Preparing a strategy that is both advantageous and tax-efficient might feel daunting at first. Thankfully, there are some things you can do now to keep from overpaying this tax season.
Build Your Team of Professionals
You might build a team for any number of pursuits, from organizing a baseball team to putting together people to run a business. Any team is not only an organization of people, it’s also a collection of varying talents.
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.
Ask your financial professional if they have worked with a CPA who would be helpful in this situation. It’s possible that they know someone who fits your needs.
Tax-Focused Investment Strategies
Once you have the right team of financial professionals who understand your financial situation, there are some investment strategies 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 (essentially you’re paying back the tax deduction you received when initially contributing to your traditional IRA).
- Pay taxes on any additional gains your traditional IRA account may have made over time.
A backdoor Roth IRA may be beneficial for those whose income level is above the ceiling limit set by the IRS. Additionally, it’s important to remember that Roth IRAs do not have required minimum withdrawals, only traditional IRAs do.
In addition to the backdoor Roth IRA, consider the mega backdoor Roth Conversion. You'll need to ask your employer if your 401(k) plan allows after-tax contributions above the annual maximum as well as whether they allow in-plan Roth Conversions.
When considering a backdoor Roth IRA, evaluate the tax obligations you might pay today versus the tax benefits you may realize toward retirement.
Contrary to the Backdoor Roth IRA idea noted above, consider maximizing your pre-tax contributions to your company 401(k) plan before the end of the year. The maximum is $19,500 for 2021, plus an additional $6,500 if you're over the age of 50.
Health Savings Accounts
Also consider maximizing your Health Savings Account if you're enrolled in a high deductible health insurance plan through work. Read more about our strategies in our Guide to Overcoming Surprising Roadblocks.
Even after all of the above ideas are exhausted, you can save & invest in an after-tax brokerage and buy tax-efficient investments to grow your funds and limit the taxes due as a result.
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 recognized. 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 get rid of your losses, it can be an approach to manage 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 you buy the same or a “substantially identical” security within 30 days before or after the sale.2
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.
You might also consider establishing a Donor Advised Fund to take advantage of an upfront tax deduction and then make subsequent donations from the fund.
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 $15,000 ($30,000 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 $11.7 million for 2021.1 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.
With these strategies in mind, there are things you may be able to do now to address both your current tax obligation and those you may be required to address further down the road.
Investment Advisory Services offered through EnRich Financial Partners LLC, a Registered Investment Advisor.
This content is developed from sources believed to be providing accurate information. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.
This material may contain forward or backward-looking statements regarding intent, beliefs regarding current or past expectations. Such forward-looking statements are not a guarantee of future performance, involve risks and uncertainties, and actual results may differ materially from those statements as a result of various factors. The views expressed are also subject to change based on market and other conditions. Furthermore, the opinions expressed do not constitute specific investment advice or recommendations by EnRich Financial Partners.
Past performance is not a guarantee of future results. This content is provided for informational purposes and is not to be construed as specific investment advice.