Earning a larger salary may entail paying more in federal and state taxes. Graduated tax rates at the federal, state, and municipal levels take a bigger portion of your income as you move up the income ladder. However, by being acquainted with the guidelines, you may optimize your tax plan and save more money. Similarly, a financial advisor can assist you in optimizing your financial plan to minimize taxes.

High-income earners are people making $400,000 to $500,000 or more each year. It’s possible that you could technically fit the IRS definition of a high-income earner without realizing it.

The IRS defines a high-income earner as any taxpayer who reports $200,000 or more in total positive income (TPI) on their tax return. Total positive income is the sum of all positive amounts shown for different courses of income reported on an individual tax return.

Reducing your tax bill when you earn a higher income generally doesn’t mean applying just one single approach. Instead, there are multiple tactics you can use to try to trim your bill. Some of these you can do yourself while others might require the help of your financial advisor to execute. This article contains some of the best ways to reduce taxes for high-income earners.

• Understanding Tax-Efficient Retirement Planning
• Traditional Retirement Accounts
• How High-income Earners Can Maximize Contributions
• Roth Retirement Accounts
• Strategies for Converting Traditional Retirement Accounts to Roth
• Taxable Investment Accounts
• Benefits of Taxable Investment Accounts
• Health Savings Accounts (HSAs)
• Real Estate Investments
• Business Ownership and Retirement Planning
• Tax Diversification Strategies
• Estate Planning and Taxes
• Hiring a Financial Advisor

Understanding Tax-Efficient Retirement Planning

Tax efficiency is when an individual or business pays the least amount of taxes required by law. A financial decision is said to be tax-efficient if the tax outcome is lower than an alternative financial structure that achieves the same end.

Tax efficiency refers to structuring an investment so that it receives the least possible taxation. There are a variety of ways to obtain tax efficiency when investing in the public markets.

A taxpayer can open an income-producing account whereby the investment income is tax-deferred, such as an Individual Retirement Account (IRA), a 401(k) plan, or an annuity. Any dividends or capital gains earned from the investments are automatically reinvested in the account, which continues to grow tax-deferred until withdrawals are made.

With a traditional retirement account, the investor gets tax savings by reducing the current year’s income by the amount of funds placed in the account. In other words, there’s an upfront tax benefit, but when the funds are withdrawn in retirement, the investor must pay taxes on the distribution. On the other hand, Roth IRAs do not provide an upfront tax break for depositing the funds. However, Roth IRAs allow the investor to withdraw the funds tax-free in retirement.

When you retire, your income typically comes from Social Security benefits, distributions from IRAs and retirement plans, and monies from savings and other investments.

Taxes will almost certainly be deducted from some of your retirement account withdrawals, depending on your retirement plan. Fortunately, you can maximize your retirement income by employing specific tax methods.

You can calculate tax efficiency by subtracting the amount of tax paid from the return to determine the net return. Then, divide the net return by the gross return. This proportion will show how much of income an individual retains. The higher the proportion, the more tax-efficient a taxpayer is.

The most obvious and direct way to become tax efficient is to utilize appropriate investment vehicles. This means contributing to your employer’s 401(k) account, leveraging individual retirement accounts, or exploring other means of deferring or avoiding taxes. You can also increase tax efficiency by gifting appreciating assets as opposed to selling and recognizing a capital gain.

Traditional Retirement Accounts

A classic individual retirement account (IRA) allows individuals to transfer pre-tax income into tax-deferred assets. Until the beneficiary makes a withdrawal, the IRS charges no capital gains or dividend income taxes. Individual taxpayers can contribute up to a certain maximum monetary amount of 100% of their earned compensation.

Income limits may also apply. Traditional IRA contributions may be tax-deductible depending on the taxpayer’s income, filing status, and other criteria. Traditional IRAs can be opened by retirement savings through their broker (including online brokers or robo-advisors) or financial advisor.

Traditional IRAs let individuals contribute pre-tax dollars to a retirement investment account, which can grow tax-deferred until retirement withdrawals occur (at age 59½ or later). Custodians, including commercial banks and retail brokers, hold traditional IRAs and place the invested funds into different investment vehicles according to the account holder’s instruction and based on the offerings available.

Contributions to traditional IRAs are tax-deductible in most cases. For instance, if someone contributes $6,000 to their IRA, they can claim that amount as a deduction on their income tax return and the Internal Revenue Service (IRS) will not apply income tax to those earnings. But when that individual withdraws money from the account during retirement, earnings are taxed at their ordinary income tax rate.

The IRS restricts contributions to a traditional IRA each year, depending on the account holder’s age. The contribution limit for the 2022 tax year is $6,000 for savers under 50 years of age and $6,500 in 2023. For people aged 50 and above, higher annual contribution limits apply via a catch-up contribution provision, allowing for an additional $1,000. This means it’s a total of $7,000 in 2022 and $7,500 in 2023.

