Income tax is an obligation for everyone, and yet there are lots of ways to reduce this burden while still staying on the right side of the law.
5 Ways for High Earners to Minimize Income Tax
If you are a high earner, or you anticipate becoming one at some point, planning to slash your tax bill is sensible, so here are a few effective strategies to implement.
Set Up a Defined Benefit Plan (if You’re a Business Owner or Partner)
Also known as a defined benefit retirement plan or DB plan, this is essentially an option made available by the government to incentivize high earners to save for retirement and thus reduce the likelihood that they will be reliant on state-funded welfare as they enter their dotage.
With defined benefit plans for small business owners and partners in place, you will not only benefit from lower income tax deductions based on how much you are putting aside for retirement, but will also be creating a fund that is legally distinct from any of the organization’s other assets, which in turn insulates it from any financial issues that may arise in relation to the company further down the line.
DB plans are better suited to smaller organizations, as well as those with a small number of high-earning executives, partners, or owners, as compared with the more modern 401k plans that are a good fit for larger firms.
Even if you do not want to change your current pension arrangements, it is still worth looking to this area to shrink your income tax, as all you need to do is maximize the contributions you make to your retirement package. Keep an eye on the regulator’s limits each year to work out how much to save.
Leverage HSA Allowances
Another option for driving down your income tax is to establish a health savings account (HSA), which is a possibility so long as you are on the right type of insurance plan.
In this case, you could add over $7000 annually to this account and write it off your tax bill, so long as you have a family. For individuals, the allowable amount is a little less than $4000 under current rules, although again these change quite regularly, so remember to check each year to see if you can increase your contributions.
Also note that over 55s are eligible for an additional $1000 of HSA contributions each year, because of course if you are in this age group then it is more likely that you will need to dip into it to cover the costs of healthcare.
The good thing about HSA utilization is that there is no specific time limit on when the cash has to be spent, so it can sit there for as long as you like.
Snap Up Municipal Bonds
The appeal of investing in mutual bonds is not just that you will be able to protect a larger portion of your income from taxation, but also that the returns you receive as a result of your investment may also be exempt from tax.
This is of course dependent on the specific tax rules which apply in your area, but since municipal bonds are free from tax at a federal level, there is a good chance that the same will be true at a regional level as well.
Municipal bonds are essentially a means of local authorities borrowing money from residents over a fixed period, with interest paid to the lender and the principal sum eventually paid back once the bond matures.
While municipal bonds may not have an especially high rate of interest, the tax advantages they offer to high earners, in particular, make them a worthwhile prospect to investigate.
Consider the Long Term Tax Implications of Any Capital Gains Made
Short-term investments obviously have their appeal, but if you are in for the long haul then you could minimize the amount of capital gains tax that you pay to the government.
Obviously, your income is taken into account when capital gains tax is calculated, but you will get preferential rates whatever the case if you hold onto an asset for more than a year, rather than pulling the trigger and selling in a shorter time frame.
Get Expert Assistance
Many high earners will have little time to dedicate to minimizing their own tax bill, so it makes sense to seek the help of a qualified accountant, wealth manager, financial advisor, or other industry specialists who will be better able to advise you according to your unique circumstances and needs.
Most importantly, having someone else look over your tax affairs and point you in the right direction will ensure that you stay in the good books of the authorities, without paying more than you need to.
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