While this blog is geared towards high-net-worth investors, you can still use some of these concepts to benefit your financial future even if you aren’t extremely wealthy. 

High net worth investors often use strategies that allow them to quadruple the value of their investment alpha. Alpha really just refers to the excess return earned on an investment above the benchmark return. The way these investors pull this off is by focusing on tax planning and achieving alpha via tax savings, instead of just worrying about investment performance. With these tax alpha concepts, some of them take proactive planning and coordination between your financial team, like CPAs, estate planning attorneys, and possibly insurance advisors.

Roth Conversions

The first tax planning strategy is one that you likely know about, but you might not have taken full advantage of it just yet, and it has to do with your pre-tax 401ks and your IRAs. For many people, these are great vehicles to defer tax and let grow tax-deferred, but there’s going to be a time later on when the government forces you to take money out of these and pay tax even if you don’t want or need the income.

This is where the idea of Roth conversions comes up quite a bit, but many people are hesitant to execute a Roth conversion because the strategy can seem quite costly if you’re still working and earning a high income in your 50s, 60s, or even your 70s.

When you compare paying the tax bill associated with a Roth conversion today to the impact of deferring those taxes 10, 20, or 30 years into the future, it often makes today’s tax bill much more attractive.

The trick is to find out what your tax rate is now, then map out what the future tax rates could be as well, and you can look at a few what-if scenarios. We never know exactly what tax rates will be, but you can look at a few different scenarios. Like many things, taxes are cyclical. Retirement-focused advisors, they’re really good at this because they do it all the time and they can clearly lay out a few routes that you can go, but here’s just a high-level example to think about.

Let’s pretend you’re 55 and have $3,000,000 in your 401(k). By the time you’re forced to take out withdrawals, that could be worth $11,000,000, and that’s just using a simple 7% growth rate. If you execute a Roth conversion on that $3,000,000 account today, your tax bill is likely to be around $1,200,000.  If instead you continued to defer the taxes and allowed that account to grow to $11,000,000 in the future, you and your family could end up paying a whopping $4,400,000 in taxes. Comparing the future tax liability to today’s opportunity and seeing what could be better for you and your family can bring a lot of clarity to your options.

Low-Cost Donor Advised Fund

The next strategy is one you’ve heard about that is often overlooked, and it has to do with many clients having appreciated assets; maybe they have unrealized gains in their portfolio, maybe they have a business or real estate – maybe they have all three. If you have a business or a real estate sale, or you need to do a reallocation of your portfolio, adding a donor-advised fund strategy to your tax planning could dramatically optimize your financial plan.

Let’s say you’re planning on moving your portfolio slightly more conservatively, are selling a business or real estate, and you’re charitable. Let’s assume the sale is going to create $2,000,000 of taxable dollars, and that you’re currently giving $10,000 annually in cash. You can take two routes. You can either keep giving the way that you’re giving each year for the next 20 years, or you can think about in that year, effectively “pre-funding” your charitable giving for the next 20 years, while saving a tremendous amount in tax liability from the sale of the business or real estate. 

Use a Tax-Efficient Portfolio

The next thing that makes quite an impact on high-net-worth clients’ portfolios is what I would call “phantom taxes.” A few years ago, we had a client come in – not a Streamline Financial client but someone we were just doing taxes for, and when we completed the return and were reviewing it, they were shocked that they had to pay about $60,000 from short-term capital gains in his portfolio. We showed them why this was and he said, “But I purposely told my advisor not to sell anything this year because I knew my income would be high.” We sadly had to tell him that while his advisor didn’t sell anything, these are capital gains happening within a mutual fund. Within the fund, there were sales happening out of your control and because the fund wasn’t optimizing for tax efficiency, it had created an unintentional tax liability. 

We began looking at how to create a tax-efficient portfolio so that he could have more control over when to actually pay taxes. We often say that you can control two things in your portfolio, and that’s taxes and cost.

Using Trust Planning to Minimize Your Estate Tax

The next topic is estate taxes. In reality, if you don’t want to pay estate tax, you most likely don’t have to, even if you’re worth $10,000,000 or more. It’s not cheap to get it set up, but the cost-benefit is pretty clear and can be done by setting up certain trusts for your heirs, some charitable giving, and then sometimes some insurance. The key here is integrating that tax management with the estate side. Additionally, you also want to include insurance and make sure it’s a team or at least they’re all communicating well.
You don’t have to be uber-wealthy to achieve this either. If you want help thinking through these things, reach out and we can talk it over.

Disclaimer: Since we don’t know your specific situation, none of this information should be construed as tax, legal, financial, insurance, financial advice, or other advice and may be outdated or inaccurate. It is your responsibility to verify all information yourself. This content is prepared for entertainment purposes only. If you need advice, please contact a qualified CPA, attorney, insurance agent, financial advisor, or the appropriate professional for the subject you would like help with. Streamline Financial Services, LLC or its members cannot be held liable for any use or misuse of this content.

Affiliate Disclaimer: This post may include affiliate links where we may earn a payment when you click on the links at no additional cost to you. 

Disclosures: Securities offered through LaSalle St. Securities LLC (LSS), member FINRA/SIPC. Advisory services offered through LaSalle St. Investment Advisors LLC (LSIA), a Registered Investment Advisor. Streamline Financial Services is not affiliated with LSS or LSIA. LSS is affiliated with LSIA.