Under the SECURE Act of 2019, age restrictions on contributions to a traditional IRA were lifted. As long as the account holder has earned income to qualify, they are eligible to contribute to a traditional IRA regardless of age.

Traditional IRAs and 401(k)s

When you have both a traditional IRA and an employer-sponsored retirement plan, the IRS may limit the amount of your traditional IRA contributions that you can deduct from your taxes.

If a taxpayer participates in an employer-sponsored program such as a 401(k) or pension program and files as a single person, they would only be eligible to take the full deduction on a traditional IRA if their modified adjusted gross income (MAGI) was $68,000 or less for 2022. That amount increases to $73,000 for 2023). Married taxpayers filing a joint return are subject to limits of $109,000 or less for 2022 and $116,000 for the 2023 tax year.

With MAGIs of $78,000 for singles in 2022 ($83,000 for 2023) and $129,000 for married couples in 2022 ($136,000 for 2023), the IRS allows no deductions. The deduction is phased out should the filer’s income fall between the minimum and maximum levels above.

IRA contributions must also be made by the tax filing deadline. For most taxpayers, this is on or around April 15th of each year. If you are above the limits, you can still contribute post-tax income to a traditional IRA and take advantage of its tax-free growth, but investigate other options, too.

How High-income Earners Can Maximize Contributions

Maxing out your 401(k) contribution every year is a no-brainer for high-income earners. In 2023, the maximum contribution to a 401(k) is $22,500 (or $30,000 if you’re age 50 or older and making a catch-up contribution, mentioned below). This contribution is made tax-free, effectively lowering your tax liability. Liabilities are calculated by adding up your existing debts (mortgage, car loans, student loans, credit cards, etc.). for the year.

If you’re not self-employed, you probably receive an employer match in addition to your own. These amounts alone aren’t generally enough to retire on, but if you invest that money and keep it growing tax-free, it can accumulate over time.

Read Also: What are Business Process Outsourcing and Types

By digging into the mechanics of a 401(k), you can find some retirement savings strategies for high earners that can amplify this valuable investment vehicle. Here are a couple of considerations:

Expand your investment options. 401(k) investment options are usually limited to a small group of mutual funds or exchange-traded funds. A type of security that allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments). Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day).

For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index. (ETFs)A type of security that allows investors to indirectly invest in an underlying basket of financial instruments (these may include stocks, bonds, commodities or other types of instruments).

Shares in an ETF are publicly traded on an exchange, and the price of an ETF’s shares will fluctuate throughout the trading day (traditional mutual funds trade only once a day). For example, one popular ETF tracks the companies in the S&P 500, so buying a share of the ETF gets an investor exposure to all 500 companies in the index.. But some plans allow you to add a brokerage link inside of your 401(k), opening up a far broader investment universe with potentially greater opportunities for growth.

Know your plan’s vesting requirements. Any contributions you make to your 401(k) vest immediately. That money is yours even if you leave the company the next day. Employer contributions are often subject to a “cliff” or “graded” vesting schedule. Cliff vesting occurs all at once (e.g., after five years of employment); graded vesting happens gradually (e.g., 20% each year for the first five years at the company).

Consider a Roth 401(k). More and more 401(k) plans A 401(k) plan is a retirement account that a company sets up on behalf of its employees. Both the participant and the employer can contribute to the account. There are two types of 401(k)s, traditional and Roth. Income invested in traditional 401(k)s isn’t taxed while it’s invested, but is taxed when it’s withdrawn.

Income invested in a Roth 401(k) is taxed before it’s invested, but no tax is paid when it is withdrawn. today offer a Roth 401(k) option, which has all the advantages of a Roth IRAA type of account in which funds can be saved and invested without being subject to tax until the account holder reaches retirement age. with one big difference—there are no income phaseouts. Splitting 401(k) contributions between a Roth 401(k) and a traditional 401(k) enables high earners to realize tax benefits now (by deducting traditional 401(k) contributions) and later (with tax-free distributions from your Roth 401(k) when you retire).

Roth Retirement Accounts

A Roth IRA is a type of individual retirement account in which you can deposit after-tax monies and subsequently withdraw them tax-free. You can collect distributions and gains without paying federal taxes if you reach the age of 5912 and have kept the Roth IRA for at least years.

Because you’ve already paid the taxes, you can withdraw your contributions, including any earnings, without penalty or taxation. This is in contrast to a standard IRA, which provides a tax benefit for contributions but requires you to pay taxes on any distributions made in retirement.

You contribute to a Roth IRA with after-tax dollars, which essentially means there is no immediate tax deduction or other tax benefit for contributing to the account. Once your account is funded, you can invest that money through the Roth IRA. Over a long time horizon, those investments will likely earn a return.

That’s when the real benefit of the Roth IRA kicks in: Qualified withdrawals from the Roth IRA during retirement (defined here as after age 59½) are tax-free, because you didn’t receive a tax benefit when you funded the account. This includes all of the investment growth we just referenced, which would otherwise be taxed.

