The Best Tax-Savings Vehicles for High-Income Earners, Episode 2
This episode zeros in on tax savings for those who have both high and fluctuating incomes — which likely describes you if you are a sales professional. Those are exactly the people my financial advisement firm caters to, so I’m hopeful that I’ll have some insights that will be of use to you on this episode.
I’m basing my comments in this episode off an article written by Micahel Kitces, a leading blogger in the financial industry. I'm referencing his work because the way he describes the investment vehicles you can use for maximum tax savings is exactly how I view the issue. So, stick around and learn how you can make the best use of that high income you generate.
You will want to hear this episode if you are interested in...
My tribute to the post by Michael Kitces (see below for a link) [0:14]
Looking at my pyramid of to discover the best options for you [1:26]
The back door Roth account [7:38]
The mega-back-door ROTH [10:20]
Today’s sales tip: Modify your question when someone answered the phone [13:18]
There are TWO types of tax-preferenced accounts for investing
If you’re not aware, there are really only two types of accounts you can invest in that help you avoid paying more tax than you should — and that should always be a goal when it comes to investing. Who needs to pay the IRS more than they really deserve? These two types of investment vehicles are:
The TRADITIONAL accounts: In these your contributions go in before you pay tax on them. The mainstays in this category are the IRA and the 401K.
The second category is the ROTH-STYLE account: In these accounts, your contributions are taxed before you put the money into them and are tax-free when you take money out of them.
Both of these types of accounts are great because your funds can grow while in the account without that growth being taxed.
Take a look at my “Pyramid” of investment vehicles for high-income earners
I like to think of my approach to maximizing tax benefits for high-income earners as a pyramid. The more important, foundational components that should be taken advantage of first, are at the bottom. As you work your way up the levels of the pyramid, each is important, but none as beneficial as the level that came before.
Starting at the BASE is the most tax-preferenced savings account - the HSA (Health Savings Account). This is what I like to think of as a “triple tax-free’ account. You will pay no taxes at the time of contribution, you will pay no taxes during the term of the investment, and you will pay no taxes when you take funds out — assuming you follow all the rules. What are those rules? The funds must be used for medical-related expenses and you must possess a high-deductible medical insurance plan to qualify.
These accounts are important for retirement planning because most of us are likely to have more medical expenses during retirement and could use the benefit of paying no taxes on the money we use to pay those expenses. Many people are tripped-up on HSA accounts by using them for immediate medical expenses rather than targeting those funds for retirement-season medical expenses. There’s nothing wrong with using the funds earlier but they really need time to grow if you want to attain their full benefit.
The NEXT LEVEL: TWO COMBINATIONS
COMBO 1: This is a combination of IRAs and 401Ks. Both are double tax-preferred accounts, meaning you make contributions to these accounts before taxes and they grow tax-free, but are taxed at distribution.
COMBO 2: This combo includes Roth IRAs, 529 Plans. In these plans, the money you invest goes in after taxes, grows without taxes, and comes out without taxes. But high-income earners are often prohibited from taking advantage of Roth IRAs due to income limits imposed. Roth 401K plans are better options in this case and are often offered through employers.
The NEXT LEVEL: THE BACK DOOR ROTH
This one is pretty straightforward. After you’ve maxed out your contributions to the other investment vehicles you can do a back-door Roth. You make an after-tax contribution to an IRA then convert it into a Roth IRA. This enables you to avoid paying tax on the distribution of the investment funds. There are some tricks to doing this if you possess other untaxed IRA accounts, so be sure you consult with an accountant or Certified Financial Planner.
The NEXT LEVEL: TAX-LOSS HARVESTING
The short version of this level is that you’re taking advantage of tax-loss harvesting. It’s not a strategy focused on dividends from stocks or on doing a ton of trading. To do this right you need an experienced investment manager who focuses their time on these strategies.
The very TOP LEVEL: Estate Planning
I go into much greater detail on this episode so be sure you listen — and subscribe so you don’t miss any of my best-practices for sales professionals.