High earners, not rich yet (HENRYs) are individuals who currently have significant discretionary income and a strong chance of being wealthy in the future. The term HENRYs was coined in a 2003 Fortune Magazine article to refer to a segment of families earning between $250,000 and $500,000, but not having much left after taxes, schooling, housing, and family costs, not to mention saving for an affluent retirement.
Tax planning for high-income earners is essential to optimize your tax strategy and effectively manage your tax burden. Here are some strategies to consider:
- Maximize Retirement Contributions: Contribute the maximum allowable amount to tax-advantaged retirement accounts such as 401(k)s, IRAs, or SEP IRAs. These contributions can lower your taxable income and provide long-term savings benefits.
- Utilize Health Savings Accounts (HSAs): If you have a high-deductible health plan (HDHP), contribute to an HSA. Contributions are tax-deductible, grow tax-free, and withdrawals for qualified medical expenses are tax-free, providing a triple tax benefit.
- Consider Deferred Compensation: If your employer offers deferred compensation plans, such as non-qualified deferred compensation (NQDC) or stock option plans, consider deferring income into future years to spread out your tax liability.
- Invest in Municipal Bonds: Municipal bonds provide tax-free interest income at the federal level and often at the state level, making them attractive investments for high-income earners in high tax brackets.
- Bunch Charitable Contributions: Consider “bunching” charitable donations by making larger contributions in specific years to exceed the standard deduction threshold and take advantage of itemizing deductions.
- Charitable Remainder Trust (CRT): Establish a CRT to make a sizable charitable donation while retaining an income stream from the donated assets. You receive an immediate charitable deduction, and the charity benefits from the remaining assets after a specified period.
- Charitable Lead Trust (CLT): Create a CLT to make charitable contributions while passing the remaining assets to beneficiaries, such as family members or heirs, after a specific term. This can offer both charitable deductions and estate tax benefits.
- Qualified Small Business Stock (QSBS): If you invest in eligible small businesses, you may qualify for the QSBS exclusion, which can allow you to exclude a portion of the capital gains from the sale of qualifying stock.
- Tax-Loss Harvesting: Offset capital gains with capital losses through tax-loss harvesting. Selling investments with losses can help reduce your overall tax liability.
- Consider Roth Conversions: If your income allows, consider converting traditional IRA funds to a Roth IRA. While you’ll pay taxes on the conversion amount, future withdrawals from the Roth IRA will be tax-free.
- Maximize State and Local Tax Deductions: For high-income earners who reside in states with high income taxes, maximizing state and local tax deductions can help reduce your federal tax liability.
- Monitor Net Investment Income Tax (NIIT): High-income earners may be subject to the NIIT, an additional 3.8% tax on certain types of investment income. Plan investments to minimize exposure to this tax.
- Establish a Donor-Advised Fund (DAF): Use a DAF to make a charitable contribution, receive an immediate tax deduction, and distribute funds to multiple charities over time.
- Work with a Tax Advisor: Given the complexities of tax planning for high-income earners, consult with a tax advisor or financial planner to create a customized tax strategy that aligns with your financial goals.
These are just some of the tax planning strategies available to high-income earners. Individual circumstances vary, so it’s crucial to seek professional advice to develop a tax plan tailored to your specific situation and objectives.