Additionally, because you paid taxes on the contributions before putting them into the Roth IRA, you can withdraw those contributions — but not investment earnings — at any time without additional taxes or penalties from the IRS.

You can fund a Roth IRA as long as your income is under the limits below; at higher income levels, the amount you’re allowed to contribute is phased out and, eventually, eliminated completely.

Filing status	2023 Income range	Maximum annual contribution
Single, head of household, or married, filing separately (if you didn’t live with spouse during year)	Less than $138,000.	$6,500 ($7,500 if 50 or older).
	More than $138,000, but less than $153,000.	Contribution is reduced.
	$153,000 or more.	No contribution allowed.
Married filing jointly or qualifying widow(er)	Less than $218,000.	$6,500 ($7,500 if 50 or older).
	More than $218,000, but less than $228,000.	Contribution is reduced.
	$228,000 or more.	No contribution allowed.
Married filing separately (if you lived with spouse at any time during year)	Less than $10,000.	Contribution is reduced.
	$10,000 or more.	No contribution allowed.

If you don’t qualify for a Roth IRA, you have the option of contributing to a traditional IRA, and then converting that account to a Roth IRA through a method called the backdoor Roth (also known as a Roth IRA conversion). This type of conversion allows you to transfer money from your traditional IRA into a Roth IRA, but you have to pay taxes on the money first. There are no restrictions on income limits or marital status for backdoor Roths, so anyone is eligible to open one.

What are the Roth IRA benefits?

What makes a Roth IRA so attractive to investors is the potential tax savings. If you think you’ll be in a higher tax bracket when you retire than you are now, a Roth IRA may be more beneficial than a traditional IRA. The reason that you’ve already paid taxes on your contributions, so your higher tax bracket won’t result in a high tax bill when it’s time to enjoy your hard-earned money.

Another reason the Roth IRA is attractive is rising inflation. Inflation erodes the value of money over time. Giving your money an opportunity to grow tax-free is lucrative.

Some other benefits of a Roth IRA include:

• No required minimum distributions: Account holders of Roth IRAs aren’t subject to the required minimum distributions required of traditional IRA or 401(k) accounts. Beginning in 2023, these RMDs must start at age 73.) This means account holders don’t have to take distributions from a Roth IRA at any point while they’re alive, unlike with traditional IRAs or 401(k)s. However, it’s worth noting that inherited Roth IRAs are subject to RMDs unless you’re inheriting it from a spouse. There are special rules in those circumstances.
• No income tax on inherited Roth IRAs: If you pass a Roth IRA to an heir, they enjoy tax-free withdrawals as long as the account was held for at least five years at the time of the account holder’s death.
• Easy withdrawals: You can withdraw the money you contributed at any time, without taxes or penalty. (You may be taxed or penalized if you withdraw investment earnings.)
• Double dipping: You can contribute to a Roth IRA in addition to an employer retirement account such as a 401(k).
• Flexible timing: You can choose when and how much you contribute to a Roth IRA. For example, you could contribute the full limit on the first day of the year, or split up your contributions throughout the year.
• Extra time to contribute: You have until that year’s tax deadline to contribute for the previous calendar year, which usually falls in mid-April.
• Tax-free distributions: At age 59½, if you’ve held the account for at least five years, you can take distributions, including earnings, from a Roth IRA without paying federal taxes or penalties.
• No age limit to open: You can open a Roth IRA at any age, as long as you have earned income (you can’t contribute more than your earned income).

Strategies for Converting Traditional Retirement Accounts to Roth

The conversion process itself is generally simple: You’ll contact the financial institution that holds your current account, complete some paperwork and roll your retirement funds into a new Roth IRA. However, certain situations may warrant an adjustment to your conversion strategy:

• Bracket-bumping conversion. In some cases, a Roth IRA can provide you with so much reportable income that you’re bumped into a higher tax bracket. With a bracket-bumping conversion strategy, you can avoid this scenario by converting only a portion of your funds to preserve your current tax bracket.
  
  To achieve a bracket-bumping conversion, calculate the difference between the high end of your tax bracket’s income threshold and your current income. The resulting number is how much you can convert to a Roth IRA without altering your tax bracket.
   
• Market-timing Roth conversion. Market downturns can create good opportunities for a conversion, though it may seem counterintuitive to convert to a Roth IRA when the value of your retirement funds has decreased. However, because you will pay taxes on any Roth IRA conversion, waiting for a down market can save you money.
   
• Back-door Roth conversion. Roth IRAs have income limits that may prevent big earners from opening or contributing to an account. You can find current contribution limits on the IRS website. High-income earners may be able to bypass these restrictions via a back-door Roth conversion strategy. You’ll first contribute to a traditional IRA with pre-tax dollars. Then, when the time is right, you’ll convert some or all of those funds into a Roth IRA. Upon conversion, you’ll owe taxes, but only on your pre-tax contributions and earnings.
   
