For high-net-worth investors, wealth preservation and growth are key priorities, but minimizing tax liabilities on investment gains is just as critical. With the right strategies, investors can help reduce their tax burden and maximize after-tax return potential. Here are 10 essential tactics to consider.
1. Leverage tax-advantaged accounts
One of the easiest ways to help minimize investment taxes is by utilizing tax-advantaged accounts. These accounts allow investors to either defer taxes or avoid them altogether, depending on the type of account used:
- Traditional IRAs and 401(k)s: Contributions to these accounts are tax-deductible, reducing taxable income in the current year. The investments grow tax-deferred until withdrawals begin in retirement, ideally at a lower tax rate.
- Roth IRAs and Roth 401(k)s: While contributions are made with after-tax dollars, qualified withdrawals in retirement are free from tax. High-net-worth investors should consider Roth conversions during years with lower taxable income.
- Health savings accounts (HSAs): HSAs offer triple tax benefits — contributions are tax-deductible, earnings grow tax-free, and withdrawals for qualified medical expenses are exempt from tax as well.
- 529 plans: These accounts provide tax-free growth and withdrawals for qualified educational expenses, making them a valuable tool for wealth transfer and education planning.
2. Utilize long-term capital gains rates
Our tax code incentivizes long-term investing by offering preferential tax rates on capital gains for investments held for more than one year. Long-term capital gains are taxed on the federal level at rates of 0%, 15%, or 20%, depending on taxable income, whereas short-term gains are taxed as ordinary income, potentially at rates as high as 37%.1
To maximize tax efficiency:
- Hold investments beyond a year to take advantage of lower capital gains rates.
- Rebalancing with tax in mind to avoid unnecessary taxable events.
- Deferring capital gains to years with lower taxable income.
- Potential for gains in years with significant deductions or lower tax rates.
3. Implement tax-loss harvesting
Tax-loss harvesting is a powerful strategy where investors sell losing investments to offset capital gains and reduce overall tax liability. The losses can be used to:
- Offset capital gains on other investments.
- Offset up to $3,000 in ordinary income annually.
- Carry forward unused losses indefinitely to reduce future taxable gains.
Pay close attention to the wash-sale rule, which prohibits repurchasing the same or substantially identical security within 30 days before or after the sale of the original security.
| Pro Tip
The wash-sale rule is an IRS regulation designed to prevent investors from claiming a tax deduction for a loss on a security if they repurchase the same or substantially identical security within 30 days before or after the sale. For example, if an investor sells a stock at a loss and then repurchases the same stock shortly thereafter, the IRS considers this a wash sale and disallows the tax deduction for that loss. Instead, the disallowed loss is added to the cost basis of the newly acquired security, which may impact future tax calculations when those shares are eventually sold. This rule applies to stocks, options, mutual funds, and EFTs and is intended to prevent investors from selling securities solely for tax benefits while maintaining their overall investment position. Investors should be mindful of this rule when executing trades, particularly during periods of tax-loss harvesting. |
4. Consider municipal bonds for tax-free income
Municipal bonds, issued by state and local governments, offer tax-exempt interest at the federal level and potentially at the state and local levels. These bonds may be attractive to high-income investors because they provide:
- Tax-free income, which is especially valuable in high-tax states.
- Lower risk compared to corporate bonds, particularly when investing in high-quality municipal bonds.
- Alternative fixed-income options that can be structured in portfolios to optimize risk-adjusted returns.
5. Invest through tax-efficient funds
Actively managed mutual funds often generate significant taxable distributions due to frequent trading, while tax-efficient investment vehicles reduce annual taxable events. Consider these alternatives to reduce tax exposure:
- Exchange-traded funds (ETFs): Due to their unique structure, ETFs generally have lower turnover and fewer taxable capital gains distributions compared to mutual funds.
- Index funds: These funds passively track an index, leading to lower turnover and fewer taxable events.
- Tax-managed funds: Designed specifically for tax-sensitive investors, these funds use strategies like tax-loss harvesting and deferring gains.
6. Use charitable giving strategies
For high-net-worth investors with philanthropic goals, charitable giving provides a dual benefit – supporting causes they care about while also reducing tax liabilities. It’s important to note that although charitable giving can reduce tax liability, it does not put the investor in a better financial situation. Effective charitable strategies include:
- Donor-advised funds (DAFs): These allow investors to donate appreciated assets, receive an immediate tax deduction, and distribute funds to charities over time.
