A lot of advice that claims to offer tax strategies for ultra-high net worth investors could really apply to anyone. That doesn’t mean it’s bad advice, but you need more than just the common wisdom. For those of you who have $5+ million investable assets that wisdom comes in part from great wealth management and tax advice from someone who will stick by your side for many years.
Table of Contents
- 1. Minimize Use of Active Management for Brokerage Accounts
- 2. Minimize Use of Taxable Bonds
- 3. For High Net Worth Retirees: Send Your RMDs to Charity
- 4. Use Your Roth IRA Conversion Opportunities While You Have Them
- 5. Be Smart with Your 401k and Defined Contribution Plans
- 6. Don’t Leave Your Tax Deferred Accounts to Heirs
- 7. Cultivate Tax Losses to Offset Gains During the Year
- Work with a Wealth Manager Who Can Help You Save Big on Taxes
If you are an ultra-high net worth investor who needs help with tax minimization, click here to read our guide on how to find a financial advisor who can help investors with over $10 million in liquid assets manage their taxes. At Pillar Wealth Management, we specialize in tax planning among other things. Our fiduciary advisory services can help you cut your costs as much as possible and grow your returns. Click here to arrange a free consultation with our wealth managers today.
The truth is, there are certain high net worth tax strategies that apply almost exclusively to people like you, and we’re going to share seven of them in just a moment.
Be warned: This article is not for the faint of heart. These are advanced strategies, not the kind you often see in shallow blogs written by 24-year old finance graduates.
Pillar Wealth Management has catered to high net worth and ultra-high net worth clients for thirty years. We’ve managed portfolios through the ups and downs of market cycles, including depressions. As fiduciaries, we put our clients’ interests first, and we work to protect your assets by leveraging the best tactics for your portfolio.
By using these seven tax strategies for our ultra-high net worth clients, we have been able to save them lots of money and thus improve their investment performance simply by reducing these unnecessary losses.
1. Minimize Use of Active Management for Brokerage Accounts
The more you trade, the more you’ll be taxed.
Realized gains in a brokerage account get taxed when they get reported, which happens whenever a trade takes place. Actively managed brokerage accounts tend to trade frequently. For high net worth investors relying too much on active management, that leads to much higher taxes than you need to be paying, and it rarely leads to better investment performance.
One of our clients came to us after generating $375,000 in realized capital gains in 2016 in her actively managed brokerage accounts from another firm. That led to sky-high taxes. The following year, we lowered her realized gains to 0, which reduced her taxes for that year by 30%.
Does a 30% tax cut sound nice to you? She was quite pleased.
This is one of the most overlooked taxes that bites high net worth investors with frequently avoidable severity.
If you’d like to learn tax reduction strategies – specifically as they apply to your portfolio – you’re encouraged to contact Hutch Ashoo, CEO and Co-Founder of Pillar Wealth Management. As a fee-only, independent, fiduciary financial advisor, he will share specific tax strategies applicable to you as a high or ultra-high net worth investor. You can get a deeper look at his approach by reading his book about how to protect your ultra-high net worth status, and it’s yours for free.
2. Minimize Use of Taxable Bonds
Like equities, taxable bonds produce capital gains every time the fund manager buys or sells securities, as this Fidelity article makes clear. You may also have to pay taxes on your gains when you sell your shares in the bond.
This is why, as this Investopedia article explains, taxable bond funds tend to be a bad deal – specifically for high net worth investors. Because you pay at the highest tax rate, you stand to gain a greater tax reduction by focusing instead on municipal bonds. Dividends from municipal bonds are not charged with federal taxes, and they often incur no state taxes either.
In general, the higher your tax bracket, the worse taxable bonds become as an investment vehicle.
This is one reason why you can’t just look at the annual average rate of return when selecting a bond fund, because those are pre-tax returns. A taxable bond with a 5% performance is probably a worse deal than a municipal bond with a 2.5% return – especially for high net worth investors in high tax states like California. If you need help finding a financial advisor who understands these nuances, click here to read our free guide.
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3. For High Net Worth Retirees: Send Your RMDs to Charity
Many high net worth retirees who are over 70.5 years old (prior to 2020) don’t need their Required Minimum Distributions from their retirement accounts. You have enough income from other sources still coming in, and this burdensome requirement does little but elevate your tax bill.
You can avoid this using a Qualified Charitable Distribution (QCD).
A QCD is a direct transfer of funds from your IRA custodian (such as Fidelity, Vanguard) to a qualified charity. This transfer counts as your RMD, up to $100,000, and thus keeps it from counting as taxable income. If your wealth manager isn’t giving you advice like this as you get closer to retirement, you might be wise to find a new one. Here’s a free guide to help.
4. Use Your Roth IRA Conversion Opportunities While You Have Them
Certain situations arise where converting your traditional IRA to a Roth can be done with lower-than-normal taxes owed. If you time your conversions well, you can remove substantial portions of your wealth from the RMD trap by the time you retire.
The reason is because money in traditional IRAs must be withdrawn – and taxed – beginning at age 72 (as of the year 2020), but money in a Roth does not.
When you make this conversion, you do owe taxes for it that year. But after the conversion, you will owe no taxes on all future gains.
And to be clear, there are many, many ways to go about this, and many variables to consider. To learn more about this, click here to order a free copy of our hardcover book, 7 Secrets To High Net Worth Investment Management, Estate, Tax and Financial Planning.
Knowing when your most tax-advantageous IRA conversion opportunities have come requires some awareness and is best done with the help of a wealth manager. For instance, suppose you have a down year in your income. That might be the year to do a large conversion, because you can do so without bumping up to the highest tax bracket.