• SEP IRA to Roth conversion. If you’re self-employed or a small business owner, you may have a special type of retirement plan called a SEP IRA. Just like other retirement accounts, SEP IRAs can be converted into Roth IRAs, but keep in mind that any pre-tax contributions you make will be taxed upon conversion.
   

If you determine that a Roth IRA conversion fits with your retirement goals, one of these strategies may help you secure a brighter financial future. Just remember that Roth IRA conversions can trigger significant tax consequences. If necessary, engage a tax professional or financial advisor to help you run the numbers before you commit.

Taxable Investment Accounts

Given the choice between something that is “taxable” or “nontaxable,” most people would choose nontaxable. But when it comes to investment accounts, multiple factors affect which type of account might best help you meet your savings and investment strategies. Many investors use a combination of taxable and nontaxable accounts to meet short-term investment goals and to help control the amount of taxable income they will have each year in retirement.

A taxable account allows an investor to deposit funds and buy and sell investments. It is not a tax-qualified retirement account. There is no tax incentive available at the time funds are deposited, but the purchase price creates a basis that will not be taxed when the asset is distributed or sold. Some taxable accounts generate annual taxable income (e.g., interest on certificates of deposit, mutual fund dividends).

For certain investments such as stocks, bonds, and other property, the increase in value above the initial purchase price will be taxable in the year the asset is sold and may qualify for lower capital gains tax rates if the asset has been held for more than one year. There are no tax law restrictions on contributions or eligibility.

A nontaxable account is typically a pre-tax retirement account, such as a traditional IRA. A traditional IRA owner receives a tax deduction in the year dollars are contributed to the IRA. Taxation on the contributions and any investment growth is delayed until money is taken out of the IRA.

Both the amount of the original contribution and investment earnings will be taxable as ordinary income when the assets are withdrawn from the IRA. (A Roth IRA follows different tax rules.) Because of the tax benefits associated with IRAs, tax laws set contribution limits and eligibility requirements to limit the amount of tax deferral.

Benefits of Taxable Investment Accounts

For most people, saving for retirement is best done through accounts specifically designated for retirement, such as 401(k)s or Traditional or Roth individual retirement accounts (IRAs). By design, these accounts offer preferential tax treatment—you either get a tax break now or later in retirement.

For example, most contributions in Traditional IRAs and 401(k) accounts reduce taxable income today, but the money is taxed later when it is taken out of the account. Conversely, Roth IRA and designated Roth contributions in a 401(k) plan do not provide a tax break today but do potentially provide tax-free withdrawals in retirement.

A good rule of thumb is to save 15% or more (including any employer contributions) of your household gross income every year for retirement. There are several situations where you may want to supplement your retirement savings with a taxable general investing account. Here are four:

1. You don’t have access to a 401(k) plan at work.

Your workplace may not offer a retirement plan at all. Some employers have a waiting period (e.g., 90 days or one year) before someone is eligible to participate. Or the plan might only be available to full-time workers.

If this is your situation and the only retirement account option is an IRA, contributions are limited to $6,500 per year in 2023 ($7,500 if age 50 or older). For many workers, an IRA by itself will not get you to that 15% savings rate. Making additional contributions to a taxable account can help you meet this savings target.

2. You want accessibility to your long-term investments.

Some households may want to start investing beyond what they’ve saved as their emergency reserve. Other households may not want to tie up all their long-term investment savings in retirement accounts. A taxable account provides the flexibility to add money and take money out with few limits, penalties, or restrictions. There are also no required distributions. You can save more toward retirement or any other future goal.

3. You have maxed out your 401(k) or IRA and want to save more.

For 2023, the 401(k) plan contribution limit is $22,500 ($30,000 if age 50 or older). Some households, especially dual-income households, may be able to save aggressively for retirement. Consider someone under age 50 earning $160,000 a year. Using the 15% retirement savings target, they should aim to save $24,000 or more each year, well above the contribution limit. The next option, an IRA, could be problematic as Roth IRAs have income limitations and a Traditional IRA may be nondeductible. Additional savings can be invested in a taxable account.

4. Your only IRA option is nondeductible.

Continuing from the previous scenario, a nondeductible IRA means that you do not qualify for a tax deduction when contributing to a Traditional IRA; therefore, you lose that tax benefit. This happens when you or your spouse have access to a workplace plan, which makes deductibility subject to income limitations. While any earnings will still be tax-deferred in a nondeductible IRA, they will be taxed as ordinary income when the money is used. With a taxable account, you may benefit from a lower long-term capital gains tax rate.

For example, the same single person under age 50 making $160,000 in 2023 cannot contribute to a Roth IRA, and, assuming they are participating in their company plan, they cannot deduct their contributions to a Traditional IRA. They would benefit from a 0% and 15% long-term capital gains rate versus a marginal income tax bracket of 24%.

