As retirement approaches, affluent Americans must address numerous questions to preserve and grow their wealth. Among these, taxes play a pivotal role—yet they’re often overlooked in wealth-building strategies. 

For those on the cusp of retirement, understanding the nuances of tax planning can significantly affect their long-term financial security. Reducing tax liabilities and taking advantage of tax-advantaged accounts and credits allows it to retain more wealth and foster a more resilient financial future.

In this blog, we’ll examine how understanding taxes is integral to wealth building, discussing essential tax principles and the role of tax planning in a strategic retirement plan.

Disclaimer: This blog and the below information are for educational purposes only and do not constitute financial or investment advice. The information provided is intended to offer general guidance and should not be interpreted as specific advice for your financial situation. Always consult with your professional financial advisor.

The Tax Implications of Wealth

Affluent individuals often face complex tax challenges that can substantially impact their wealth. Taxes affect not only the income earned during retirement but also the withdrawals made from investment accounts, pensions, and retirement accounts. For instance:

• Income Taxes on Withdrawals: Withdrawals from traditional retirement accounts, such as 401(k)s or IRAs, are often subject to potential income tax.
• Capital Gains Tax: Investments outside retirement accounts may be subject to potential capital gains tax, which varies based on the investment duration.
• Estate Taxes: Wealthier individuals may also be subject to potential estate taxes, impacting the legacy they intend to leave behind.

Being proactive with tax planning enables individuals to identify ways to help reduce their tax liabilities across various income sources while minimizing the impact of taxes on their investments.

The Role of Tax Efficiency in Wealth Building

The concept of tax efficiency refers to the strategy of organizing one’s financial affairs to help minimize the tax burden. Tax efficiency can help enhance wealth-building potential by freeing up more funds for investment, savings, and other financial objectives. Some ways individuals can work towards greater tax efficiency include:

1. Prioritizing Tax-Advantaged Accounts: Accounts like IRAs, 401(k)s, Health Savings Accounts (HSAs), and Roth IRAs are designed to offer tax benefits at the time of contribution, during the investment period, or at withdrawal.
2. Understanding Tax Brackets and Rates: Since the United States follows a progressive tax system, high-income individuals may fall within multiple tax brackets. Strategic planning can help retirees manage their income withdrawals to potentially stay within lower brackets, reducing overall tax liability.
3. Taking Advantage of Tax Deductions and Credits: Although certain deductions and credits are more common among lower-income earners, deductions such as charitable contributions, medical expenses, and certain business expenses can be useful for high-net-worth individuals as well.
4. Capital Gains Management: Knowing when and how to sell appreciated investments can help investors manage their exposure to capital gains tax. For example, holding investments for over a year qualifies for the more favorable long-term capital gains rate.
5. Required Minimum Distributions (RMDs): After the age of 73, retirees with tax-deferred accounts must take RMDs, taxed as regular income. However, with careful planning, individuals may be able to reduce their tax burden from RMDs.

Tax-Advantaged Accounts for Retirees

Understanding the differences in taxation across various accounts can help wealthier retirees retain more of their earnings. Here are some tax-advantaged account types commonly considered for tax-efficient retirement strategies:

• Traditional and Roth IRAs: Contributions to traditional IRAs are typically tax-deductible, while Roth IRAs are funded with after-tax dollars, allowing for tax-free withdrawals in retirement. This distinction can be beneficial in planning withdrawals to avoid moving into higher tax brackets.
• 401(k) Accounts: Many employers offer matching contributions to 401(k) plans, providing an effective way to help grow retirement savings with tax benefits. Contributions are tax-deferred, allowing growth until withdrawals begin in retirement.
• Health Savings Accounts (HSAs): If eligible, HSAs offer a unique triple tax advantage: contributions are tax-deductible, growth is tax-free, and withdrawals for qualified medical expenses are tax-free.
• 529 Plans: Designed primarily for education savings, 529 plans offer tax-free growth if funds are used for qualified education expenses. This can help high-net-worth individuals cover educational costs for children or grandchildren while reducing taxable income.

