Top 10 Ways to Reduce Income Taxes through Investment Strategies

1)??????? Open a Solo 401k – for gig workers and other self-employed persons only.? Solo 401k plans offer most of the same benefits of a traditional employer-sponsored plan:? a $23,500 employee contribution limit in 2025, plus an employer limit of up to $46,600 plus additional catch-up contribution limits of $7,500 or $11,500 for older workers.? If you are self-employed, opening a Solo 401k is a no-brainer.

2)??????? Pre-tax IRA rollover to your Solo or employer 401k plan.? This is a precursor strategy for individuals with large tax-deferred IRAs to enable after-tax, back-door ROTH contributions.? Traditional ROTH conversions require account holders to pay tax on the pre-tax portion of IRAs (plus any appreciation) being converted.? But for tax purposes, IRAs and 401k plans are treated as separate pools, which allows for this strategy.? There is potential risk with this strategy, depending on the quality of your 401k.? For Solo 401k account holders, another no-brainer.

3)??????? Backdoor ROTH.? This would be number 1 on many advisors’ lists of tax minimization strategies, but the annual limit is capped at $7,000 (plus $1,000 catch-up for people over 50).? Before April, you can contribute for 2024 and 2025, and if you are married so can you spouse (regardless of whether s/he has employment income).? If you have not heard of a Backdoor ROTH, you need to read about this strategy. Backdoor ROTHs are a lay-up for most investors.

4)??????? ROTH conversion.? ROTH conversion (of a pre-tax IRA balance) involves accelerating current taxes to save on future taxes.? The gist of the strategy derives from the following fact:? investment returns in traditional IRAs are tax-deferred; investment returns in ROTH accounts are tax-free.? As such, high risk / high return assets should be maintained in your ROTH account to maximize future tax savings, even if you need to pay some current taxes now to get money into the ROTH.? I first wrote about the counterintuitive economics of ROTH conversion over a decade ago, when ROTH conversions were first allowed for high income participants. If you would like a copy of that article, let me know via direct message, our website contact form, or in the comments below.

5)??????? Taxable accounts.? Consider holding equities in a taxable account rather than a traditional IRA or 401k.? This is a recommendation that you will not get from most investment advisors.? Traditional retirement accounts---- IRAs, 401k and 403(b) accounts---offer the ability to contribute pre-tax funds (subject to certain limits) and earn tax-deferred returns.? Regular brokerage accounts are fully taxable, but equities (stocks) are intrinsically tax-deferred; investors do not pay tax on capital gains until a position is sold.? If a position is never sold, and the account holder dies, their heir(s) receive a step-up in basis to the current market value.? You might say “well if I cannot ever sell, and I do not get the step-up in basis until I am dead, what kind of a benefit is that?”?? But for an investor looking at equities as a store of wealth --- wealth that might never be spent during their lifetime --- equities in a taxable account are better than equities in a tax-deferred retirement account.

6)??????? Tax loss harvesting.? Tax loss harvesting has become more difficult in a world where many investors hold just a handful of funds in their investment portfolio, while expecting all the funds to appreciate over time.? But most investors add to their investments over time, and the vicissitudes of the market will usually cause some investments to experience declines in value.? Tax loss harvesting is the process through which such positions are sold, realizing a capital loss.? Investors are permitted to deduct up to $3,000 of such realized losses against ordinary income, and an unlimited amount of realized capital losses against realized capital gains.? With the broad range of low cost, factor based mutual funds and ETFs available to investors, and the massive reduction in transaction costs over the past 20 years, it is generally quite simple for investors to find a suitable proxy for whatever investment is sold for tax loss harvesting purposes.? Separately managed account managers go a step further, promoting tax loss harvesting as a distinct source of alpha:? sell the losers, keep the winners, rebalance risk, rinse and repeat.? There are limits to the efficacy of this strategy, and transaction costs and fees must be carefully considered, but all investors with taxable accounts should be on the lookout for tax loss harvesting opportunities.