Examples of Tax-efficient Portfolio Construction

Most investors know that if you sell an investment, you may owe taxes on any gains. But you could also be on the hook if your investment distributes its earnings as capital gains or dividends regardless of whether you sell the investment or not.

By nature, some investments are more tax-efficient than others. Among stock funds, for example, tax-managed funds and exchange-traded funds (ETFs) tend to be more tax-efficient because they trigger fewer capital gains. Actively managed funds, on the other hand, tend to buy and sell securities more often, so they have the potential to generate more capital gains distributions (and more taxes for you).

Bonds are another example. Municipal bonds are very tax-efficient because the interest income isn’t taxable at the federal level and it’s often tax-exempt at the state and local level, too. Munis are sometimes called triple-free because of this. These bonds are good candidates for taxable accounts because they’re already tax-efficient.

Treasury bonds and Series I bonds (savings bonds) are also tax-efficient because they’re exempt from state and local income taxes. But corporate bonds don’t have any tax-free provisions, and, as such, are better off in tax-advantaged accounts.

Here’s a rundown of where tax-conscious investors might put their money:

Taxable Accounts (e.g., brokerage accounts)	Tax-Advantaged Accounts (e.g., IRAs and 401(k)s)
Individual stocks you plan to hold for at least a year	Individual stocks you plan to hold for less than a year
Tax-managed stock funds, index funds, exchange traded funds (ETFs), low-turnover stock funds	Actively managed stock funds that generate substantial short-term capital gains
Qualified dividend-paying stocks and mutual funds	Taxable bond funds, inflation protected bonds, zero-coupon bonds, and high-yield bond funds
Series I bonds, municipal bond funds	Real estate investment trusts (REITs)

Many investors have both taxable and tax-advantaged accounts so they can enjoy the benefits each account type offers. Of course, if all your investment money is in just one type of account, be sure to focus on investment selection and asset allocation.

Health Savings Accounts (HSAs)

A Health Savings Account (HSA) is a tax-advantaged account created for or by individuals covered under high-deductible health plans (HDHPs) to save for qualified medical expenses. Contributions are made into the account by the individual or their employer and are limited to a maximum amount each year. The contributions are invested over time and can be used to pay for qualified medical expenses, such as medical, dental, and vision care and prescription drugs.

As mentioned above, people with HDHPs can open HSAs. Individuals with HDHPs may qualify for HSAs, and the two are usually paired together. To qualify for an HSA, the taxpayer must meet eligibility standards established by the Internal Revenue Service (IRS). An eligible individual is someone who:

• Has a qualified HDHP
• Has no other health coverage
• Is not enrolled in Medicare
• Is not claimed as a dependent on someone else’s tax return

The maximum contribution for an HSA in 2022 is $3,650 for an individual ($3,850 for 2023) and $7,300 for a family ($7,750 in 2023). The annual limits on contributions apply to the total amounts contributed by both the employer and the employee. Individuals age 55 or older by the end of the tax year can make catch-up contributions of an additional $1,000 to their HSAs.

An HSA can also be opened at certain financial institutions. Contributions can only be made in cash, while employer-sponsored plans can be funded by the employee and their employer. Any other person, such as a family member, can also contribute to the HSA of an eligible individual. Self-employed or unemployed individuals may also contribute to an HSA, provided that they meet the eligibility requirements.

Contributions made to an HSA do not have to be used or withdrawn during the tax year. Instead, they are vested, and any unused contributions can be rolled over to the following year. Also, an HSA is portable, meaning that if employees change jobs, they can still keep their HSAs.

An HSA plan can also be transferred to a surviving spouse tax-free upon the account holder’s death. However, if the designated beneficiary is not the account holder’s spouse, then the account is no longer treated as an HSA, and the beneficiary is taxed on the account’s fair market value, adjusted for any qualified medical expenses of the decedent paid from the account within a year of the date of death.

All in all, HSAs are one of the best tax-advantaged savings and investment tools available under the U.S. tax code. They are often referred to as triple tax-advantaged because:

• Contributions are not subject to tax.
• The money can be invested and grown tax-free.
• Withdrawals are not taxed as long as you use them for qualified medical expenses.

As a person ages, medical expenses tend to increase, particularly when reaching retirement age and beyond. Therefore, starting an HSA early if you qualify—and allowing it to accumulate over a long period—can contribute greatly to securing your financial future.

Real Estate Investments

Investing in real estate is the pinnacle of investment achievements in the eyes of many new investors. Unlike stocks and bonds, real estate can be touched and stood upon, regardless of market conditions. When the market tanks, you still have a piece of the planet that’s not going anywhere. For plenty of investors, this is a sort of comfort they can’t find in other types of investments that may seem more ethereal — even if they’re secured by very real companies.

Although many people think of buying a small rental property when they think about real estate investing, there are actually a lot of different ways to get into the real estate market. Each comes with risks and rewards, and many are unique investment experiences.

