Managing the Opportunities and Risks of an Exceptionally High-Income Year

When navigating a windfall event, it helps to stay proactive rather than reactive.

Is a large cash influx in your future? This might stem from selling a business or property, a company acquisition, receiving an inheritance, a substantial salary increase, or other major events. If so, it’s crucial to begin planning early to manage the added complexity—such as tax considerations, reinvestment opportunities, and estate planning—which are all interconnected. While these events can be financially rewarding, they also introduce important new factors to assess for your overall financial strategy.

Understand the Impact on Your Tax Bracket and Payments

A critical consideration during a higher-than-usual income year is the effect on your federal and state tax brackets and required tax payments. For example, if your income is pushed into another tax bracket, that additional income will be taxed at the higher marginal rate. Therefore, a core strategy can be to seek to reduce taxable income to avoid moving into a new bracket and incurring additional taxes.

Ways to Lower Your Taxable Income while Addressing Other Financial Priorities

Fortunately, there are practical ways to reduce your taxable income that may also help you achieve other financial goals.

• Retirement savings opportunities: Maximize your retirement contributions.
• Charitable giving: Make direct gifts, use Donor-Advised Funds (DAFs), or bunch contributions to maximize deductions during high-income years.
• Health savings: Increase contributions to pre-tax Health Savings Accounts (HSAs) and Flexible Savings Accounts (FSAs).
• Tax-loss harvesting:  Tax-loss harvesting can be particularly beneficial in a high-income year, as it allows you to offset capital gains with investment losses, potentially reducing your overall tax liability. You can use up to $3,000 of excess losses to offset ordinary income, and any remaining losses can be carried forward to future years.
• Specialized trusts. The creation of specialized trusts can shield taxable income and support philanthropic goals.
• Equity compensation: In a high-income year, be mindful of exercising Incentive Stock Options, in particular, as it may affect your overall tax liability. Strategic timing of exercising stock options may help improve after-tax outcomes.

Productive Uses of Higher Income

When you experience an elevated income year, it can be an opportunity to use your resources in ways that may not be possible otherwise.

• Saving and paying for education: A high-income year may be an ideal time to contribute to a 529 plan for children or other beneficiaries.
• One-time purchases: Consider home improvements or large purchases, such as property or vehicles.
• Build an emergency reserve: Set aside funds for unexpected expenses and hold them in a liquid vehicle, such as a money market fund, which may offer higher yields than traditional savings accounts.
• Fund an investment account: Consider allocating newly available funds to various asset classes, such as equities and fixed income, based on your financial objectives and risk tolerance.

Analyze Liquidity Needs, Cash Flow, and Debt Circumstances:

• Evaluate your liquidity needs and cash flow before making major decisions.  For example, you may need to reserve funds for a potentially larger tax bill.
• Be cautious not to let one-time income translate to ongoing lifestyle spending that you can’t sustain over the long run.
• Evaluate your financial obligations.  Consider paying off your educational debt, mortgage, or other liabilities, depending on the cost of the debt service.

Consider the Impact on Your Existing Estate Plan and Trusts:

Remember to consider how a one-time income increase may affect your estate planning.

• A particularly elevated income year may increase your overall estate size and future estate taxes.
• It may be an appropriate time to create specialized trusts.
• Additional funds may present more gifting or charitable giving opportunities within your estate plan.
• If an increase in income substantially raises the complexity or size of your estate, you may require a higher level of expertise than was previously necessary. For example, you may want to consider new or additional professional trustees to oversee your trusts.

An exceptionally high-income year may be a good time to partner with a financial professional – or consider if your current advisory relationship still meets your needs. Be proactive: Begin planning as soon as you anticipate a year with elevated income. At Welch & Forbes, our clients encounter a variety of circumstances that result in high-income events. We help them make the most of these opportunities through strategic tax planning and comprehensive asset management, aiming to optimize after-tax wealth and support their financial goals. If you would like to learn more about how we may be able to help you, please contact us online or call our Client Development team at 617-557-9800.

Disclosure: This information is provided for educational purposes only and does not constitute investment, financial, tax, or legal advice. Consult your tax advisor or legal counsel for advice and information concerning your particular situation. Welch & Forbes, LLC is an SEC-registered investment adviser. Registration does not imply a certain level of skill or training.