There’s an assumption that once you land a solid professional job, the money side takes care of itself. It sounds like a lot of income, but it doesn’t always feel that way. When my partner and I looked closely at our expenses, the single biggest line item wasn’t the mortgage or childcare. It was taxes. We spend more there than on anything else.
I’m a hospital pharmacist, and I’m genuinely passionate about this topic, because it isn’t taught nearly as often as it should be, and a lot of the content out there comes with conflicts of interest that make it hard to sift through.
This post is organized into three levels. Level 1 covers the most straightforward strategies, and each level gets a little more complex from there. If you live in a higher income tax state, you can easily land in the 30 percent plus bracket, so even the basics are worth getting right.
Disclaimers: First, I’m not a financial advisor, attorney, or accountant, and I don’t know your specific situation, so treat this as a starting point and do your own research. Second, just because something is tax advantaged doesn’t automatically make it a good investment. Always zoom out and look at your whole financial picture. All figures below are 2023 numbers and change year to year, so check the current limits before you act.
Level 1: The Low-Hanging Fruit
These are the basic, widely available options. If you do nothing else, start here.
403(b) or 401(k)
These are the retirement savings plans offered through your work. The money you put in is pre-tax, which directly reduces your taxable income. Many plans also offer an employer match: if you put in $1,000, your employer adds $1,000, which is basically free money. In 2023, the employee contribution limit is $22,500.
My first instinct was to just max it out every year, since I’m likely in a higher tax bracket now than I will be in retirement. You can do that, but here are three downsides I wish I’d considered:
- Required minimum distributions kick in at age 72, whether you need the money or not, which limits your options.
- The investment choices inside these plans can be more limited.
- The money is fairly illiquid. I now ask myself whether that chunk of cash could be better invested elsewhere, like a business or real estate, versus locked into the plan.
Personally, I aim for slightly above the amount needed to get the full employer match. Everyone’s strategy is different.
457
This may be available to you if you work in government or for a nonprofit. Think of it as a second 403(b) that holds pre-tax dollars under similar rules, except the 457 has its own separate $22,500 limit. If you wanted to shelter as much pre-tax income as possible, you could max out both. I don’t, for the same liquidity reasons above.
Backdoor Roth
A Roth IRA is a post-tax account. You contribute after-tax money, it grows tax free, and you withdraw it tax free after age 59.5. A few things make it attractive:
- No required minimum distributions. If you don’t need it, leave it there indefinitely and pass it to your kids.
- If you do need it, your contributions (not the earnings) are withdrawable penalty free and tax free after five years, in the case of a conversion. Put in $5,000 today, let it grow to $7,000 over seven years, and you can pull your original $5,000 back out without penalty. I’d avoid doing that if possible so the money keeps growing, but it’s reassuring to know the option exists.
Because of your income, you most likely can’t contribute to a Roth directly. The backdoor Roth gets you there anyway: you put post-tax money into a traditional IRA, then convert it to a Roth IRA. Do the conversion quickly, before the money earns interest that would complicate your taxes. The limit is $6,500 per person in 2023, unless you get into the mega backdoor Roth, which is in Level 2.
529
A 529 is a college savings account. Like the Roth, it uses post-tax money, grows tax free, and comes out tax free when used for qualifying college expenses. There’s a specific list of what counts, so read up before opening one. The obvious downside is that the beneficiary has to actually attend college, though it can be transferred to a sibling or another family member. Investment options are also limited, even more so than a 403(b) or 401(k). The main draws:
- Gifting and estate planning. If a grandparent owns the 529, it’s useful for moving assets to grandchildren with less tax, and grandparent-owned assets aren’t counted on financial aid applications.
- State tax deductions. Some states offer a deduction on state income tax for contributing to an eligible 529. In Minnesota, for example, that’s up to $3,000 per year. In a high tax state, this can be worthwhile.
HSA
A health savings account is only available if you have a high-deductible health plan, and it’s one of my favorites. The money goes in pre-tax, up to $7,750 for a family in 2023, grows tax free, and comes out tax free when used for healthcare expenses. Unlike a flexible spending account, the balance doesn’t expire at the end of the year.
