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Year-End Tax Strategies for High-Income Earners

We’ve got one month left!  Let’s make sure you have the know-how to implement these year-end tax strategies made especially for high-income earners.  In this blog, we will discuss tax withholdings, maximizing tax-advantaged accounts, and charitable tax deductions.


Review Your Withholdings to Avoid Underpayment Penalty

We’ll need a couple of things for this.  Grab your 2020 tax return and your most recent pay stub.  Let’s start by reviewing 1040 on your 2020 tax return.  If your adjusted gross income (AGI) on line 11 is above $150,000, then you need to at least withhold 110% of your 2020 total tax obligation.  To be clear, I don’t mean the additional amount you had to fork over when you filed your taxes, rather the entire amount you owed in federal taxes for 2020.  Therefore, take 110% of your 2020 taxes owed and make sure to pay at least that amount.

-OR-

(Alert: this way is more complicated!) Pay 90% of the taxes due for this year.  In order to calculate that amount, you will need to know how much income you’re going to make in 2021.  That’s where your paystub comes in handy.  Review your year-to-date gross earnings.  Next, add in your projected gross earnings for the remaining weeks in the year (don’t forget about bonuses, restricted stock units, and other awards).  

Next, we need to start deducting from your pay.  This would include pre-tax 401(k) contributions, medical insurance, dental/vision insurance, and possibly more.  Your paystub may indicate which deductions are pre-tax.  Then you’ll have to run your income and deductions through a tax simulator (or manually calculate using this document) to understand what you will owe for 2021 taxes.  The point is, make sure you pay at least 90% of that figure!

Let’s sum this up: Make sure you pay 110% of last year’s tax obligation or pay 90% of this year's tax obligation.

NOTE: Your state may have different rules to follow.  The state of Minnesota follows the same rules as federal (110% of last year (if AGI over $150k) or 90% of this year).  The state of California also follows federal guidelines; however, if your AGI is above $1,000,000 you only have the option to pay 90% of this year’s tax liability to avoid a penalty.


Charitable Contributions to a Donor Advised Fund

Most taxpayers are allowed to get an above-the-line charitable deduction of $300 for single and $600 for married filing jointly regardless of whether you itemize (hence: above-the-line).  However, if this is a high-income year for you and you’re feeling charitably inclined, it may be worth establishing a Donor Advised Fund (DAF).  Here are some quick tips on the DAF:

  1. You can contribute cash, securities, cryptocurrency, or other assets into the fund;
  2. You will receive a current-year deduction for the value of the security;
  3. The investments can grow within the account tax-free;
  4. You can donate the investment/cash to a charity at any time, 
  5. NOTE: the deduction for the donation counts when the dollars hit the DAF, not when they go to the charity of choice;
  6. It is an irrevocable donation once the funds hit the account.


Retirement Plan Contributions

Solo 401(k)

This one is for our couplepreneurs and entrepreneurs.  A solo 401(k) is a great option to maximize retirement savings.  You likely can contribute significantly more to a solo 401(k) compared to an IRA or SEP IRA.  We go much deeper into each plan here.

401(k) / 403(b)

Maximize your 401(k) contribution in 2021 ($19,500 for those 49 and younger).  If your plan allows for it, consider making an after-tax contribution to the account.  The total amount of contributions into a 401(k) for 2021 is $58,000.  This includes your $19,500 contribution, your employer contribution, and your after-tax contributions.  Here’s an example:

Rachel makes $220,000.  Her employer has a 4% match.  She maximizes her $19,500 contribution and her plan allows for after-tax contributions.  Here’s what she can contribute:

  • $19,500 (Rachel’s pre-tax contribution)
  • $8,800 (Rachel’s employer contribution)
  • $29,700 (Rachel’s after-tax contribution)
  • Total = $58,000

Make sure to convert your after-tax contributions to the Roth 401(k) as soon as possible.  Most companies allow you to do it quarterly.  This way, the earnings have more time to grow tax-free.