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7)??????? Donor Advised Fund.? DAFs offer a highly flexible and tax-efficient way of managing charitable giving.? If you do not make gifts to charity, skip to the next item.? But if you belong to the 85% of affluent American households who make charitable gifts, a DAF can help you save on taxes to make your giving more impactful.? DAFs are themselves qualified charitable organizations, so your contribution to a DAF is tax-deductible at the time of the gift.? This allows you to time your donation while retaining the ability to ultimately direct the funds to qualified charities of your choosing, over a future time frame also determined by you.? If the assets grow after they are in the DAF, you will have more funds to support your charitable causes.?? If the investments decline in value, you will have less money to direct out, but you still will have locked in the value of your donation.? The bigger tax benefit comes from being able to easily transfer appreciated assets to the DAF.? Let’s say you have $25,000 of a stock with an original cost basis of $2,000.? If you were to sell the stock, pay tax, and donate the net proceeds, you could pay up to $9,200 in taxes and you would receive a reduced tax deduction for your net gift of as little as $15,800.? By making an in-kind donation of $25,000 of appreciated stock to the DAF, you pay no tax and receive the full market value of your in-kind donation as a tax deduction.? The ability to accept in-kind donations is not unique to DAFs; many qualified charities will accept transfers of appreciated assets.? However, it is far easier to bifurcate your tax decision (how much, what to transfer, and when to transfer) from your disbursement decisions (which charity should receive what, and over what time frame).

8)??????? 529 Plan.? 529 Plans are well-known as a tax-efficient savings vehicle for college savings and even for private elementary and secondary schools.? However, you may not be aware that you can open a 529 Plan in your own name, even if you have graduated from college, to fund potential post-graduate education.? If you do not end up pursuing grad school and do need the funds, they can be redesignated for the qualified education expenses of a relative or you can now roll over the balance of a long-held 529 Plan account to a ROTH retirement account, subject to certain requirements and limits spelled out by the Internal Revenue Service.? The aggregate lifetime rollover limit is $35,000, and the annual rollover limit is currently equal to the ROTH contribution limit.

9)??????? RYO Qualified Opportunity Fund (RYO QOF).? You may have heard of Opportunity Zones and Qualified Opportunity Funds, but you probably have not heard of a RYO QOF, an acronym I came up with earlier today.? It stands for Roll Your Own Qualified Opportunity Fund.? The rules surrounding QOFs are complex and difficult to understand, so this strategy is not for the faint of heart.? There also are significant transactions costs – legal, accounting, administrative – that make this strategy unsuitable unless you have (1) significant realized capital gains; (2) an appetite for investment risk; (3) a plan or a desire to invest in private assets:? real estate, a new business, or other qualifying property.? There are many managed qualified opportunity funds, including some public funds, that offer the tax benefits of QOFs for passive investors, but the fees tend to be high, liquidity is poor, and investors sacrifice control. ?For many investors, these negative attributes are too much to swallow. ?A Roll Your Own Qualified Opportunity Fund is a self-directed structure that leaves control with the investor:? you choose the investment, the amount, and the type of investment, and we help design a structure that qualifies the investment as a Qualified Opportunity Fund.

10)? Cash Balance Plan.? A cash balance plan is an exceptional tax planning tool for high income, self-employed individuals.? A small subset of investors fall into this category, and the complexity of CBPs is relatively high.? But if you are an individual who earns $500,000 or more per annum as a self-employed individual, you should learn about Cash Balance Plans.? High-income earners can potentially save hundreds of thousands of dollars in taxes through a well-designed Cash Balance Plan.

Note:? The information contained in this post is for educational purposes only and is not an investment recommendation or investment or tax advice, and it should not be relied upon.? There may be other, more suitable strategies that are not discussed in this post.? The needs, goals, income, expenses, and tax status of investors vary widely and will affect the applicability and suitability of the “Top 10” ideas referenced herein.? Consult with your tax expert and/or financial advisor before making any investment or account decisions.? Do not rely upon LinkedIn posts for advice.? That would be stupid, because you do not even know whether this post was written by an AI agent.? But in case you are wondering, it was not. ?Not one word of it.?

Contact Jim Dowd at [email protected], via our website contact form, or at 415 315 9916 to learn more about these strategies or to develop a customized tax mitigation plan.

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