Property flipping

By now, everyone knows about property flipping. But what you see on television isn’t the whole picture of what’s involved in successfully purchasing a residential property, fixing it up, and selling it to someone who will love it. You’ll need substantial capital to cover labor and supplies, as well as a construction crew or subcontractors you can trust. You also will likely be subjected to multiple inspections, all of which you must pass before being allowed to market your property.

Construction loans are possible, but they are often difficult to obtain as a first-time flipper due to experience requirements and other bank-imposed terms. However, in the current real estate market, a flip that’s priced accordingly and will appraise for the asking price may not sit very long at all. Be prepared to make additional repairs that the buyer’s inspector finds. No house is perfect, no matter how many people have been working on it.

In a worst-case scenario, your flip house can be converted into a rental property. This isn’t ideal, of course, and it will take a lot longer to recover your investment, but it can be a solution if the property can’t find a buyer. Sometimes the market turns after you’ve started a project, and the only option you have is to keep going forward. Always have an exit strategy when getting into property flips.

Short-term rentals

Short-term rentals are a great way to make a little extra money with spare houses or accessory dwelling units (ADUs) already on your property. When you rent short-term rental units out by the night or the week, you can be very choosy about who gets the keys. You can also potentially see more significant returns than you would with a regular residential lease.

Take care that the neighborhood that houses your short-term rental property allows for that kind of transaction since many homeowners associations and towns are on the warpath against short-term rental landlords, and many have banned them outright. You also need to be right on top of your customer service game since guest reviews can determine your rental’s popularity.

Small-scale residential rental properties

Some people choose to invest in real estate by simply buying a few small residential properties. A couple of houses or a duplex might be a good starting point just to give you a feel for what it’s like to be a hands-on landlord. Most very small landlords choose their own renters and handle their own maintenance (as well as their own evictions). As you build your property portfolio, it may make sense to hire a property manager. Early on, however, the margins are likely too slim for a manager.

Landlording is a business a lot of us already understand since we’ve almost certainly rented something from someone at some point. That makes it a bit more comfortable than, say, land speculating. However, you’ll also have to enforce your leases and maintain the property, which can mean anything from collecting rents from stubborn tenants to calling out the plumber and the backhoe when a sewer line decides to randomly collapse at 3 a.m. on a Saturday.

Large-scale residential rental properties

Unlike small-scale residential rentals, larger-scale rental properties are generally pretty hands-off operations. These are often larger apartment buildings or housing communities with a single owner or even a portfolio of residential housing. Unless you have a significant amount of cash available, you’ll invest in these properties as part of an investment group. The group can be a few friends who also have cash to invest or a firm that allows you to buy a share of a development.

Large-scale residential rental portfolios can be a really good way to get into real estate investing without any experience with landlords or construction. Pay close attention to the company that’s managing the investment, though. They should have little debt, a cash cushion for the property’s upkeep, and clearly defined goals for the future. Also, find out how long you have to stay invested before you can divest. Some groups will lock you in for a longer term than others, no matter what the market is doing.

Commercial real estate

Putting your money into commercial real estate can mean a lot of different things. You might build a small self-storage facility or you could buy into a series of empty warehouses in an industrial park, a mini-mall, or even an office building. Leasing each of these properties takes a different kind of skill set, but at the end of the day, commercial properties tend to have higher values than residential real estate and often bring in higher rents.

Commercial real estate can be risky. Some types of real estate are difficult to rent in down markets. For example, during the COVID-19 pandemic, office rentals have been very hit-and-miss, since some companies are having their employees return to work at the office and others are still keeping workers at home. (Warehouses, on the other hand, couldn’t be rented fast enough.)

When stepping into directly owned commercial real estate, it’s very important to have a good property manager or real estate agent on your side. There are many ways to make a profit with commercial real estate.

Real estate investment trusts (REITs)

Real estate investment trusts (REITs) are funds that you can buy shares from on the open market. Unlike private real estate projects, REITs are traded just like stocks. Like stocks, REITs are essentially liquid — as long as you don’t mind losing money if you have to cash out quickly.

You won’t have to worry about property management or any of the day-to-day issues with REIT investing, but you should be concerned with the leadership of any REIT and how their money is being spent. As with other fractional real estate investments, you want to be sure their debt is low, that they have a fair amount of equity they can tap in case of a market downturn, and that they have a long-term vision for their properties.

REITs are very transparent and have to disclose a lot of information about their income and expenses, making them a great way for first-time real estate investors to add a little real estate exposure to their portfolios. The risk with REITs is the same as with any kind of stock — the company could fold or you could lose considerable money due to someone else’s mismanagement. Be sure to really explore the REIT before you make a buy.

Business Ownership and Retirement Planning

As a small business owner, you are completely responsible for your own retirement planning. If you have employees, you may feel responsible for helping them plan for a successful retirement. The considerations and retirement savings plans that work you, as a small business owner, should be paramount when planning for both your own retirement and that of your employees.