Today I was working with a client that retired in February and has plenty of liquid money to live on this year. We discussed using the Roth conversion on some of his retirement plans this year since we could control his taxable income. In future years his income will once again be high.
This is just one of many reasons to have a high net worth financial advisor in your corner. As CEO and co-founder of Pillar Wealth Management, a fee-only, independent, fiduciary financial advisory firm, I have 30+ years of experience and expertise helping high and ultra-high net worth investors. I can help you assess your tax situation and offer proven tax-reduction strategies that can have a significant impact on your wealth and improve your portfolio performance.
5. Be Smart with Your 401k and Defined Contribution Plans
When you begin to withdraw money from 401ks, traditional IRAs, and pensions after you turn 59.5, you avoid the early penalty but you will still be taxed. However, once you also start collecting Social Security, your income will increase even more.
Retirees think they should not touch their retirement plans until age 72 and live on the dollars invested in the brokerage accounts. This can be a big mistake.
One smart tax strategy for high net worth investors is therefore to take larger withdrawals from your 401k and other plans before you turn 72, and thus reduce your RMDs when they arrive.
A Hypothetical Example of this Tax Strategy
For instance, a 62 year old with a $3,000,000 IRA/401k today, could leave the retirement plan to grow for 10 years and if he earns an assumed rate of 5% annually it would be worth $4,886,000. The new life expectancy rate at age 72 is proposed to be 29.1 years. This means the required minimum distribution at 72 would be $167,000. Add Social Security, pensions and other income and you might find yourself planted in some of the highest tax brackets the rest of your life.
However, if you take advantage of the Roth IRA opportunities and begin to take income from the IRAs at an earlier age, your RMD could be significantly less. As an example; at age 62 you live on some of the earnings from the 401k, instead of the brokerage assets, at age 72 the $3,000,000 IRA would only have an RMD of $103,000. And yes, there might be a chance you can have a lower tax bracket during retirement.
Also consider the IRAs are fully taxable to the heirs, and with the newly enacted SECURE ACT signed into legislation in December 2019, they must take it out over 10 years after your death and no longer can defer the taxes over their lifetimes. This is why wealth protection is an ongoing art and serious business. You have a lot to lose if you don’t pay attention!
Another set of strategies can be developed using trusts and other estate planning tools. Here are three such tax minimization strategies and several types of trusts you can make use of. These sorts of strategies give you other options besides just withdrawing the money, while preserving more control of what happens to your wealth.
If you are interested in understanding these strategies in greater depth, click here to talk to one of our wealth managers today.
6. Don’t Leave Your Tax Deferred Accounts to Heirs
The IRS has a party whenever a high net worth individual dies and leaves their tax deferred accounts to their heirs. Letting this happen provides a windfall for the government that would be far better utilized if it stayed in your family, or went to an organization that aligns with your values.
This follows up on strategy 5 a bit, but when doing your estate planning, you want to do everything possible to avoid leaving money in tax deferred accounts to your heirs.
How you go about this depends in part on your goals and values. If leaving more money to your heirs matters more to you than minimizing your taxes, you might opt to pay taxes now – by withdrawing more money sooner – to reduce the tax burden facing your heirs. This may be a better option for reasons similar to what you saw in strategy 4. However, if your heirs have much lower income, they may not be hurt as badly if they inherited some of your tax deferred account.
The size of your estate and estate taxes might also impact your decision.
To be clear – this is not necessarily an either/or situation. You have many other options available, and other variables to consider. The income of your beneficiaries matters, as does the size of your estate and the estate taxes you may end up paying.
This is another reason high net worth families need the help of a wealth manager who works only with people like you, and knows all the ins and outs of the many tax strategies available to you.
And this is exactly why you want to choose the best financial advisor for your family’s needs. You can set up a free call with me as soon as is convenient. If you have over $10 million in liquid assets, then we also recommend reading this guide on how to find a financial advisor that can help you manage your accounts in a comprehensive manner.
7. Cultivate Tax Losses to Offset Gains During the Year
This final high net worth tax strategy requires more diligence, but it can produce substantial savings. In one instance, we saved a client $34,000 in taxes in a single year from this strategy alone.
The great thing about this tax strategy is, you don’t have to ‘do’ anything, in the same sense as some of these other strategies where you have to withdraw money, adjust your investment portfolio, or make other difficult choices. Here, you can keep the same investment plan you have now. You just have to finesse it more often.
Tax cultivation means, in a nutshell, the process of balancing realized gains with losses that occur in the same year.
Most years, some equities gain in value while others lose. If you have a wealth manager who stays on top of this, you can use your losses to reduce the taxes you owe on the gains. By effectively managing your gains and losses, you can reduce the taxes you owe.
If you are interested in learning more about how this works, click here to read our guide on the 5 critical shifts that help with portfolio growth.
Work with a Wealth Manager Who Can Help You Save Big on Taxes
Some of these high net worth tax planning strategies are, as promised, a bit more complicated than what you often hear about elsewhere. But there is a lot of money to be saved if you start implementing some of these strategies now.
For some strategies, the sooner you begin, the better. For others, you must wait until you reach a certain age.
Will you remember to keep up with all this when those times come? Most of these strategies don’t work if you only pay attention during tax season. Most of these are ongoing, holistic tax strategies, not one-time fixes.
Isn’t it worth a few minutes of your time to talk with a high net worth expert about this? If you want to make the most of your assets and limit the money you pay out in taxes, it is in your best interest to contact an experienced financial advisor.
We absolutely love making high net worth families happy by showing them how they can greatly reduce their tax burdens. Click the link below and see what Pillar Wealth Management can do regarding your specific tax situation.