Tax Shelter Ideas: 6 Strategies That Can Reduce Your Tax Burden
High taxes have always been a driving concern among high net worth investors. If you ‘re a high net-worth individual having a net worth between $5 million to $500 million, then you need to be aware of which strategies you can use to reduce your tax burden. Hiring a qualified financial advisor is essential for this. If you have a net worth of over $10 million, we recommend reading our guide on finding a financial advisor to make this process easier. Inside this guide, you will find everything you need to know about choosing a financial advisor who can introduce you to tax shelter ideas and help you achieve your investment goals.
At Pillar Wealth Management, we offer fiduciary advisory services and can help you manage your wealth. We work with high net worth clients with $5 million to $500 million in liquid assets.Among other things, we also specialize in tax minimization and can help you control your tax burden. If you are interested in learning about this, click here for a free consultation.
In this article, we will discuss the most common strategies for reducing taxes. For example, you can:
• Invest in municipal bonds
• Take long-term capital gains
• Start a business
• Max out retirement accounts and employee benefits
Let’s take a look at these tax shelter ideas in more detail.
Table of Contents
6 Tax Minimization Strategies for High Net Worth Investors
1. Start Investing in Municipal Bonds
Among the first things you can do to control your tax burden is invest in municipal bonds. Municipal bonds are a kind of debt security. It is issued by a state, county, or municipality to manage its capital expenditures. Some examples include funding the construction of a bridge, opening a new school, building highways, etc.
When you buy a municipal bond, you are essentially loaning money to the government entity. In return, you receive a fixed number of interest payments until the bond matures. Once the bond has matured, the government entity you lent money to will return the principal amount with interest.
Municipal bonds are typically low-risk investments and have a low interest rate. The default rates on these bonds are also lower than corporate bonds. Another reason why they are so attractive to high net worth investors is that you don’t have to pay federal taxes on these bonds. Depending on where you live, they are also exempted from most local and state-level taxes. Besides serving as a tax shelter, municipal bonds also have a tax-equivalent yield which makes them attractive for certain investors. Since high net worth individuals fall in a higher tax bracket, their tax-equivalent yield is also higher.
If you want to learn about municipal bonds, get in touch with a financial advisor. Pillar Wealth Management also offers a free guide on selecting a financial advisor for high net worth families. Click here to read it!
2. Opt for Long Term Capital Gains
Short-term and long-term capital gains can make a big difference to your tax costs. These gains are taxed differently. For instance, if you hold a capital asset for less than a year, then the gains you generate on the sale of this asset will be taxed at 37% (for high net worth investors).
In comparison, if you are holding a capital asset for more than a year before you sell it, then you can pay a tax rate of 20%. Understanding how the difference between these tax rates impacts your returns is an essential part of wealth management.
To understand this better, let’s suppose that you generate a short-term capital gain of $20,000 on the sale of an asset. If you’re in a high tax bracket, you’d have to pay $7,400 in taxes, which would reduce your returns to $12,600.
In comparison, if you take long-term capital gains of $20,000, then you would pay $4000 in taxes, and your returns would be $16,000. As you can see, there is a lot of difference between paying $4,000 and $7,400 in taxes. Moreover, since you are a high net worth investor, you won’t be dealing with capital gains taxes for a single asset. Instead, you will have numerous capital assets to consider. Figuring out how you want to manage these assets to generate capital gains and the resulting taxes from the same can have a huge impact on your wealth.
One way to control your capital gains is to balance between active and passive investing techniques. Active investing primarily focuses on short-term capital gains, while passive investing generates long-term capital gains.
To understand how these investment techniques work, click here to arrange a free consultation
3. Start A New Business
High net worth individuals can grow their wealth in several ways. For most people, the first choice can be investing to generate passive income. However, you can also open a new business and enjoy the tax advantages that come with the same.
If you already have a business, then you are probably aware of how operational expenses can be deducted from your business revenues. This can lower the total amount of taxes you owe.
As per the guidelines provided by the IRS, if you have a home office, then you can also deduct some portion of your home expenditures. For instance, if a portion of your utilities are being used to manage your business, then you can deduct these expenses from your total income.
You can also read up on the SECURE Act (short for Setting Every Community Up for Retirement Enhancement). This Act offers multiple tax benefits to employers enrolled in multiple-employer plans and providing retirement options to the employees under their care.
4. Open Up a Health Savings Account
Among other tax shelter ideas, you can also consider opening a Health Savings Account.A Health Savings Account is an essential part of retirement planning. You can put money in it for your usual medical bills and other medical expenses that are not covered under your current health insurance plan. For example, dental care, vision care, and certain other medical expenses are not covered under most health insurance plans. The money you put in your Health Savings Account can also be used for deductibles and co-pays. Bear in mind that only individuals with a high-deductible health insurance plan can open this type of assignment.
