Nobody wants to part with their hard-earned money. It is even more difficult when you are giving money to the IRS in the form of taxes, and especially disheartening to discover you overpaid in taxes or that you could have avoided unnecessary taxes.

The truth is that many affluent individuals use wealth-building strategies that may not be very tax-efficient or tailored to their own personal situation, or underuse smart strategies when it comes to taxation.

Whether you are saving for retirement, building wealth to pass on to your children, or working toward a larger cause, knowledge of how to navigate the tax code and avoid unnecessary “gifts” to Uncle Sam could possibly save you money – money that could otherwise be used to build wealth and further your financial goals.

In this article, we are going to explore some of the most common ways affluent individuals may pay too much in taxes and how to possibly avoid the same fate.

In a snapshot, the most affected areas are:

  • Taxes on Earned Income
  • Taxes on Investment Income
  • Taxes in Retirement
  • Estate & Inheritance Taxes

While there are more nuanced ways that taxes can slip in, these categories cover the most significant sources of taxation for affluent individuals.


1. Taxes on Earned Income

It’s no secret that the higher your reported income each year, the more you likely will pay in taxes. How do you know if you are overpaying on your income taxes? The first place to look is your tax refund. If you receive a large tax refund each year, then you have overpaid the IRS and they are giving you that amount back.If your income fluctuates from year to year, monitoring your income and expenses throughout the year and consulting a tax professional and a financial advisor to help you plan properly may help you avoid paying too much or unnecessary taxes. 

However, beyond just looking at your tax refund, you can also work with a savvy financial advisor who can assess whether some of your earned income could be recharacterized and therefore possibly subject to a lower income tax rate. If you are an employee and receive a salary reported on a W-2, your options may be limited. However, if you are a business owner, you may have more options to recharacterize your income or set up a retirement plan to direct some of your income into tax-deferred accounts for retirement. More on this later. 

You can also divert some of your earned income and take advantage of some basic options like:

  • Setting up and contributing to a Health Savings Account (HSA)
  • Contributing to a 529 plan for your children’s/grandchildren’s education
  • In very specific situations, buying life insurance may have a tax benefit
  • Investing in municipal bonds or Treasury bills which may be Federal/state-tax free
  • Making a charitable donation

When making a charitable donation which could offset your taxable income, there are tax-efficient methods in which to do so which may create a “double” tax benefit. For example, rather than just making a charitable donation with cash, donating appreciated assets may allow you to offset your taxable income with the donation and also avoid paying tax on the appreciation of those assets.

These are just a few of the ways you can allocate your hard-earned money while possibly reducing your reported income. 


2. Taxes on Investment Income

Taxes on the gain from an investment when sold, also referred to as “realized gains,” can be characterized as either short-term gains on investments held less than a year or long-term gain on investments held for a year or more. The distinction in this characterization matters as the tax rate on short-term capital gains can be significantly higher than on long-term capital gains depending on your total overall income and the tax bracket within which you fall. 

Capital gains taxes can be assessed on the sale of assets such as (but not limited to):

  • Real Estate
  • Vehicles
  • Business
  • Stocks
  • Bonds
  • Collectibles

The easiest way for most to avoid overpaying taxes is to hold onto your investments longer. You can hold on to the investment for one year or more to be subject to long-term rather than short-term capital gains rates. And, if you wait until after retirement to sell stocks, your taxable income might be lower, putting you in a lower income bracket overall.  

In some cases, you can also buy and sell investments within your retirement account without being subject to capital gains taxes. But, you will be subject to ordinary income taxes when you withdraw funds from your tax-deferred retirement accounts. 

Also, if you experienced any capital losses during the year, you may be able sell the investments at a loss to “harvest losses” and apply those losses against future realized gains, lowering your taxable income and possibly reducing your tax bill.

Speak with a financial advisor about applying these strategies and others to avoid overpaying capital gains taxes.


3. Taxes in Retirement

While no one likes paying taxes, no matter what the situation, taxes in retirement become somewhat of a double whammy. For most, not only are you no longer earning money and accumulating wealth, you have to draw down on your wealth to pay for your living expenses and then, on top of that, often pay taxes on the withdrawals. 

Much of the money you have saved for retirement could be in tax-deferred accounts meaning, at retirement when the money is withdrawn, taxes will be owed.

While these accounts help you avoid taxes in the present, they are generally subject to taxes in retirement, that deferral period is over and taxes are owed, often at ordinary rates. While there are retirement accounts that exist today that can help you avoid taxation in retirement, there are still plenty of ways the IRS can come calling. 

The most common ways are:

  • Distributions from traditional 401(k) and traditional IRA accounts
  • Investment income
  • Income from work – if you decide to keep working full-time or part-time.
  • Some of your Social Security benefits (not always applicable)
  • Some of your pension income (not always applicable)

The best strategies to avoid paying these and other taxes in retirement are:

  • Invest in Roth 401(k) and Roth IRA accounts (you may be able to roll over your traditional retirement  account into one of these.)
  • Convert tax-deferred retirement accounts into after-tax Roth accounts, ideally pre-retirement
  • Put retirement assets in the most tax efficient accounts and investments
  • Move to a more tax-friendly state

Talk to your financial advisor for a more detailed approach on you can avoid overpaying on taxes in retirement.


4. Estate and Inheritance Taxes

Another significant way that you lose money to taxes is through your estate.

While very few estates and inheritances are subject to taxes, once your estate surpasses the $11.70 million estate tax exemption (in 2021), the value of your estate in excess of this exemption will be taxed at a rate of 40% (in 2021) and the result could be that a hefty chunk of change gets handed to the IRS instead of your desired beneficiaries.

However, there are some ways to avoid handing over too much of your estate to the government in the form of taxes.

The most common ways are:

  • Setting up an estate plan that ensures tax-efficient distribution of assets at your passing
  • Ensuring proper beneficiary designations are in place
  • Reviewing ownership of businesses and investments
  • Gifting appreciating assets prior to death to the extent possible
  • Using life insurance outside of your estate to pay for estate taxes

As always, talk to your financial advisor about the best ways for you to allocate your estate so it avoids too much taxation. 


Getting it Right and Keeping What’s Yours

When it comes to taxes, the terrain can get rocky and difficult to navigate and taxes may hit from many different angles. Rarely are the best tax strategies the ones that are the easiest to uncover. 

To manage and mitigate taxes, you need someone who understand your whole situation and is comfortable with investments, income and estate tax, insurance, charitable planning and other disciplines. 

At Prosperity Road, we understand how tricky taxes can be, and without the right strategy, you could be losing a portion of your hard-earned wealth to Uncle Sam. 

We will work with you and your tax professional to put together a well-constructed plan to make the most of your investments and avoid losing money to taxes or any other financial roadblock. 

Schedule a consultation with us today to see how you can save on taxes and what’s possible for you to build and preserve wealth for your family’s future. 



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