The Impact of Capital Gains on High-Income Retirees

Capital gains taxes apply to the profits from selling assets like stocks, bonds, or real estate. High-income retirees who frequently buy and sell investments, or those with a significant portion of their portfolio in taxable accounts, may face substantial capital gains taxes. Capital gains are typically classified into two categories:

1. Short-Term Capital Gains: Gains from assets held for one year or less are taxed at ordinary income tax rates. For high-income earners, these rates are generally higher and can lead to a considerable tax bill.
2. Long-Term Capital Gains: Assets held for over a year are taxed at a lower, long-term capital gains rate. Currently, these rates are set at 0%, 15%, or 20%, depending on income level.

For retirees, managing investments to prioritize long-term gains can help reduce tax exposure. Additionally, strategies like tax-loss harvesting can offset capital gains by selling investments at a loss, which can help minimize tax liabilities on high-gain assets.

Estate Taxes and Legacy Planning

For those with substantial assets, estate planning, and understanding estate taxes are crucial. As of 2024, the federal estate tax exemption is set at $12.92 million per individual, though this exemption may change in the future. Estate planning strategies, such as trusts, charitable donations, and lifetime gifting, can help reduce estate taxes while helping ensure that assets are transferred according to an individual’s wishes.

Some of the tools commonly used in estate planning for high-net-worth retirees include:

• Trusts: Establishing irrevocable or charitable remainder trusts can be a powerful way to manage estate taxes, offering flexibility in transferring wealth.
• Lifetime Gifting: Individuals can gift up to a certain amount each year without incurring a gift tax, which is a common method to help reduce the taxable estate.
• Charitable Giving: Many high-net-worth retirees engage in philanthropic endeavors to not only support causes they believe in but also to take advantage of tax benefits associated with charitable contributions.

Essential Tax Considerations as You Approach Retirement

Tax planning as part of retirement strategy should begin as early as possible. Here are a few tax considerations to keep in mind:

1. Timing of Withdrawals: Withdrawing from retirement accounts at specific times can help individuals avoid unnecessary tax burdens. For instance, Roth conversions during lower-income years can help reduce tax exposure in retirement.
2. Tax Diversification: Diversifying retirement accounts across taxable, tax-deferred, and tax-exempt accounts provides retirees with more flexibility in managing withdrawals to help minimize taxes.
3. Inflation and Tax Impact: Inflation not only affects the purchasing power of retirees but can also push individuals into higher tax brackets over time. A tax-efficient portfolio and withdrawal strategy can help address these concerns.
4. Estate Planning Updates: Regularly updating estate plans helps ensure that retirees take advantage of current tax laws to minimize their tax liability and maximize the legacy they leave for future generations.

Key Takeaways for Wealth Building Through Tax Planning

Effective tax planning isn’t about avoiding taxes altogether; rather, it’s about understanding how different tax laws and strategies can be used to build wealth. By organizing finances in a tax-efficient manner, high-net-worth individuals approaching retirement can help retain more of their earnings and help create a more sustainable financial future.

Tools to Remember: 

1. Tax-Efficient Investments: Prioritize investments that provide favorable tax treatments and utilize tax-loss harvesting when appropriate.
2. Withdrawal Strategies: Implement a withdrawal strategy that allows you to maintain flexibility and potentially reduce tax exposure.
3. Estate Planning: Take advantage of gifting, trusts, and other estate planning tools to reduce the impact of estate taxes on your legacy.

As high-net-worth individuals move closer to retirement, planning for taxes is essential to preserving wealth and helping ensure that assets are distributed in a way that aligns with personal goals. With strategic tax planning, retirees can make their money work harder, fostering a more financially secure and rewarding retirement.

For more insights on preparing for retirement and understanding how tax-efficient planning can help you retain and grow your wealth, connect with CKS Summit Group. Our team is experienced in retirement strategies designed to meet the unique needs of high-net-worth individuals, equipping you with the knowledge to make informed, tax-efficient decisions as you approach your golden years.

Reach out here to schedule a complimentary consultation.