It might seem strange that developing a business exit strategy should be one of your first considerations when planning for retirement. But consider this: the small business you spend your life building might become your largest asset. If you want it to fund your retirement – and to stop working – you’ll need to liquidate your investment. To prepare to sell your small business one day, it needs to be able to operate without you. It’s never too early to start thinking about how to accomplish that goal and about how to find the best buyer for your small business. 

Market conditions will affect your ability to sell your business. You might want to build flexibility into your retirement plan so you can sell your stake during a strong market or work longer if a recession hits. You definitely want to avoid a distress sale: One problem you’ll encounter if you wait until the last minute to exit your business is that your impending retirement will create the impression of a distress sale among potential buyers and you won’t be able to sell your company at a premium. 

Many small business owners say that they don’t want to retire, or at least not retire fully. But even if you’re among the many small business owners who plan to keep working, establishing a retirement plan for your small business is a good idea because it gives you options—and having options means you’ll feel more satisfied with whatever path you choose. 

SEP IRA: A simplified employee pension (SEP) is another type of individual retirement account (IRA) to which small business owners and their employees can contribute. In 2022, it lets employees make pretax contributions of up to 25% of income or $61,000 (rising to $66,000 in 2023), whichever is less.

Internal Revenue Service. “SEP Plan FAQs.” Like a SIMPLE plan, a SEP lets small business owners make tax-deductible contributions on behalf of eligible employees, and employees won’t pay taxes on the amounts an employer contributes on their behalf until they take distributions from the plan when they retire.

Almost any small business can establish a SEP. It doesn’t matter how few employees you have or whether your business is structured as a sole proprietorship, partnership, corporation or nonprofit. Each year, you can decide how much to contribute on behalf of your employees, so you aren’t locked into making a contribution if your business has a bad year. Owners of the business are also considered employees and can make employee contributions to their own accounts.

Solo 401(k)s: If you’re in a competitive field and want to attract the best talent, you might need to offer a retirement plan, such as the two described above. However, employers are not required to offer retirement benefits to their employees. If you don’t, one way you can save for your own retirement without involving your employees is through a Roth or traditional IRA, which anyone with employment income can contribute to.

You can also contribute to an IRA on your spouse’s behalf. Roth IRAs let you contribute after-tax dollars and take tax-free distributions in retirement; traditional IRAs let you contribute pretax dollars, but you’ll pay tax on the distributions. The most you can contribute to an IRA in 2022 is $6,500 or $7,000 if you’re 50 or older. These limits increase to $6,500 and $7,500 respectively for tax year 2023.

Tax Diversification Strategies

Tax diversification is an investment strategy that uses tax-advantaged, fully taxable and tax-free investment accounts to help lower taxes. Diversification is the name of the game when it comes to investing. This even applies to taxes. When you invest in accounts with different tax structures, you can save significantly on your tax bill both now and into retirement. But first, you need to understand how different investment accounts are taxed. Here’s how it works.

Let’s take a look at tax diversification and why it’s so effective. Like other investment diversification principles, tax diversification allows you to lower risk and put yourself in a more profitable position in the long run. There are three key benefits to tax diversification.

The first is lowering your overall tax bill. For instance, you can choose to withdraw from your tax-deferred accounts in early retirement, to lower your tax bracket and reduce the amount of taxes you pay over the life of the account. Diversified accounts allow you to make choices that save you tax money in the long term.

The second benefit is not getting hit by a huge tax bill all at once. If you save in both a Roth IRA and a 401(k) plan, you’re paying taxes upfront for the former and paying taxes when you withdraw for the latter. This saves you money in retirement, where a dollar might be dearer.

The final benefit is flexibility. If you have surprise expenses in retirement, not having to take a huge amount of out a tax-advantaged account that will push you into a higher tax bracket could be a lifesaver.

Like most financial topics, tax diversification is complex and can take many forms. You might take a simple tax diversification strategy by using both a 401(k) plan and a Roth IRA to save for retirement, spreading out your tax bill and risk over the lifetime of those accounts. Or you might want to take a more complex strategy and spread your savings over multiple instruments with different tax brackets and tax risks.

An additional challenge when planning for tax diversification is that tax laws are constantly in flux. The specifics of taxes, investments and retirement accounts are likely to change over time. Working with an expert can help you keep more of your money both now and when you retire.

Estate Planning and Taxes

The term estate planning refers to the preparation of tasks that serve to manage an individual’s financial situation in the event of their incapacitation or death. The planning includes the bequest of assets to heirs and the settlement of estate taxes and debts, along with other considerations like the guardianship of minors and pets. Most estate plans are set up with the help of an attorney experienced in estate law. Some of the steps included in estate planning typically include listing assets and debts, reviewing accounts, and the writing of wills.

Estate planning involves determining how an individual’s assets will be preserved, managed, and distributed after death. It also takes into account the management of an individual’s properties and financial obligations in the event that they become incapacitated. Contrary to what most people believe, this isn’t a tool meant just for the ultra-wealthy. In fact, anyone can and should consider estate planning.

