High-net-worth individuals typically have between $1 million and $5 million in liquid assets. Financial advisors can provide great value to these clients by being proactive and helping them take advantage of opportunities.
While having a high net worth increases clients’ opportunities, it also requires additional planning when it comes to investing, taxes and estate planning. In 2022, an individual can leave up to $12.06 million to heirs free of any federal estate taxes, and a married couple can leave up to $24.12 million.
Even if a client’s net worth is under the federal estate tax exemption limits, financial advisors can help their high-net-worth clients minimize taxes by planning ahead and implementing certain strategies throughout the year. Some strategies financial advisors can help their clients implement are as follows:
- Maxing out retirement accounts.
- Backdoor Roth IRA.
- Tax loss harvesting.
- Contributing to a health savings account.
- Contributing to a 529 plan.
- Charitable gifting strategies.
- Investing in municipal bonds.
- Investing in qualified opportunity zones.
Maxing Out Retirement Accounts
Finding opportunities to invest on a pretax basis is often the first strategy advisors can help their clients implement. For 2022, the 401(k) contribution limit is $20,500, with an additional catch-up contribution of $6,500 for those age 50 and older, for a total of $27,000. Very often, high-net-worth individuals are also self-employed. In this case, they can also make employer contributions and take advantage of the total combined maximum contribution to a 401(k), which is $61,000 plus the additional catch-up contribution of $6,500, for a combined total of $67,500.
Backdoor Roth IRA
Oftentimes, high-net-worth individuals are also high earners, and therefore phase out of the income limits to contribute to a Roth IRA. For 2022, the phase-out range is $129,000 to $144,000 for single individuals, and $204,000 to $214,000 for married couples filing jointly. If the client is above the income phase-out, an option is to make a nondeductible traditional IRA contribution and then convert the funds into a Roth. There is an IRS pro rata rule when it comes to taxes, which will determine what percentage of the money converted to a Roth is going to be taxable based on the balance of traditional IRAs at year-end. However, if a client does not have a traditional IRA balance at the end of the year, they can make the maximum contribution of $6,000 per year, plus an additional $1,000 catch-up contribution for ages 50 and older, into a traditional IRA and then convert it into a Roth IRA. Although the conversion itself would not be taxable in this case, there could be income taxes on earnings that a traditional IRA with a balance may have collected prior to conversion.
Tax Loss Harvesting
This is a popular year-end planning strategy, and it’s especially important for those in higher tax brackets. Tax loss harvesting entails selling assets that have lost money in order to offset capital gains in other assets. This provides a great opportunity to rebalance a client’s portfolio while also lowering their overall tax liability.
Contributing to a Health Savings Account
If your client has a high-deductible health insurance plan, contributing to an HSA provides an additional pretax savings opportunity. For 2022, individuals can contribute a maximum of $3,650 and families can contribute $7,300. There is also an additional catch-up contribution for ages 55 and older of another $1,000. This can be a great pairing to maxing out a 401(k). Even if the client does not need the money in the current year, it can be invested on a pretax basis and used in future years. If used for qualified health care expenses, the distributions are income tax-free. There is a 20% penalty in addition to ordinary income taxes if withdrawals are made for any reason other than a qualified medical expense before age 65. After reaching age 65, clients can withdraw without the 20% penalty and pay ordinary income taxes on the distributions if not used for qualified medical expenses.
Contributing to a 529 Plan
A 529 plan can be a great estate planning tool. Contributions to 529 plans can grow tax-free if used for qualified education expenses. This also allows clients to develop a long-term gifting strategy while removing the funds from their taxable estates. Withdrawals can be used to pay for undergraduate expenses as well as up to $10,000 for K-12 education. For 2022, up to $16,000 per year per donor qualifies for the gift tax exemption. However, the 529 allows for a lump-sum contribution that combines up to five years of the maximum gift-tax exemption. This means a grandparent can contribute $80,000 as a lump sum to the 529, and the IRS treats it as if it had been spread evenly over the five-year period, as long as no other gifts are made to the same beneficiary over the next five years.
Charitable Gifting Strategies
If one of your client’s values is donating to charity, there are a few tax-advantaged options. One option is using a donor-advised fund, or DAF. DAFs give clients the opportunity to deposit assets into an account and get a tax deduction in the year of the contribution, but still be able to spread out the distributions to the preferred charities over years to come. Funds put into a DAF are not subject to estate taxes and can also help lower or avoid capital gains, since assets put into a donor advised fund can be deducted at the current market value instead of the original cost.
For clients that have required minimum distributions, or RMDs, from their retirement accounts, a strategy you can use is a qualified charitable distribution, or QCD. Instead of paying taxes on the distribution and then donating cash, clients can use their required minimum distributions to do a QCD and therefore exclude the amount donated from taxable income. The amount that qualifies for a QCD is $100,000 per individual.
You can accelerate tax benefits by combining some of these strategies. For example, your client can do a Roth conversion and contribute to a DAF in the same year. This allows the DAF contribution to offset the taxes on the amount converted to the Roth, saving the client today while also shifting assets to vehicles that will grow tax-free and can be distributed tax-free in the future.
As part of an overall diversification strategy, a great addition to your client’s portfolio can be investing in municipal bonds. Some municipal bonds generate income that is free of federal taxes and, in some cases, free of state and local taxes as well.
Qualified Opportunity Zones
The Tax Cuts and Jobs Act of 2017 introduced a new tax rule that allows investors to defer their capital gains taxes. Qualified opportunity funds, or QOFs, are designed to boost investment to distressed communities that are part of a qualified opportunity zone, or QOZ. If clients have capital gains from an investment, they can roll over those gains into a qualified opportunity zone and defer or reduce their capital gains tax liability. There are certain rules to follow, but this can provide an opportunity to further diversify their portfolio while reducing taxes.