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It is peak tax season and high earning executives typically find themselves in the highest tax brackets paying 35%+ in Federal Income taxes plus any state taxes. Fortunately, there are several options available to high earning W-2 employees to defer taxable income during the years of higher tax rates.
In this quick case study, we will review how a high earning executive can reduce their annual tax bill by $100K using tax efficient tactics available to most executives.
Disclaimer: The purpose of the exercise is to illustrate the various tax efficient tactics available to high earning corporate professionals. Of course, this case study is for illustrative and educational purposes only. For individual guidance seek advice from a tax or financial professional.
How Alicia, a Walmart VP, Cut Taxes by $100K
Alicia is Vice President of International Finance at Walmart. She lives in Bentonville, earns $650,000/year and is married to a professor at the University of Arkansas. The couple is in the 37% marginal tax bracket at the Federal level and is also subject to Arkansas State Tax, Net Investment Income Tax and the Additional Medicare Tax - all of which can be comparatively reduced in retirement.
Alicia's goal is to defer as much taxable income as possible to the future when she plans to be in a lower tax bracket. The below chart illustrates how Alicia can reduce her current year tax bill by $100,000.
Assumptions: 37% Ordinary Tax Rate I 23.8% Long-Term Capital Gain Tax Rate I Bond Yield 5% I $1.5M Investable Assets with 50% in Brokerage/50% in Tax Deferred account I Asset Mix is 50% Equity / 50% Bonds I Portfolio Turnover is 20% I Average Cost Basis is 70% I State Tax, NIIT and Payroll Taxes not accounted for.
It is important to note that these taxes are mostly deferred. She will pay taxes on this income eventually - excluding the HSA and DAF contributions. For high earning professionals that are likely paying the highest tax rates of their lifetime, deferring taxes can generate significant wealth in two ways:
Tax Arbitrage: Deferring income taxes while you are in a high tax bracket in exchange for paying taxes at a lower tax rate in the future.
Interest Free Loan: While you have a tax liability embedded in your tax deferred accounts, you are able to invest and earn a return on those funds, possibly for decades.
A tax efficient strategy enables you to invest more for longer which is the recipe for wealth accumulation.
If you are interested in learning more about these concepts, here are few resources:
Thanks for reading,
Mark Chisenhall, CFA, MBA
Taurus Financial Planning
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