Assets that could make up an individual’s estate include houses, cars, stocks, artwork, life insurance, pensions, and debt. Individuals have various reasons for planning an estate, such as preserving family wealth, providing for a surviving spouse and children, funding children’s or grandchildren’s education, or leaving their legacy behind for a charitable cause.

Federal and state taxes applied to an estate can considerably reduce its value before assets are distributed to beneficiaries. Death can result in large liabilities for the family, necessitating generational transfer strategies that can reduce, eliminate, or postpone tax payments. There are significant steps in the estate planning process that individuals and married couples can take to reduce the impact of these taxes.

A-B Trusts

Married couples, for example, can set up an A-B trust that divides into two after the death of the first spouse. Trust A is the survivor’s trust while trust B becomes the decedent’s trust. Each individual places their assets in the trust and names someone other than their spouse as the beneficiary.

Education Funding Strategies

A grandfather may encourage his grandchildren to seek college or advanced degrees and thus transfer assets to an entity, such as a 529 plan, for the purpose of current or future education funding.

That may be a much more tax-efficient move than having those assets transferred after death to fund college when the beneficiaries are of college age. The latter may trigger multiple tax events that can severely limit the amount of funding available to the kids.

Cutting the Tax Effects of Charitable Contributions

Another strategy an estate planner can take to minimize the estate’s tax liability after death is by giving to charitable organizations while alive. The gifts reduce the financial size of the estate since they are excluded from the taxable estate, thus lowering the estate tax bill.

As a result, the individual has a lower effective cost of giving, which provides additional incentive to make those gifts. And of course, an individual may wish to make charitable contributions to a variety of causes. Estate planners can work with the donor in order to reduce taxable income as a result of those contributions or formulate strategies that maximize the effect of those donations.

Estate Freezing

This is another strategy that can be used to limit death taxes. It involves an individual locking in the current value, and thus tax liability, of their property, while attributing the value of future growth of that capital to another person. Any increase that occurs in the value of the assets in the future is transferred to the benefit of another person, such as a spouse, child, or grandchild.

This method involves freezing the value of an asset at its value on the date of transfer. Accordingly, the amount of potential capital gain at death is also frozen, allowing the estate planner to estimate their potential tax liability upon death and better plan for the payment of income taxes.

Hiring a Financial Advisor

A financial advisor can be a wonderful resource for getting your finances in order, offering you expert advice across a range of financial matters. But financial advisors are not all created equal, and those looking for an advisor must understand the potential drawbacks of using one.

Finding a great financial advisor can help your business:

• Select investment and retirement plans for your employees
• Plan equipment purchases and paying off debt, as well as investing in or acquiring other businesses
• Align investments with current and future taxation

A great Financial Advisor candidate will have the following skills and attributes as well as work experience that reflects:

• Bachelor’s degree in finance or economics
• Knowledge of tax laws governing investments
• Series 7 and/or 66 may also be required
• Good listening skills
• Interdependent work style
• Attention to detail

Investors looking for the right advisor should ask a number of questions, including:

• Do you have experience working with a client like me? A financial advisor that works with you will likely not be the same as a financial advisor who works with another. You may be looking for someone who specifically works with retired people, same-sex couples, divorced people, surviving spouses, a woman, a Black or Indigenous Person of Color (BIPOC), an LGBTQ+ individual, or any applicable niche.
• What services do you offer? Depending on whether you’re looking for a wide-ranging financial plan or are simply looking for investment guidance, this question will be important.
• How do you charge your clients? Financial advisors have different methods of charging their clients, and it will often depend on how often you work with one. Be sure to ask if the advisor follows a fee-only or commission-based system.
• What sort of education do you have? If you’re working with a human advisor, you’ll undoubtedly be curious about their education. For instance, do they have a college degree in a field like accounting or finance? You want to make sure their education matches the type of advisory services you need.
• What are their credentials? Are they regulated by the SEC, for example, or certified by an organization like the National Financial Educators Council? Resources that can help you investigate whether an advisor is registered, certified or in trouble include FINRA’s BrokerCheck tool, the CFP verification tool, and the SEC’s Action Lookup tool.
• How often will they contact you, and by what method? Are there any limitations on how frequently they can be contacted?

The nature of the advisory field is also changing. Investors now usually have access to their accounts digitally and thus, beyond traditional in-person meetings, may meet with their advisors virtually for some or all of their portfolio review sessions.

Conclusion

For high income earners, tax planning can feel overwhelmingly complex. There are many considerations from tax loss harvesting to charitable giving. However, a good wealth advisor will always make it simple and relevant to you. They should also properly frame all risks, remove the hassle, and empower you to make decisions that are in line with your goals.

The more money you make, the more complicated your taxes are going to be. So, if you have a higher income than most people, it’s important to work with a skilled accountant to figure out how to reduce the amount of income taxes you pay. In addition to taking your standard deduction and other deductions, there are many things you can do to lower the amount you pay.