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Sheltering Clients From the Taxman

Several investment strategies can protect high-income clients from new taxes and higher tax rates.

This year brought a slew of changes to the tax code, hitting high-income investors especially hard.

Just to name a few: The tax rate on income over $400,000, or $450,000 for couples filing jointly, jumped to 39.6 percent from 35 percent; the 3.8 percent Medicare surtax may be applied to different forms of investment income for clients making more than $200,000 in modified adjusted gross income; and single filers with $250,000 adjusted gross income, or $300,000 for joint filers, may lose out on taking some or all of their deductions.

Thankfully, there are still several investments that you can offer to your clients to delay, reduce, or avoid taxation on their investment income and interest.



Kicking the proverbial tax can down the road works best when high-income clients are working and earning, as tax-deferred assets will be withdrawn when the clients retire and are in a lower income tax bracket at that time.

Gains and interest left in variable and fixed annuities are sheltered from taxation, and the taxes are incurred only when the funds are withdrawn. But the withdrawals are generally considered income, and taxed as such—which will likely be at the client’s highest-possible rate at the time. However, once all of the gains and increase have been exhausted, the amount left over (the deposited principal) is tax-free.

When investing in U.S. savings bonds, interest is exempt from state income taxes and can either be registered (and taxed) each year, or deferred until the bonds are finally cashed in.

Individuals are limited to purchasing $10,000 of the bonds per person each year, and must be bought online at Those expecting a federal income tax refund can also use that money to purchase an additional amount (up to $5,000 annually per person) of the Series I savings bonds by filing IRS Form 8888 with their return.



For most investors, the special tax exemption for “qualified dividends” survived the contentious debate in Congress at the end of 2012. But clients in the higher income brackets may still have to watch out for a subtle tax hit.

In 2013, taxpayers with income over $36,250 for single filers and $72,500 for married couples filing jointly will pay a 15 percent federal tax rate on qualified dividends, unless they’re in the top bracket (39.6 percent) and will pay 20 percent on qualified dividend income.  

Unfortunately, even qualified dividends count as “unearned income” for those with adjusted gross income over the $200,000/$250,000 levels, and therefore the dividends could be subject to the special “Medicare surtax” of 3.8 percent.

Another way you can increase income for clients without a substantial bump to their tax bill is through the use of an immediate annuity, funded by non-qualified dollars.

The annuity payment to the client can be scheduled over a certain time period, the lives of the client(s), or some combination of both. Because a portion of each payment is considered a return of the client’s principal, it is exempt from taxation.

For instance, according to the calculator at, a 65-year-old couple could deposit $100,000 into a single-premium annuity today, and then receive $473 per month for as long as either is alive. Only after the $100,000 initial deposit has been returned will the subsequent payments be considered interest, and therefore be fully taxable as ordinary income.


Muni Bonds

Tax-free municipal bonds are certainly not without risk, but the rewards could be worth the drawbacks.

According to the “Bond Market Yields” chart from FMS Investments, a sample 30-year AAA-rated tax-free bond was recently paying 3.1 percent. For those in the 39.6 percent bracket, that’s the equivalent of 5.1 percent yield from a fully-taxable instrument.

Keep in mind, though, that some tax-free bonds pay interest that can be included in the calculations that determine if the taxpayer is subject to the alternative minimum tax, or “AMT.” That’s a tax that was not eliminated this year, and likely won’t be any time soon.

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