Tax Guide: Strategies of High-Income and High-Net-Worth Inviduals

Strategies for high-income and high-net-worth individuals

See our newest planning guide, with tips and strategies for 1998!

Wealthy individuals
can take steps
to defer taxes.

Contribute directors' fees to retirement accounts. Compensation for serving on a company's board of directors, even to the extent you are also an employee of the company (if the compensation is sufficiently segregated from your wage income), may enable you to make a contribution to a tax-deferred self-employed retirement account and receive a current income tax deduction for the amount contributed.

Make gifts to grandchildren or children to encourage contributions to individual retirement accounts (IRAs). Children and grandchildren with earned income can contribute up to $2,000 (and an additional $2,000 for a spouse) annually to a tax-deferred IRA. To encourage the child or grandchild to make the maximum contribution to a tax-deferred IRA, you may make a gift to the child or grandchild that is at least equal to the after-tax cost of the IRA contribution. (See Chapter 8.)

Make pretax gifts to low-income parents and grandparents. Individuals in a 40% income tax bracket need income in excess of $16,600 to make a $10,000 gift to their parents or grandparents. If income could be shifted to the relative in need (for example, through the use of a trust), significantly less income would be required to fund the $10,000 gift after taxes. The ultimate savings will depend upon the relative's current income tax picture (including such factors as the relative's income tax bracket and whether deductions and exemptions are being wasted).

Contribute to flexible spending accounts. If your employer allows you to contribute pretax earnings to fund accounts for medical and child care expenses, you can obtain significant tax savings by contributing the projected annual out-of-pocket expenses (after insurance). Although you will lose whatever is not expended during the year (which should not occur if you are monitoring how much is available to you), it is generally still advantageous to make the contributions after considering the income tax savings.

Select the right beneficiaries for qualified retirement plans. You can maximize the time over which your retirement plan distributions are paid (which results in more time for tax-deferred growth) by selecting the right beneficiaries for your retirement accounts. Consult with a specialist in this area who can assist you in selecting the proper persons to designate as your primary and secondary beneficiaries and in understanding how the distribution amounts are calculated. (See Chapter 6.)

Weigh the tax effects of withdrawing retirement funds early. Large retirement account balances may be subject to income, excise, and estate taxes, which could significantly reduce the balance remaining for heirs. Review whether it would be more advantageous to withdraw additional funds currently and benefit your heirs more in the long run through the use of gifts. (See Chapter 6 and Chapter 8.)

Use gift tax exclusions, including paying certain medical and educational expenses. Each year, a donor may give $10,000 ($20,000 if a spouse joins in the gift) per-donee without paying federal gift tax. In addition, a donor can pay certain medical and educational expenses of the donee without any gift tax liability. Using these "exclusions from gift tax" to the maximum extent annually continues to be a good estate planning strategy. (See Chapter 8.)

Use all or part of the unified credit for federal estate and gift taxes. Each individual can transfer, either during life or upon death, $600,000 ($1.2 million if the spouse joins in the gift) free of federal estate and gift taxes. If you can afford to use this exemption during life, you should consider doing so as early as possible. This strategy can save estate taxes on the appreciation on the gifted assets at rates up to 55%.

Use all or part of the federal generation-skipping exemption. Each individual can transfer, either during life or upon death, $1 million ($2 million if the spouse joins in the gift) free of the 55% federal generation-skipping transfer (GST) tax. If you want to maximize the amount of wealth you transfer to future generations, you should consider using this exemption (and possibly leveraging this exemption through the use of life insurance) as early as you can afford to do so. With proper planning, millions of additional dollars can be made available for future generations. You may have to file gift tax returns to allocate part of the GST exemption, even if the gifts you make fall under the annual exclusion. (See item 7 above and Chapter 8).

Make taxable gifts to pay less in taxes. Although the federal estate and gift tax rates are based on the same tax rate schedule, the computation of the tax liability is very different. The federal gift tax is computed using the net amount gifted to the donee, while the federal estate tax is computed using the gross amount. For example, assume a donor with a 50% federal estate and gift tax rate has $1.5 million. The donor could make a gift of $1 million (and pay $500,000 in federal gift tax). If the donor dies with the $1.5 million, only $750,000 would be available for heirs after paying the $750,000 federal estate tax.

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