You might be thinking you can’t risk a high-deductible plan with a family. I don’t know your specific options, but when I compared my employer’s plans at their out-of-pocket maximums, I looked at the worst case, where the whole family racks up major medical bills. Even then, the high-deductible plan was only about $1,000 more than the high-coverage plan. That felt like a reasonably small risk against the upside: very low premiums in the good years, plus access to an HSA that grows over time.
One advanced move: you can take HSA reimbursements whenever you want, right away or years later. In theory you could save up receipts and reimburse yourself in one large batch during retirement, or wait to sell your positions when they’re up. I’m not organized enough to track that, but it’s worth knowing.
Dependent Care FSA
This is pre-tax money set aside for childcare. The cap is $5,000 per household, which isn’t much given actual childcare costs, but it’s still worth taking.
Level 2: Intermediate
Once the basics are handled, here’s the next tier.
Mega Backdoor Roth
To understand this, picture your money in several buckets with different capacities:
- The employee bucket for workplace retirement accounts like a 401(k) or 403(b), which holds $22,500.
- A 457(b) bucket, another $22,500, if your employer offers it.
- The IRA bucket, $6,500, whether traditional or Roth.
What most people overlook is the total retirement bucket, which can be up to $66,000 in 2023. That total holds your employee 401(k)/403(b) contributions, your employer match, and then whatever space is left, which is the after-tax 401(k) portion. If your plan allows it (many don’t, including mine, so check), you can contribute regular post-tax money into that leftover space and then convert it to a Roth.
A few cautions: move the money quickly before it accrues earnings, and don’t contribute so much that you lose your employer match. I haven’t used this method personally, because there’s a more optimal version available to some people, covered in Level 3.
Tax-Loss Harvesting
Get into the habit of tax planning rather than waiting until April. Before the calendar year ends, review your investment positions and sell what makes sense to realize losses that offset gains, which lowers your tax bill. Don’t sell purely for the tax benefit if it doesn’t make sense as an investment.
Along the same lines, if you do some planning in late summer or fall and know roughly what you’ll owe, you can explore buying something like a business or real estate, where the tax savings effectively put the purchase on discount.
Municipal Bonds
These are essentially loans to local governments to fund public projects, and the interest you earn is often tax free.
Credit Card Points
A slightly odd one to end on. Rewards you earn on credit cards aren’t taxable, so you can almost treat them as extra untaxed income. Between you and a partner (or “player two,” as the credit card world calls it), you can realistically earn $10,000 to $20,000 per year in value, especially with travel spending and a more aggressive card strategy. The caveat is that you need good credit, but there’s very little downside if you use credit responsibly.
Level 3: Advanced (Business Strategies)
Now the good stuff: business-related tax strategies.
If your reaction is that you don’t have a business and don’t want a side hustle, and that you’d rather just work extra hours for guaranteed good money, I understand. I was stuck in that mindset for far too long, treating any side venture as an hourly trade where I couldn’t match my day-job rate on something new. But there’s an upside that isn’t immediately obvious: a business is time invested now for a future reward that’s potentially uncapped, unlike the linear hours-for-money trade of a job, and it comes with tax benefits.
You don’t need an LLC or any formal structure to start. By default you’re a sole proprietor, and that’s enough from a tax perspective. Form an LLC for legal reasons if you want, but the IRS doesn’t require it here.
As for what qualifies, IRS guidance says the activity needs a profit intent, needs to eventually be profitable, and needs to be done regularly, though it can be part time. Examples range from a rental property, to being a part owner in someone else’s business if you want something passive, to a monetized hobby (a real one, not something the IRS would call a hobby). Selling handmade cards counts. So would a two-weeks-a-year holiday photo business, or a friend of mine running goat yoga and glamping at her farm.
Once you have a business, a number of tax incentives open up.
Deductions
Anything ordinary and necessary for the business is deductible: office supplies, equipment, travel, and so on. Travel to service an Airbnb, vet bills and feed for a farm-based business, crafting supplies and the mileage to buy them, even training to improve at the craft. Because you may be spending on things you partly enjoy anyway, these deductions can put the business at a loss on paper, which offsets some of your high W-2 income and reduces your tax bill.
