Advising High Net Worth Clients

What Does “High Net Worth” Really Mean?

Do you have many—or any—high net worth clients? Is the term “high net worth” disconcerting to you? You may even have high net worth clients whom you do not think of as being high net worth. In this day and age of retirement plans, life insurance, expensive housing, cryptocurrency, and alternative investments, becoming a high net worth person is easier to do than ever before.

What do we mean by “high net worth” individual? The most common definition is someone who has at least $1,000,000 in financial assets, excluding their primary residence. How hard is that to achieve? What about a $200,000 second home, $300,000 in a retirement plan, $500,000 in insurance coverage, and several thousand in emergency savings or taxable investment accounts? Wow! Maybe most of my clients are high net worth individuals.

I am reminded of the days (1990s) when working in estate tax planning, we often talked about how easy it was to accumulate $600,000 in total assets: $300,000 home (primary residence in this case), $150,000 in retirement savings and $250,000 in life insurance. With the estate tax exemption today approaching $15,000,000, $600,000 or $1,000,000 has become a relic of the past.

Just to confound matters, the terms very high net worth individual and ultra-high net worth individual have been added to the mix. Very high net worth is now commonly defined as $5,000,000 or more net worth. Ultra-high net worth is defined as at least $30,000,000 in investible assets.

Now, how many ultra-high net worth clients do you have? Maybe none. How many very high net worth clients do you have? Probably a few. How many high net worth clients do you have? Perhaps a majority of your practice.

You may not think of your doctor client as being high net worth, because she only has a couple of thousand dollars of passive income, but how much has she been able to stash away in a retirement plan? Does she own a beach house? How much life insurance does she have in place? My goodness — is a client with only a W-2 and some 1099s a high net worth client? You betcha.

Tax Planning Opportunities Abound

Do your high net worth clients deserve your best tax planning advice and are they willing to pay for it? You can bring their financial situation to their attention and let them know there are tax-saving devices they can take advantage of. This will get the attention of most clients, who may not even think of themselves as being high net worth.

What are some of the strategic tax planning techniques in our arsenal?

Many clients will benefit from maximizing contributions to retirement plans – profit-sharing plans, 401(k), IRA, and defined benefit plans. I had a client who did not want to have a profit-sharing plan, because he felt he was giving away money to his employees that they did not deserve. It turned out that about 85% of the contributions benefited himself and family members who worked in the business. The tax savings alone covered the cost of making the contribution to the profit-sharing plan for non-family members. Who knew?

Let’s not forget that older (over 50) clients have the ability to make catch-up contributions. Given a choice between making additional 401(k) contributions of $7,500 ($11,250 for age 60 to 63) and buying a boat, what would your client choose? Heck, you can rent a boat when you want to go sailing. The two happiest days in a boat-owner’s life are the day they buy their boat and the day they sell their boat. Even the $1,000 catch-up contribution to an IRA with compounding can be very worthwhile.

Roth IRAs do not save taxes today, but they grow tax-free and can make tax-free distributions during retirement. I am a big fan of Roth IRAs if my client can qualify under the MAGI limitation. Also, you can make contributions to Roth IRAs at any age, so you do not have to stop at age 70½.

Tax rates and IRAs: is your client going to be in a lower tax bracket during retirement or not? If there will be a substantial reduction in tax rates upon retirement, a traditional IRA is probably the better choice. If the tax rate is likely to be about the same or higher, then a Roth IRA is definitely better.

Consider converting a traditional IRA to a Roth IRA. If your client can stand the tax hit from paying tax on the distribution from a traditional IRA and is in good health and likely to live a good while longer, converting a traditional IRA to a Roth IRA is an excellent idea. The continued tax-free buildup in the Roth IRA and nontaxable distributions will make up for the tax hit in a fairly short period of time. In addition, your client can roll over their 401(k) or profit-sharing plan to their traditional IRA and then make the conversion to a Roth IRA. Finally, you do not have to convert an entire traditional IRA to a Roth IRA at once. You can bleed out the traditional IRA over a period of years to maximize the benefit of lower tax brackets if your client is not in the highest tax bracket.

Staying with qualified plans, recommend Health Savings Accounts. HSA contributions are tax deductible, the earnings grow tax-free, and withdrawals for medical expenses are tax free as well. The only ‘drawback’ is that you have to reduce your medical expense itemized deduction by the amount of medical expenses paid with HSA funds. One practice I found helpful is to accumulate a record of your medical expenses during the year, then take a one-time distribution at the end of the year, equal to the amount of medical expenses. You can use the funds as a reserve to pay for the following year’s medical expenses. Rinse and repeat.

Giving and Advanced Considerations

With the standard deduction for couples at $31,500, and $15,750 for singles, many former itemizers are now just using the standard deduction. In fact, if the amount of potential deductions is close to the standard amount, some folks will forgo the itemized deduction, which in their mind saves work and reduces potential for IRS audits. I prefer not to pay a penny more in tax than is legally required, but you have to listen to your client’s desires.

While we are on the subject of itemized deductions, one area that holds a great deal of potential for tax planning is charitable deductions. Your client can control timing and amounts of charitable contributions for the best benefit. For example, if your client makes annual contributions in January and December of the same year, they can double up their deductions. Effectively, they can satisfy the current year’s contributions and either the previous or the following year’s contributions. The client would not make any contributions in the following year. Choose odd years to itemize and even years to take the standard deduction, or vice versa.

As an alternative, the client might make a large contribution to a donor-advised fund. The amount would be deductible in the year of the contribution, and the client can later decide when and to whom to make distributions in future years. This technique would only require that the client prime the itemized deduction pump one time and be set for years to come. I used this technique to help a client who was retiring to reduce their taxable income to $0. The client then took a distribution from their IRA to utilize the full 10%, 12%, 22%, and 24% tax brackets for the same year. This had an additional benefit of reducing future RMDs which would have put them in the 32% and 35% brackets. See what can be done with a little creative thinking?

The ideas presented here are low-hanging fruit. Time and space do not permit us to discuss tax loss harvesting, real estate optimization, tax credits, tax efficient investing, income structuring, aggressive tax positions, life insurance strategies, estate and gift tax planning, ESOPs, domicile and other strategies that may be beneficial to the right client.