Taxes: The Unexpected Retirement Killer (5 Strategies to Keep Your Wealth)
As we all know, a high income equals high taxes.
When that high income is compressed down into just a few years (often the case for professional athletes and successful business owners), Uncle Sam can take a big bite out of your wealth as well as your retirement. Needless to say, it’s easy to see why a good tax strategy is critical to making wealth last.
At Watts Gwilliam and Company, we specialize in helping clients with more complicated financial situations like this. In our experience, there are 3 common taxes that end up killing retirement for high net worth individuals, like professional athletes – and 5 strategies that help reduce them!
Professional athletes are subject to what’s called a “jock tax,” where they pay taxes in each state they play in.
For example, if a player lives in Florida where there is no state tax, they won’t pay any tax to Florida. But if they play away games in California and Massachusetts, they’ll file state tax returns for those two states and pay taxes on all the money earned there.
On average, NFL players file eight to 12 non-resident state returns, NBA players file 16 to 20 returns, and MLB players file 20 to 25 returns each year, according to CNBC.
As you can imagine, this makes for a complicated tax situation that requires year-round planning to get right.
Where you choose to establish residency can greatly impact your taxes. Alaska, Florida, Nevada, Tennessee, Texas, South Dakota and Washington are seven states that don’t have a state income tax. California and New York, on the other hand, are two states with some of the highest income tax.
As a high net worth individual, you may do business in a state with no income tax. If that’s not the case, you may be able to establish residency in a non-tax state.
Taxes on Royalties
Royalties and endorsements are another financial planning concern for professional athletes and high net worth individuals. These are typically taxed based on your home state. This means that, depending on where you live, you could pay massive taxes on any deals that come your way.
A high net worth retirement comes with complex financial planning concerns. Contact the financial advisors at Watts Gwilliam and Company to see how we can help.
5 Tax Strategies for Professional Athletes and High Net Worth Individuals
Implementing certain strategies can help you protect your wealth and keep more of it. Here are 5 common strategies that can help lower taxes as a high-income earner.
1. Create a Trust
Trusts serve many purposes – they help you carry out charitable wishes, protect your assets from creditors, and even protect your assets during a divorce. But they also help you reduce income taxes over your lifetime earnings.
The right tax-efficient trust strategy may involve distributing capital gains to beneficiaries who are in a lower tax bracket, paying deductible expenses before year-end, or even distributing trust income to beneficiaries. Work with your financial advisor to create the right strategy for your situation.
2. Be Strategic with Charitable Giving
Donating to charity is a great way to give back to the community and lower your taxes. Giving can take on many forms, including:
- Starting a foundation. Many high-income-earning athletes choose to start a charitable foundation with their wealth. There are two main types: Public foundations and private foundations. Both have pros and cons, and one may make more sense for you depending on your charitable goals and financial situation.
- Opening a Donor Advised Fund (DAF). A DAF is like a savings account for charitable donations. You fund it with a large sum of money one time, and get an immediate tax benefit. Then, you can let the money grow or divvy it out to as many charities as you’d like.
- Setting up a charitable trust. You can set up a Charitable Remainder Trust (CRT), where you receive income from the trust for a set period of time, then the remainder of the money goes to charity. Or, you can do the opposite with a Charitable Lead Trust (CLT), where the money goes to charity for a set period of time, then you get the remaining funds. CLTs often help you reduce your tax burden now, making them a suitable option for high income individuals and professional athletes.
3. Maximize Your Tax Deductions
Before the Tax Cuts & Jobs Act, you could typically deduct a whole host of expenses, including entertainment fees, agent fees, union dues, training expenses, education expenses – the list goes on. You could also deduct 100 percent of your state and local tax.
Unfortunately, this is no longer the case.
The state and local tax deduction is now capped at $10,000 a year and you can’t deduct things like your cell phone bill, new clothes, and temporary living expenses.
It’s not all bad news though. Depending on your situation, you may still be able to deduct items like:
- Endorsement deals
- Card signings
- Speaking fees
- Travel expenses
- Marketing agency fees
Deductions have changed a lot under the Tax Cuts and Jobs Act. An experienced financial advisor should work with your CPA to help make sure you’re optimizing every single deduction you qualify for.
4. Do a Backdoor Roth Conversion
Roth IRAs can be key to amassing substantial wealth in retirement because you fund the accounts with after-tax dollars, then you don’t pay any taxes on growth or withdrawals.
Unfortunately, you’re not eligible for a Roth IRA if your modified adjusted gross income is more than $140,000 as a single filer or $208,000 as a married couple.
To get around this income limit, many high-income earners do what’s called a “backdoor Roth conversion.” This is where you put money in a Traditional IRA first, then convert it to a Roth IRA later. You pay taxes on any contributions and gains you’ve accumulated up until that point. But once you pay these taxes upfront, it’s not taxed again. You can also withdraw any of your contributions tax-free before age 59-½, so your Roth IRA can act as a secondary emergency fund.
5. Set Up an S-Corporation for Royalties and Endorsements
High-income-earning athletes with endorsement deals can often save on taxes if they set up an S-corporation for business earnings. Setting up an S-corporation can be expensive (and it involves a lot of paperwork), but it can soften the tax blow by trimming down the amount of Social Security and Medicare taxes you pay on your profits. You’re still required to pay yourself a “reasonable salary,” but any extra earnings pass to you as the owner of the company (not an employee).
Need Help Implementing These Strategies?
At Watts Gwilliam and Company, we specialize in helping athletes and other high net worth individuals assemble a financial plan that enables them to reduce taxes, reach their financial goals, and plan for life’s next chapter. Headquartered in Gilbert, AZ, our financial advisors help clients nationwide.
If you’d like help putting some of these tax strategies into play – or if you have financial concerns you’d like to discuss – schedule a no-obligation consultation with our team. Together, we’ll strategize ways to help you keep more of your wealth.