Maximizing Your Wealth: 7 Tax Planning Strategies for High Earners

If you’re one of the many high-earning taxpayers who just paid their federal and state income taxes, you may be feeling the sting of a hefty tax bill. Indeed, the top 1% of earners in the United States account for roughly 40% of federal income taxes, according to the Tax Foundation.

But that doesn’t mean you need to overpay Uncle Sam. In fact, with careful tax planning, you can minimize your overall tax liability for years to come. 

In this article, we’ll explore a variety of tax planning strategies that can help you proactively lower your tax bill, so you can preserve more of your hard-earned wealth. 

If you’re a high-income taxpayer, consider the following tax planning strategies for high earners: 

#1: Maximize Tax-Advantaged Account Contributions

When it comes to tax planning strategies for high earners, an easy first step is to reap the benefits of tax-advantaged savings and investment accounts. Common examples include retirement accounts, health savings accounts (HSAs), and 529 college savings plans. 

First, be sure to check the contribution limits on your employer-sponsored or individual retirement accounts. In 2023, you can contribute up to $22,500 to a 401(k) plan, plus an additional $7,500 if you’re age 50 or older. You can also contribute up to $6,500 to an individual retirement account ($7,500 for those 50 and over).  

In addition, high earners with qualifying high deductible health plans are eligible to contribute to a health savings account (HSA). An HSA can be a great way to defray healthcare costs while taking advantage of the associated tax benefits. 

Specifically, contributions, capital gains, and withdrawals are all tax-free with an HSA if you use your funds for eligible healthcare expenses. And like qualified retirement accounts, you can typically deduct your contributions from your taxable income to reduce your overall tax liability. 

Lastly, if you have young children, consider contributing to a 529 college savings plan or other education-specific account on their behalf. 

A 529 plan is an investment account that offers certain tax advantages if the funds go towards qualifying education expenses. While contribution limits vary by state, keep in mind you may trigger the federal gift tax if you contribute more than the annual exclusion amount ($17,000 in 2023).

You can also contribute up to five years of gifts at once, per beneficiary, to a 529 plan—up to $85,000 in 2023. This may be particularly useful in years when your income is above average due to a large bonus, inheritance, or other windfall.  

#2: Defer Your Income to Future Years

If you’re a high-earning executive or key employee with a deferred compensation plan, you may be able to defer part of your income to lower your tax bill in the near term. This can be a helpful tax planning strategy if you expect to be in a lower tax bracket in the future—for example, after you retire.

Employees with deferred compensation agreements typically pay taxes on the money when they receive it—not as they earn it. That means if your employer pays you a lump sum per your distribution agreement, you could potentially get hit with a large tax bill.

While there are different ways to structure income from a deferred compensation plan, your options depend on your agreement with your employer. In most cases, your distribution schedule is in your plan documents. 

If you haven’t reviewed your plan details recently, make sure you’re familiar with the terms of your deferred compensation agreement. You may also want to consult a financial planner with expertise in executive compensation plans to avoid costly missteps and identify alternative tax planning strategies for high earners. 

#3: Take Advantage of Down Markets and Lower Income Years with a Roth Conversion

The IRS allows individuals, regardless of their income, to convert a traditional IRA to a Roth IRA via a Roth conversion. 

After you convert your traditional IRA to a Roth, any withdrawals you make in retirement will be tax-free if you’re over age 59 ½ and satisfy the five-year rule. And since Roth IRAs don’t have required minimum distributions (RMDs), you can leave your funds to grow tax-free until you need them.

However, it’s important to note that a Roth conversion shifts your tax liability to the present. Therefore, it’s one of the tax planning strategies for high earners that typically makes more sense in years when your income is below average, or the market and your account balances are down. 

Also, keep in mind Roth conversions can be complicated and don’t make sense for everyone. Be sure to consult a trusted financial planner or tax expert before taking advantage of this strategy.  

#4: Plan Your Equity Compensation Strategically 

For many high-earning professionals, stock options, restricted stock units (RSUs), and other types of noncash compensation can be a valuable piece of your overall compensation package. Yet failing to understand the associated tax implications can be costly. 

In general, the following tips can help you avoid unnecessary tax consequences:

• For incentive stock options (ISOs), hold your shares for at least one year after exercising your options and two years after the grant date to avoid paying taxes on gains at your ordinary income tax rate. Instead, the long-term capital gains tax rate will apply. 

• If you have non-qualified stock options (NSOs), consider exercising “in-the-money” options in lower-income years since immediate gains are taxed as ordinary income. If possible, hold your shares for at least one year before selling so the long-term capital gains rate applies to subsequent gains. 

• For restricted stock units (RSUs) consider selling your shares in lower-income years, if possible, to potentially reduce your overall tax liability.

Stock options, RSUs, and other types of equity compensation come with a variety of complex tax considerations. Be sure to work with a financial planner or tax expert, who can help you maximize your benefits. 

#5: Consider Gifting and Giving Strategies to Lower Your Tax Bill 

Gifting and giving can be effective tax planning strategies for high earners who plan to leave behind significant wealth. Indeed, these strategies can help you efficiently transfer wealth to your heirs today while reducing the value of your overall estate.  

Each year, the annual gift-tax exclusion allows you to gift a certain amount (up to $17,000 in 2023) to as many people as you like without incurring the federal gift tax. Furthermore, spouses can combine the annual exclusion to double the amount they can gift tax-free. 

Meanwhile, the IRS allows you to pay educational and medical expenses on behalf of someone else without incurring federal taxes if you pay the institution directly. If you have grandchildren or other family members who need financial assistance, covering these expenses can be both tax-efficient and fulfilling. 

In addition, certain charitable giving strategies—for example, contributing to a donor-advised fund (DAF)—can help you meaningfully reduce your tax bill. 

When you contribute cash or non-cash assets to a DAF, you can take an immediate tax deduction in the year you make the donation (if you itemize). You can then invest the funds tax-free and spread your donations out over several years to maximize your charitable impact. 

#6: Establish a Residence in a Tax-Friendly Location

Another potential tax planning strategy for high earners to consider is relocating to or maintaining a residence in a more tax-friendly location. Several states, including Florida, Texas, and Nevada, have no state income tax. 

Establishing a residence in one of these states can result in significant tax savings—especially if you live in a state with a high income-tax rate, such as California or New York. However, keep in mind that in most cases, you’ll need to spend at least 183 days of the year in your alternate home for the IRS to consider it your permanent residence.

#7: Consider Working with Simplicity Wealth Management to Identify Additional Tax Planning Strategies for High Earners

While this isn’t an exhaustive list, many of the above tax planning strategies for high earners may help you reduce your tax liability and retain more of your hard-earned income. An experienced financial planner can help you identify which tax savings opportunities make the most sense within the context of your long-term financial plan. 

At Simplicity Wealth Management, we specialize in helping busy tech professionals with equity compensation navigate their complex financial lives. If you’re interested in learning more about how we can help you make the most of your money, schedule a call with us today. Together, we can develop a customized financial plan designed to minimize your tax liability and optimize your financial well-being.