As we step into 2025, high-income earners face unique challenges and opportunities when it comes to tax planning. With potential changes in tax laws on the horizon, it’s crucial to explore advanced strategies to maximize savings and minimize liabilities. Here, we delve into sophisticated tax-saving opportunities, including Roth conversions, donor-advised funds, super fund variable universal life insurance policies, and qualified opportunity zones. It’s important to note that these strategies also have potential risks are not suitable for all investors. We encourage our clients or potential clients to contact our team if you have any questions.
Roth Conversions
A Roth conversion involves transferring funds from a traditional IRA or 401(k) into a Roth IRA. This strategy can be particularly advantageous in 2025 due to the anticipated expiration of the Tax Cuts and Jobs Act (TCJA) at the end of the year. By converting now, you can lock in the current lower tax rates before they potentially increase in 2026
Benefits of Roth Conversions:
- Tax-Free Growth: Once the funds are in a Roth IRA, they grow tax-free, and qualified withdrawals are also tax-free.
- No Required Minimum Distributions (RMDs): Unlike traditional IRAs, Roth IRAs do not require RMDs, allowing your investments to grow longer.
- Estate Planning: Roth IRAs can be powerful estate-planning tools, as they can be passed on to heirs tax-free.
Donor-Advised Funds
Donor-advised funds (DAFs) are a key way for high-income earners to manage their charitable giving while receiving immediate tax benefits. By contributing to a DAF, you can take an immediate tax deduction and then distribute the funds to charities over time.
Advantages of Donor-Advised Funds:
- Immediate Tax Deduction: You receive a tax deduction in the year you contribute to the DAF, even if you distribute the funds to charities in future years.
- Tax-Free Growth: The funds in the DAF can be invested and grow tax-free, increasing the amount available for charitable giving.
- Flexibility: DAFs offer flexibility in timing and choosing which charities to support, allowing for strategic philanthropic planning.
However, there are some drawbacks to donor-advised funds. Once a donation is made, it cannot be retracted and administrative fees can reduce the amount available for grants. Additionally, donors can potentially have limited control over the fund’s investments.
Variable Universal Life Insurance Policies
Variable universal life (VUL) insurance policies offer both a death benefit and an investment component, making them a versatile tool for high-income earners.
Key Benefits of VUL Policies:
- Tax-Deferred Growth: The cash value grows tax-deferred, and you can access the funds through tax-free loans or withdrawals.
- Flexible Premiums and Death Benefits: VUL policies offer flexibility in premium payments and death benefits, allowing you to adjust the policy as your financial needs change.
- Estate Planning: VUL policies can be used to provide liquidity for estate taxes or to leave a legacy for heirs.
Qualified Opportunity Zones
Qualified Opportunity Zones (QOZs) were created to spur economic development in distressed areas by offering tax incentives to investors. By investing in a Qualified Opportunity Fund (QOF), you can defer and potentially reduce capital gains taxes.
Benefits of Investing in QOZs:
- Tax Deferral: Capital gains invested in a QOF can be deferred until the investment is sold or until December 31, 2026, whichever comes first.
- Tax Reduction: If the investment is held for at least five years, you can reduce the deferred gain by 10%. If held for seven years, the reduction increases to 15%.
- Tax-Free Appreciation: Gains on investments held in a QOF for at least ten years are tax-free.
Although there are many advantages to having a QOZ, there can be certain disadvantages if not set up properly or if the fund isn’t a fit for you. Investors in QOFs must adhere to a 10-year holding period for their investments. QOZ investments offer some great tax benefits, but those advantages must be balanced against the potential negatives. Since these tax benefits are years into the future, the biggest risk is the unknown. Because capital is dedicated to the QOZ fund during this time, investors must consider opportunity costs with both potential current investment opportunities and those that might arise while capital is locked up in the QOZ fund. Failure to comply with these timeframes could lead to a reduction or elimination of potential tax benefits.
High-income earners have several advanced strategies at their disposal to optimize their tax situation in 2025. By leveraging Roth conversions, donor-advised funds, super fund variable universal life insurance policies, and qualified opportunity zones, you can potentially enhance your financial planning and achieve possible tax savings.
Some donor-advised funds are considered mutual funds and are sold only by prospectus. The prospectus will provide information on charges, risks, expenses, and investment objectives and should be reviewed carefully before investing. Investment companies can provide a prospectus, or you may prefer to ask your financial professional. Please read it carefully before you invest or send money.
Variable Universal Life Insurance Policies: Investing in such products involves substantial charges and or tax penalties for early withdrawal. Any guarantees depend on the claims-paying ability of the issuing insurance company.
Avantax does not provide tax/accounting services; these services are provided by Wymer Brownlee and outside businesses.
Andrew Barnes, Wealth Advisor & Shareholder
Category: Financial Service Team