Now that you understand how health savings accounts work let’s take a look at how they function as a tax shelter. You see, the money you put in this account is exempt from all taxes. You won’t have to pay federal income tax, FICA tax, or state or local taxes. The balance you add to this account can grow and allow you to defer taxes. You can also invest it in mutual funds. Besides this, if you make any withdrawals to pay your medical bills, then you won’t be taxed for this, as well.
For high net worth investors looking to capitalize on the tax benefits of a health savings account, we recommend you add portions of your pre-tax income to this account. As you do this, you can manage the health costs not covered under your health insurance and pay them out of your pocket. This can allow the funds in your Health Savings Account to grow without being subject to taxes.
If you are interested in learning other ways that can help you reduce your taxes, offer a hard copy of Pillar Wealth Management’s book – The Art of Protecting Ultra-High Net Worth Portfolios and Estates – Strategies For Families Worth $25 Million To $500 Million. It’s completely free!
5. Use Charitable Contributions
If you make a habit of donating a portion of your wealth to charity, we recommend that you donate long-term appreciated capital assets like stocks, bonds, or real estate. When you do this, you won’t have to pay any taxes on the capital gains generated for these assets. Instead, you can get an income tax deduction equivalent to the current fair market value of the assets not what you paid for them. This can be up to 30% of your adjusted gross income.
When you are making charitable contributions, avoid donating stocks and mutual fund shares that have depreciated in value. In this case, you would benefit more if you sell off the asset and file for capital losses on your taxes. This can reduce your tax burden. It is known as tax loss harvesting.
To learn more about tax loss harvesting, talk to our wealth managers. We can help you figure out how to make the most of this tax minimization strategy. Click here for a free consultation.
If you want to find a financial advisor specializing in tax minimization, click here to read our guide on finding a financial advisor for individuals with $10 million+ in liquid assets.
6. Max Out Your Retirement Accounts And Employee Benefits
Another strategy that you can consider using is to max out retirement accounts and employee benefits. This strategy primarily applies to investors with a 401(k) or an individual retirement account (IRA). You can contribute a portion of your income to these retirement accounts and plans. This can reduce your taxable income and help you reduce your tax burden.
Moreover, the amount added to your retirement plan will not be taxed. Therefore, you won’t just get a tax break over your reduced gross adjusted income. You also get to defer taxes on the money added to your retirement accounts. Like a Health Savings Account, the balance in this account can keep growing.
We recommend maximizing the tax benefits offered on your retirement accounts and employee retirement plans to make the most of this tax minimization strategy.
How Can You Use These Tax Shelter Ideas Effectively?
If you want to benefit from these tax shelter strategies, we suggest you hire a financial advisor for high and ultra-high net worth clients. Here are some things you need to keep in mind when choosing a financial advisor:
1. They Should Be a Fiduciary
A fiduciary refers to a financial advisor who works to protect your interests. For example, some financial advisors may make big promises to their clients in the hope of securing more commissions or getting a bonus. In doing so, they may utilize strategies that are costly and increase your tax burden. When this happens, there is a conflict of interest that can prevent you from achieving your investment goals.
To understand this better, we suggest you read our guide on what you can do to boost your portfolio performance.
2. They Should Be Well-Versed with IRS Regulations
An effective financial advisor needs to stay up-to-date with IRS regulations. This can allow them to use your assets to manage charitable contributions, deduct expenses for your home office, and other tax minimization strategies discussed above effectively.
3. They Should Be Able to Balance Active and Passive Investing
As mentioned earlier, active and passive investing styles can have a significant impact on your tax burden. While active investing offers higher returns, it is also more costly and generates short-term capital gains. In comparison, passive investing is less risky, generates the same returns as the market index it follows and focuses on long-term capital gains.
Your financial advisor must be able to use both of these investment styles effectively to offer the best of both worlds. To learn more about active and passive investing, click here to read our guide on the essential shifts high net worth investors must make to achieve their goals.
Contact Pillar Wealth Management Today
If you are searching for a fiduciary advisory service, reach out to Pillar Wealth Management. We help you control investment costs, earn optimal returns, and control your tax burden. Our wealth managers are well-versed with tax minimization strategies. From helping you invest in municipal bonds and take long-term capital gains to figuring how to max out retirement accounts and employee benefits, we can help you capitalize on all tax shelter ideas to boost your net worth.
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