which is a readjustment of the value of an asset upon inheritance. For example, let’s consider someone who buys a house for $300,000 that appreciates in value to $500,000 at the time they pass it onto their child. If their child then sold the house, he or she would only pay tax on the difference between the selling price and $500,000. While the step-up on basis is currently in place, the Biden administration has proposed plans to eliminate it for gains of $1 million or more ($2 million or more for married couples). If this comes to fruition, your estate planning may need to change. Inheriting property versus other assets will mean a different tax burden for your heirs.

Consider planning for the tax rates of tomorrow – not today. Although we don’t know exactly what they’ll be, it’s likely that they’ll be higher in your lifetime than at this moment. We’ve seen increased government spending to fight COVID as well as additional proposals to spend trillions. Along with this, we see the Biden administration proposing new and increased taxes on high-net-worth individuals and businesses. If we see an end to the favorable 20% long-term capital gains for those earning more than $1 million annually, capital gains could instead be taxed at over 39%. Those with investment income and tax-deferred retirement accounts should think long-term when it comes to taxes.

One long-term tax-minimization strategy is a Roth IRA conversion, in which you pay tax on some or all of the money in a traditional IRA, 401(k) or other tax-deferred retirement account to convert it to a Roth IRA. After that, the money can grow in the account and be withdrawn tax-free after five years. A Roth conversion may make sense in a year in which your income is lower than usual, or if you think your tax burden will increase in the future. Roth IRAs are not subject to required minimum distributions (RMDs), which can increase your tax burden after age 72 by forcing you to withdraw a certain amount each year from a traditional retirement account. Roth IRAs may also help reduce your beneficiaries’ tax burden by providing tax-free distributions, but keep in mind most non-spouse beneficiaries must drain a Roth account within 10 years of the original owner’s death.

Trying to minimize your tax burden on a year-to-year basis isn’t the same as creating a long-term tax strategy that is integrated with your overall financial plan. That’s why a good financial planner will help you make sense of the process. In fact, my firm, Cornerstone Wealth Management, has a dedicated branch for tax advisory services with the goal of pursuing tax minimization strategies aimed at putting money back into our clients’ pockets.

Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Topics

Building Wealth Tax Cuts And Jobs Act Of 2017

Jammie Avila is the managing partner/co-founder of Cornerstone Wealth Management in Las Vegas and Henderson, Nevada. Jammie has passed the Series 7 and 63 exams and is licensed to sell insurance products. Jammie and his wife, Danielle, have four children.