Taxes

Bill Murray once said the best way to teach your kids about taxes is to eat 30% of their ice cream. Give it a try. When my daughter was young, she poured herself a glass of milk, and when she turned her back, I drank it all. She was not happy with me and still gets upset (but not really) talking about it today.

Lately, there’s a lot of talk about taxes, and not in a good way. President Biden is considering raising the capital gains tax rate to 43.4% from 20% for individuals who earn $1 million or more.[1]  His estate tax proposal would drop the exemption to $3.5 million from $11.7 million. If you’re worth more than $3.5 million, your estate could pay a 40% tax on every dollar above the threshold. Also, President Bident is talking about eliminating the cost basis step-up. Not to be left out, the corporate tax rate could rise to 28% from 21%. We’re moving on up.

Since 1913, the highest individual income tax bracket has ranged from a high of 94% to a low of 7%. The 108-year average has been 57.69%.

If you’re concerned about rising taxes, here are a few strategies to help you reduce the bite.

  • Buy stocks in your retirement accounts. When you realize a profit inside your IRA, you won’t pay a capital gains tax.
  • Open a Roth IRA. Roth contributions grow tax-free. Distributions are tax-free as well.
  • Contribute to a Roth 401(k). Consider changing your contributions from the traditional plan to the Roth, and they will grow tax-free.
  • Consider a Roth conversion. If you own a traditional IRA, consider moving it to a Roth IRA. You will pay income taxes when you convert, but it will occur at a lower rate if tax rates continue to increase.
  • If you’re a business owner, a doctor, a lawyer, an architect, or other professional services provider, open a cash balance plan for your company. A cash balance plan allows you to contribute significant amounts of money to your retirement plan, lower your taxable income, and increase your retirement savings. For example, if you’re 55 years old, you can contribute up to $230,000 to your plan in addition to your 401k, IRA, and profit-sharing contributions.[2] A cash balance plan is well suited for high-income earners.
  • Give your money away. The IRS allows you to give away $15,000 per person per year. An annual gift to loved ones can lower your taxable estate and give them a boost.
  • Donate to charities and non-profits. The government allows you to deduct up to 100% of your adjusted gross income through charitable cash donations.
  • Consider a donor-advised fund. If you own a stock with a low basis, transfer it to a donor-advised fund, sell it, and buy new securities. You will not pay taxes when you sell, and the charities you select will benefit from your donation. You can deduct your contribution from your taxes as a charitable gift.
  • Transfer your life insurance policies to an irrevocable life insurance trust. The trust will remove them from your taxable estate, but they will still benefit your loved ones. For example, if you own a $1 million life insurance policy in your name, the proceeds are added to your estate when you die, potentially increasing the taxes you owe. If the policy is inside the trust, it’s exempt from your estate assets.

So far, Biden’s proposals are just that, so don’t make any changes yet. You will have several chances to act if there is an increase in taxes, even if it’s retroactive to January 1, 2021.

For now, hold on to your wallet!

The only difference between death and taxes is that death doesn’t get worse every time Congress meets. ~ Will Rogers

April 26, 2021

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.


[1] https://www.wsj.com/articles/capital-gains-taxes-are-on-bidens-radar-as-he-seeks-money-for-social-programs-11619192256?mod=searchresults_pos5&page=1, Richard Rubin, 4/23/2020.

[2] https://assets.futureplan.com/futureplan-assets/FPCashBalance.pdf