Many aspects of tax planning apply for all clients no matter their age, but younger clients often require specific strategies, advisors say.
Part of the issue is that many younger tax filers are making more money than they used to.
“We’re seeing larger income levels for younger clients, which can create a need for more deliberate tax planning now,” said Kassi Hyde, wealth management advisor at Apollon Wealth Management in Peachtree Corners, Ga. “Tax planning for younger clients is often to build the tax situation you want to see [existing] for older clients.”
“Themes of tax planning are mostly the same regardless of age: Emphasize long-term over short-term capital gains, try to get into lower income and capital gains brackets, and defer taxes when possible,” said David Flores Wilson, managing partner at Sincerus Advisory in New York. “Most younger wealthy clients also aren’t familiar with many tax strategies, so a significant amount of time is spent educating them.”
For example, young clients who borrow from parents to buy a primary home should make sure that the loan is set up to be eligible to deduct the interest paid “while enjoying the likely lower long-term interest rate compared to a bank loan,” said Jody R. King, CPA, director of Wealth Planning at Fiduciary Trust Company in Boston.
Advisors say they often need a different mindset with younger taxpayers than with older clients. Younger clients often have proportionately more debt and “face more uncertainty due to the likelihood that tax laws will likely change several times during their life,” said Kim Kamin, partner and chief wealth strategist at Gresham Partners in Chicago, and “are often more concerned about ordinary income tax rates and planning related to ordinary income, as they’re more likely still to be working.
“From an income tax perspective, younger clients who have time on their side can focus on gifting assets to grantor trusts to get the appreciation out of their estates,” Kamin said. “They can consider doing Roth conversions of smaller IRA accounts—and backdoor Roth conversions—for retirement savings to avoid future income taxes.”
Certain savings vehicles work particularly well for younger clients. For instance, “more 401(k) s are now offering Roth options,” Hyde said. “This can be a great option for saving in a tax-efficient way for later but needs to be balanced with tax needs of today.”
The tax-free growth can extend 10 years beyond the joint lives of the younger client and their spouse, King said.
Employment can offer some of the best tax-advantaged tools for younger clients—though education might be needed.
“I recommend that they familiarize themselves with every benefit their employer provides. Max out on employee stock purchase plans, HSAs, restricted stock units, stock options,” said Mary Kay Foss, a CPA in Carlsbad, Calif. Younger clients might also not know they can bank receipts for medical expenses and take reimbursements for designated accounts later, she said.
Clients who are early in their careers are likely in lower tax brackets than they will be later and have a choice between choosing a traditional or Roth 401(k) or 403(b). “I’d generally recommend taking the Roth option because they’re young, in lower tax brackets and the Roth will have plenty of time to grow tax-free,” said Larry Pon, a CPA and advisor in Redwood City, Calif. Advisors should remember that the aging of younger clients changes tax considerations, Pon added, to involve such tools as child credits, tax-advantaged medical spending accounts, education credits and 529 Plans for their kids.
Clients in mid-career with higher incomes should max out retirement accounts and be mindful of tax brackets, said Eric Herzog at Prime Capital Investment Advisors in Fargo, N.D., especially the deductions for contributions if a client is nearing the next marginal income tax bracket.
Younger clients must also avoid lifestyle creep, advisors said. “When [the client] gets a raise, sell a business or just find yourself with more money, it is easy to spend more,” Herzog said. “Systematize saving by investing a preset dollar amount or percentage of income.”