Happy New Year! It’s time to make your 2017 resolutions, and we believe that one of the smartest things that you can do in the new year is to resolve to learn more about all the ways you can be handling your finances. That’s an especially important task for high income-earners, and so, to help you keep those financial new year’s resolutions, we at Lineweaver Financial Group have some tips to help you this year.
1. Pay taxes now rather than later on retirement accounts:
Many high-income earners, or those on their way, will likely be in the top tax bracket even after retirement when they consider any pensions, investment income or other income accumulated over time. That means any deferred income put into a traditional 401k may be taxed at the highest rates in the future.
Consider using a Roth 401k if your company offers it. The Roth 401k has a few distinct advantages over a traditional 401k for those with high incomes:
1. There is no income limit to making Roth 401k contributions, unlike Roth IRAs which are phased out at higher income levels.
2. While the deferred income is taxed before going into the Roth 401k, the growth on that money is tax-free.
3. Roth 401ks can be rolled into Roth IRAs upon retirement or leaving a company.
Best of all, since there are no required distributions from Roth IRAs upon reaching age 70 1/2, there are more opportunities for planning. This is a great way to diversify your retirement income, and potentially provide tax-free income to your heirs upon your passing. Put another way, this can be a powerful estate planning strategy.
2. Leave a Legacy
There are many things you can do now to protect your future estate. Once someone has a taxable federal estate ($5,450,000 for an individual or $10,900,000 for a married couple for tax year 2017), it may make sense to use more advanced estate planning strategies to remove assets or the growth of assets from your estate. For example, a Grantor Retained Annuity Trust (GRAT) removes all of the growth of assets from an estate (in excess of an interest rate designated by the IRS). Similar strategies, including things like family limited partnerships, stretch IRAs, LLC’s, credit shelter trusts, Roth conversions and others can remove hundreds of thousands or even millions of dollars from a taxable estate. As with many highly sophisticated planning strategies, there are a lot of complexities that must be carefully considered. You should consult with an attorney or a financial advisor who is knowledgeable about GRATs to see if this strategy is right for you.
3. Life Insurance
Along with leaving a legacy, life insurance is another often overlooked area. Often times, the proceeds from a life insurance policy will bring a family over the estate tax limit, either at the federal or state level. Owning the policy within an irrevocable life insurance trust or ILIT, removes the assets from the estate and may save your heirs hundreds-of-thousands of dollars in estate tax. If you already have an ILIT, make sure premiums are paid from a trust account to make sure the IRS does not move the assets back into the estate. If you want to save the expense of a trust, it can also be owned by another family member.
4. Invest in Municipal Bonds
Generally speaking, bond prices go down as interest rates go up, and, while it may seem counter-intuitive to buy bonds in this environment, it can be a smart strategy. Some high-income earners (singles with MAGI – Modified Adjusted Gross Income – exceeding $200,000, and couples with MAGI exceeding $250,000) are now subject to the 3.8% Medicare surtax on all investment income. Municipal bonds avoid this additional tax, and while this surtax may be going away in the first days of the Trump administration, municipal bonds also typically avoid all federal and state income taxes as well. That means the tax equivalent yield, the yield an investor would require from a taxable bond, has increased for those taxpayers, making municipal bonds more attractive. If you are worried about interest rates rising, you can also ladder your bonds over the next 3, 5, or 7 years, and, as they mature, reinvest them at higher rates.
5. Review your Asset Allocation
Real Estate Investment Trusts (REITs) and Corporate bonds (or bond ETFs) are generally not the most tax efficient assets. The income from these investments is usually taxed as ordinary income, which means a possible Federal tax rate of 39.6%, state taxes, and then possibly the 3.8% medical surtax. That means high-income earners could end up keeping less than half of the interest earned after paying taxes.
Stocks are taxed differently, usually as a mix of capital gains and dividends. Long-term capital gains (which is defined as any gain from the sale of a stock held longer than 1 calendar year (365 days) and qualified dividends are taxed at a preferential rate. The rate can be 0% for those in or below the 15% Federal income tax bracket, 15% for those individuals or couples in the 25-35% Federal brackets, or up to 20% for those in the highest tax bracket. For now, the 3.8% surtax still applies if applicable.
That means you should generally hold all taxable bonds and REITs inside of tax-sheltered accounts. Stocks and municipal bonds belong in taxable accounts. If you can’t fill your tax-sheltered accounts with bonds or REITs, put the highest dividend paying stocks in there.
If you own both actively and passively managed stock mutual funds (or ETFs), you should almost always place actively managed funds inside of tax-sheltered accounts. They are usually much less tax-efficient than passive funds.
6. Use a professional when it’s needed:
At Lineweaver Financial Group, we always say that one size never fits all. Some of our clients could personally manage their assets, but most of them don’t want to, or simply do not have the time because they are focused on their careers, their families, and their passions. This is also true in terms of using a CPA, estate planning attorney, or insurance professional.
Paying for professional help can be expensive, and there are so many options out there, from robo-advisors, to TurboTax, or even legal and accounting websites and “do it yourself,” services. These may be perfect for some people, but they can’t replace what a company who can coordinate all your tax, legal, financial, and insurance needs under one roof – what we like to call the Financial Quarterback – can do for you. We can provide all these services, or work with advisors you already know and trust. It’s our goal to understand you, your financial situation, goals, and dreams, and to help you get there. We believe that nothing can replace that relationship.
We hope that you’ve found this 2-part series for high-income earners helpful, and we’ll continue to post important information and advice for high-income earners. If you have questions, we hope that you’ll reach out to us by clicking here, emailing us at quarterback@Lineweaver.net, or calling us at (216) 520-1711. There’s no obligation to ask us questions or for advice.
Information contained herein is not tax advice and should not be considered as such. Each individual’s tax situation is unique and different. For advice related to your specific tax situation, please contact your personal tax professional.