- Qualified Charitable Distributions (QCDs): IRA owners aged 70 ½ or older can donate up to $108,000 annually directly from their IRA to a charity, satisfying Required Minimum Distributions (RMDs) without increasing taxable income.
- Bunching charitable deductions: A charitably inclined investor who regularly takes the standard deduction on their tax return may consider consolidating their charitable contributions for future years and making the donation in a single year to receive a larger deduction. The investor can then refrain from making charitable donations in subsequent years and still take the standard deduction as they normally would.
7. Estate planning for income taxes
When it comes to taxes, estate planning is primarily utilized to mitigate estate, gift, and generation-skipping transfer taxes. However, some strategies can address income as well. Charitable remainder trusts and upstream gifting are advanced estate planning strategies that allow investors to mitigate capital gains tax.
- Charitable remainder trust: An irrevocable trust that allows donors to make a tax-deductible gift to charity while also receiving income for themselves, with the remaining assets ultimately going to the charity. The technique provides a reliable income stream, reduces tax burden through a charitable deduction, and defers capital gains tax. Assets that grow in the trust remain tax-exempt.
- Upstream gifting: a tax strategy where assets are gifted to older family members, like parents, with the expectation that those assets will eventually be passed back to the original donor after the older family member’s death. Upon the death of the older generation, the assets are inherited by the original owner, and the cost basis of the assets is “stepped up” to the fair market value at the date of death. In other words, capital gains may be subject to different tax rates, which could potentially affect your tax liability.
8. Take advantage of opportunity zones
The Qualified Opportunity Zone (QOZ) program allows investors to defer or eliminate capital gains taxes when investing in designated economically distressed areas. Key benefits include:
- Deferral of capital gains taxes until 2026 if invested in a QOZ fund.
- Reduction in taxable gains if held for five or seven years.
- Potential elimination of capital gains on new appreciation if held for ten years or more.
| Pro Tip
An Opportunity Zone is a designated economically distressed area where investors can receive tax benefits for investing in real estate or businesses. These zones were created as part of the 2017 Tax Cuts and Jobs Act to encourage long-term investments in underdeveloped communities. Investors who put capital gains into a Qualified Opportunity Fund (QOF) — which invests in businesses or real estate in an Opportunity Zone — can defer or even reduce their capital gains taxes. If they hold the investment for at least 10 years, they may eliminate capital gains taxes on any appreciation of the investment. The goal of Opportunity Zones is to stimulate economic growth and job creation in struggling areas while providing tax incentives to investors willing to commit long-term capital. |
9. Invest in real estate for potential tax benefits
Real estate can provide significant tax advantages for high-net-worth investors, including:
- Depreciation deductions: Investors can deduct depreciation expenses to reduce taxable rental income.
- 1031 exchanges: This strategy allows investors to defer capital gains taxes by reinvesting proceeds from a sold property into another like-kind property.
- Pass-through deductions: Under the Tax Cuts and Jobs Act, investors in certain real estate businesses may qualify for a 20% deduction on qualified business income.
- REIT investments: Real Estate Investment Trusts (REITs) provide indirect real estate exposure with potential tax advantages, such as dividends taxed at favorable rates.
10. Work with a tax and investment professional
Given the complexity of tax laws, high-net-worth investors should regularly consult tax and financial advisors to stay updated on tax-saving opportunities and regulatory changes. A proactive approach helps ensure compliance while optimizing long-term wealth preservation.
By implementing these strategies, investors can effectively minimize taxes on investment gains, helping them to retain more wealth for future growth potential, legacy planning, and charitable giving.
For more information, contact your wealth advisor. If you’re not a Mercer Advisors client and want to learn more, let’s talk.
1 “2024 and 2025 capital gains tax rates. Fidelity, Dec. 23, 2024.
Mercer Advisors Inc. is a parent company of Mercer Global Advisors Inc. and is not involved with investment services. Mercer Global Advisors Inc. (“Mercer Advisors”) is registered as an investment advisor with the SEC. The firm only transacts business in states where it is properly registered or is excluded or exempted from registration requirements.
All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. Some of the research and ratings shown in this presentation come from third parties that are not affiliated with Mercer Advisors. The information is believed to be accurate but is not guaranteed or warranted by Mercer Advisors. Content, research, tools and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. All investment strategies have the potential for profit or loss. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio. For financial planning advice specific to your circumstances, talk to a qualified professional at Mercer Advisors.
