Company executives are in a unique position that can create interesting tax challenges and opportunities. Here at SYM Financial, most executives that we work with will be in the highest marginal tax bracket during their working years — so it’s important to consider strategies that will provide current savings, or future savings opportunities, or even both.
While you may not consider yourself a high earner, according to a report from US News, families that earn between $106,827 and $373,894 are considered upper-middle class. The more you make, the more taxes play a role in financial decision-making. In this post, we’re breaking down five tax-savings strategies that can help you keep more money in your pocket.
1. Re-examine Standard or Itemized Deductions
Despite the increases of the standard deduction limits in recent years, it may still make sense for high earners to forgo the standard deduction and opt for itemized deductions.
For 2021, the standard deduction is $12,550 for single filers and married filing separately, $25,100 for joint filers, and $18,800 for head of household. It’s estimated that 90% of taxpayers end up taking the standard deduction. However, for high income earners, itemizing could lead to a larger deduction.
What could you count as part of your itemized deduction? Here are a few ideas.
In today’s low interest rate environment, a popular strategy for those who have a mortgage (or two) is to itemize and deduct the interest paid. While interest alone may not be enough to justify itemizing, higher earners usually find themselves taking other deductions. Added up, those deductions may just push them past the standard deduction limits.
Another commonly used deduction is charitable donations, such as contributing to a donor advised fund. We often recommend giving every 3–5 years to maximize deductibility and to make sure that contributions are being used in the most efficient way possible.
2. Make Retirement Plan Contributions
Another popular way to reduce taxable income is by maximizing the benefits of tax-advantaged retirement accounts.
Most executives are already contributing to 401(k) and individual retirement accounts. However, contributions to these accounts should be reviewed annually. Maxing out retirement plan contributions is one of the easiest ways to invest in your future and potentially lower this year’s taxable income at the same time.
One area that executives often overlook is the catch-up provision for individuals over 50. The catch-up rules allow older investors to contribute an additional $6,500 to their 401(k) each year, which can have a significant impact on boosting retirement savings. Since many companies don’t automatically enroll employees into the catch-up contributions, employees typically need to make an election once they turn 50.
In addition to company retirement plans, contributing to a Roth IRA is another option for high earners. It won’t provide current tax year benefits, but it does allow for tax-free growth and tax-free withdrawals upon reaching age 59 1/2. While high income earners typically fall outside the income limits to make direct contributions to a Roth IRA, it is possible to maneuver around the limits with a Backdoor Roth IRA strategy.
3. Be Strategic with Taxable Investments
For many executives, taxable investment accounts make up a large portion of their investment portfolio. These accounts don’t provide the same tax benefits that retirement accounts do. However, they can be used strategically to grow your net worth.
One area of investment management that we find to be valuable is making sure that assets are being placed in the correct accounts. This strategy is known as asset location. For example, consistently placing tax-efficient investments in nonqualified (i.e. taxable) accounts and placing income-producing investments in tax-deferred accounts can add significant value over the lifetime of a portfolio.
Tax loss harvesting is another strategy that can be relevant for those who have investments in taxable accounts. Taking strategically timed losses can be an effective way to reduce capital gains on other investments. In years with significant market downturns, savvy investors can choose to absorb hefty losses that can be carried forward to offset capital gains in upcoming years. Selling investments at a loss may seem counterintuitive since age-old advice says to “buy low and sell high,” but it can be an effective part of your comprehensive strategy to lower lifetime tax bills.
Another way to reduce capital gains is to donate highly appreciated investment assets. These can be gifted directly to a qualified 501(c)3 charity or a donor advised fund to leverage charitable deductions and reduce potential capital gains.
4. Contribute to Your HSA
A hidden gem in the world of personal finance and tax planning is the health savings account, or HSA.
In order to qualify for an HSA, you must be enrolled in a high deductible health plan (HDHP). For some individuals, the premium savings of a high deductible plan may be worth the cost in itself. However, the true power comes from what happens when you contribute to an HSA.
An HSA allows you to utilize a triple tax advantage: tax deductible contributions, tax-free asset growth, and tax-free withdrawals (when used for qualified medical expenses). There is no other savings account that can match this tax treatment. Given that there is no time limit as to when you must take withdrawals, HSAs can be a great long-term investment strategy as they can provide tax-free withdrawals both now and in retirement when medical expenses can become burdensome on a fixed income.
In 2021, the HSA contribution limit for individuals with self-only coverage under an HDHP is $3,600. For those with family coverage, the new limit is $7,200.
5. Defer Increased Compensation
The last tax strategy executives should consider is deferring compensation. That strategy can allow you to potentially lower your current year’s taxes by deferring compensation over several years. For executives, deferred compensation typically comes in the form of a non-qualified plan.
While deferring compensation can be an attractive strategy, it’s important to acknowledge that it comes with some risk. Any time you defer compensation, you become an unsecured creditor of the employer. This means if the company were to go under for whatever reason, your deferred compensation may be at risk. Therefore, it is important to evaluate your overall strategy before taking on more concentrated risk.
At SYM Financial, we work with executives and other high earners to help them effectively manage their financial life from a tax perspective. Work with a professional to identify and deploy the tax strategies that are appropriate, efficient, and effective for your personal situation.