Tax-efficient investing strategies for high-income earners

Why taxes are the silent drain on investment returns

High-income earners often focus on market volatility or investment fees, but taxes may be one of the largest costs in an investment portfolio. In taxable accounts, certain investment distributions may generate current-year tax liabilities, which can reduce after-tax returns and affect long-term wealth accumulation.

Even a small improvement in annual after-tax returns can compound into a significant difference in net worth over decades.

Tax efficiency is not about complicated tax avoidance or searching for loopholes. Instead, it’s about making informed investment decisions that allow more of your money to stay invested and continue compounding.

Asset location: Putting the right investments in the right accounts

Improving the tax efficiency of your investments is not just about what you own, but where you hold it. This is called asset location—placing investments in the types of accounts where they may receive the most favorable tax treatment. By aligning investments with the appropriate account type, you may be able to improve tax efficiency without changing your overall investment mix. Most accounts fall into three buckets: taxable accounts, such as standard brokerage accounts; retirement accounts that can grow tax-deferred , such as traditional 401(k)s or IRAs; and retirement accounts that can generate tax-free income, such as Roth IRAs. 

While every investor’s situation is different, a few general guidelines can help determine which investments might generally be best suited for each type of account:

• Tax-inefficient assets belong in tax-deferred accounts: Investments that generate frequent taxable distributions, such as corporate bonds, real estate investment trusts (REITs), and actively managed mutual funds, can create ordinary income, meaning income taxed at regular income tax rates, or short-term capital gains. Holding these investments in a traditional 401(k) or IRA can defer those annual taxes until retirement withdrawals.
• Tax-efficient assets belong in taxable accounts: Some investments, such as broad-market index funds, exchange-traded funds (ETFs), and long-term growth stocks, tend to create fewer taxable events because they trade less often. That can make them a good fit for taxable brokerage accounts.

• High-growth assets belong in Roth accounts: Roth accounts may be a good fit for investments with strong long-term growth potential because qualified withdrawals are tax-free.

Tax-loss harvesting: Turning losses into planning opportunities

Even with investments in the right accounts, market fluctuations can create additional planning opportunities. For high-income earners with taxable brokerage accounts, tax-loss harvesting can turn temporary market losses into planning opportunities.

The strategy involves selling an investment that has declined in value and using the loss to offset capital gains from other investments. If losses exceed gains for the year, IRS rules generally allow you to use up to $3,000 of excess losses to offset other taxable income, while any remaining losses can be carried forward to future years.

This strategy must follow the wash-sale rule, which generally prevents you from claiming a tax loss if you buy the same or a substantially identical investment within 30 days before or after the sale. To maintain market exposure, the proceeds are typically reinvested in a similar, but not identical, security. Because tax-loss harvesting can affect your overall tax situation, it’s generally most effective when used as part of a broader investment and tax planning strategy rather than a standalone move.

Maximizing tax-advantaged accounts

High-income professionals and dual-income households may assume they are locked out of certain tax-advantaged planning opportunities, yet many still have access to a range of tax-advantaged accounts that can strengthen their overall financial plan.

• Employer-sponsored plans: Maximizing traditional 401(k) or 403(b) contributions may help lower current taxable income while allowing investments to grow tax-deferred, depending on your individual tax situation.
• Health savings accounts (HSAs): For those in high-deductible health plans, HSAs offer tax-deductible contributions, tax-deferred growth, and tax-free withdrawals for qualified medical expenses.
• Deferred compensation plans: Some executives can defer salary or bonuses into future years, which may provide additional planning flexibility depending on when that income is recognized.

Roth strategies for high-income earners

Contributions to Roth IRA Accounts are with after-tax dollars. These retirement accounts can provide tax-free growth…may need another plan.

A backdoor Roth IRA uses a nondeductible traditional IRA contribution followed by a Roth conversion. However, existing IRA balances and other tax considerations can affect whether this approach is appropriate.

A Roth conversion can also move tax-deferred retirement savings into a Roth IRA, with income tax due in the year of conversion. It may be appropriate during lower-income years, such as a career transition, sabbatical, or early retirement before required minimum distributions (RMDs) begin, but the decision should be evaluated within the context of your overall financial and tax plan.

Insurance as a tax-advantaged investment tool

Insurance can also play a role in tax-efficient investing as part of a broader wealth strategy. Permanent life insurance, such as whole life I, can complement retirement accounts that have annual contribution caps, income limits, or RMDs. It also offers several distinct tax advantages:

• Tax-deferred cash value growth: Cash value accumulates tax-deferred within the policy.
• Tax-free access to capital: Policy loans may provide access to cash value without triggering a current tax event.
• Tax-free wealth transfer: The death benefit generally passes to beneficiaries free of income tax.

For high earners who have already maximized workplace plans and other tax-advantaged vehicles, permanent life insurance can serve as an additional source of tax-advantaged accumulation while continuing to provide valuable protection. Whether it fits within your financial strategy depends on your goals, how long you plan to keep the policy, and the role you want it to play in your broader wealth plan.

Charitable giving as a tax strategy

For high-income earners with philanthropic goals, strategic charitable giving can support charitable objectives while also creating tax advantages.

A donor-advised fund (DAF) allows you to make a charitable contribution in a high-income year, claim an immediate tax deduction, and recommend grants to charities over time. Funding a DAF with appreciated securities can also help manage capital gains exposure on appreciated assets.

A qualified charitable distribution (QCD) allows eligible IRA owners to direct funds from an IRA to charity, satisfy RMD rules, and exclude the amount from taxable income. Those with more complex estate planning needs may also consider charitable remainder trusts.

When to work with a financial advisor, CPA, and attorney

Managing wealth at higher income levels often requires guidance from multiple professionals, each with a distinct area of expertise:

1. The certified public accountant (CPA) prepares tax returns, estimates tax payments, and helps keep your tax planning on track.
2. The estate planning attorney drafts trusts, wills, and other legal structures that support wealth preservation and the transfer of assets.
3. The financial advisor brings investment, protection, and tax planning together to support your broader financial goals.

When these professionals work together, each decision can support a more cohesive financial strategy rather than being made in isolation. This coordinated approach can help align investment decisions with your tax and estate planning objectives as your goals evolve.

Tax-efficient investing strategies for high-income earners FAQs