457(b)

A 457(b) is typically offered through government and non-profit employers.  The big employer in our city, Mayo Clinic, offers a 457(b) to their high-income earners.  You can contribute another $19,500/yr in pretax dollars on top of the contribution you make into your 403(b).  Be mindful of the contribution windows and the rules around who can contribute and what your distribution schedule looks like.

Back-door Roth Contributions

If you’re a high-income earner, you likely can’t make a deductible IRA contribution or Roth IRA contribution.  However, you may still be able to contribute to a Roth IRA through the back-door method.  To do this, you have to establish an IRA.  Contribute to that account (make sure you don’t take a deduction for that contribution!!), then convert those dollars from the IRA to the Roth IRA.  

NOTE: If you already have IRA assets, you may be subject to the pro-rata rule.  This means part of your conversion into the Roth IRA could be taxable.  If that’s the case, you may want to think twice before completing the back-door Roth contribution.  


Health Savings and Flex Spending Accounts

More often than not we see these accounts underutilized.  Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs) are both tax savings vehicles.   Let’s set a few things straight:

Health Savings Accounts (HSA):

  • Cannot utilize this account in combination with the traditional FSA
  • Contribution = $3,600/individual ($7,200/family)
  • Tax-deductible contributions
  • Earnings grow tax-free (yes, you can [and likely should] invest your HSA dollars!)
  • No deadline to use money; let this baby grow!

Flexible Spending Accounts (FSA)

  • Cannot utilize this account in combination with the HSA
  • Contribution = $2,750/individual employee
  • Contributions are made with pre-tax dollars
  • You cannot invest the dollars
  • There is a deadline to use the money and a limit on how much you can rollover
  • Typically, by December 31st or a grace period is offered 1-3 months after that
  • The amount you can rollover typically varies between $0-500

Limited Purpose + Dependent Care Flexible Spending Accounts

  • Can be utilized with the HSA
  • Contribution = $2,750 (limited purpose) - $10,500 (2021 dependent care limit)
  • Contributions are made with pre-tax dollars
  • Distributions can be used for dental/vision/orthodontia expenses (limited purpose FSAs) or dependent care expenses (dependent care FSAs)
  • This helps you keep more dollars in your Health Savings Account!

Let’s put this all together. If you have access to a health savings account plus limited purpose FSAs, you could potentially sock away thousands of dollars.  Here’s an example of a couple on one medical plan, but separate dental/vision plans: 

  • $7,200 into HSA
  • $2,750 into one partner’s limited purpose FSA 
  • $2,750 into other pattern’s limited purpose FSA 
  • $10,500 into one dependent-care FSA

Total Contribution = $23,200 (that’s more savings than the pre-tax 401(k)!) 


Tax savings is an important part of strategic financial planning.  The more you make, the more important it becomes.  Not only is tax savings important, but savings, in general, is critical to make sure you set enough aside for retirement.  Suppose you make $320,000 and “just” set aside the maximum $19,500/yr into a 401(k).  That’s only a 6% savings rate. 

If you’re ready to take advantage of tax savings while maximizing your savings rate, contact us today.  We’ll help you evaluate your options and guide you in the right direction.

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Disclaimer: This article is for informational purposes only and is not a recommendation of Fyooz Financial Planning, Natalie Slagle CFP®, or Daniel Slagle CFP®. Past performance may not be indicative of future results and may have been impacted by events and economic conditions that will not prevail in the future. Therefore, it should not be assumed that future performance of any specific security, investment product or investment strategy referenced in the article, either directly or indirectly, will be profitable or equal to the corresponding indicated performance level(s). No portion of the article shall be construed as a solicitation to buy or sell any specific security or investment product or to engage in any particular investment or financial planning strategy. Any reference to a market index is included for illustrative purposes only, as it is not possible to directly invest in an index. Indices are unmanaged, hypothetical vehicles that serve as market indicators and do not account for the deduction of management fees or transaction costs generally associated with investable products, which otherwise have the effect of reducing the performance of an actual investment portfolio.

Natalie Slagle
Founder, Fyooz Financial
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