Depreciation
If you hold large assets like rental or Airbnb real estate, you can use depreciation against earnings. The idea is that a building has a lifespan (27.5 years for residential, 39 for commercial), so each year you deduct roughly 2.5 to 3.5 percent of the building’s value. It doesn’t sound like much, but on a $500,000 building that’s over $12,000 a year. If real estate is your business of choice, you’re almost always at a paper loss.
To go further, a cost segregation study splits the property into components (carpet, windows, kitchen fixtures) that depreciate faster than 27.5 years, letting you take more of that deduction up front. Bonus depreciation accelerates it further, though in 2023 it’s phasing down to 80 percent. Even at 80 percent, that’s far more than standard straight-line depreciation. A cost segregation study costs money, so talk to a professional about whether it makes sense for you.
Home Office
If you use a space exclusively for the business (filming videos, managing rentals), it qualifies as a home office. You can then deduct a portion of your home insurance, mortgage interest, HOA fees, utilities, and more. This one can’t push you into a business loss, but any amount you can’t use this year carries over to offset future business income once you’re profitable.
Hiring Your Kids
Paying your kids for legitimate work is a business expense. Depending on age, that might be feeding animals, moving laundry between washer and dryer while flipping an Airbnb, or modeling in your social media content, say for a family-oriented beach house listing. Older kids can take on more substantial roles. Keep the pay reasonable (you can’t pay a child $1,000 to appear in one Instagram reel), and track what work they did, when, and how much you paid. You can do the same with elderly parents.
The point is income shifting: moving income taxed at your 30 percent plus bracket to someone in a 0 percent bracket. As long as they earn under roughly $12,000 per year (the number changes annually), they owe no income tax. Business-related education can also be an expense. If your child is a regular employee producing, say, one Instagram reel a week, you could reasonably send them to photography lessons to improve the work. There’s a limit to how far this stretches (would you do it for a non-family employee, and how necessary is it), but it’s worth thinking about.
Once your kids have earned income, they can contribute to their own IRA. A Roth is ideal, since they have no income tax, making it effectively zero tax in and zero tax out. The rule about withdrawing contributions penalty free still applies, so they could use their own Roth to fund college if needed, and Roth money isn’t counted on financial aid applications.
Solo 401(k)
As a sole proprietor or solo LLC owner, you can set up a solo 401(k) in addition to your workplace retirement accounts. Remember that $66,000 total retirement bucket with space left after your work contributions? You can fill that space here, giving you access to a higher effective limit. Unlike the employer-based option in Level 2, you’re not limited to what a workplace plan allows: you pick a plan that suits you, and you can even hold crypto, NFTs, or real estate inside it.
You can also pair this with the mega backdoor Roth, contributing post-tax money into the solo 401(k) as a Roth, so that a Bitcoin purchase or a property held in the account grows tax free indefinitely. Check the rules carefully. For the real estate example, you and certain relatives can’t live in the property, so talk to an advisor before doing anything complex.
One more feature: because you’re both employer and employee, you can give yourself an employer match. It’s capped at 25 percent of your business net profit, and if you’re maxing out deductions (especially in real estate), you may not have much net profit on paper, so this may not help. But if the business becomes a real earner, that match is a powerful write-off.
Renting Your Home to Your Business
Depending on the type of business, your business can rent your home from you personally for up to 14 days a year, for an event or retreat. The premise: you don’t have to report rental income on your home if it’s rented for fewer than 14 days. You don’t get extra write-offs (like mortgage interest or property taxes) from this, but your business still deducts the rent it pays you. I picked this up recently at a workshop and was annoyed I hadn’t thought of it sooner, since I already knew the 14-day rule from studying Airbnb rules, just never in reverse.
Two Important Caveats for Business Strategies
Passive Activity Rules
If the activity is long-term rental real estate, or you’re a passive partner in someone else’s business, the income or loss is deemed passive. Passive losses can’t offset your active W-2 income. You can still use the other strategies (home office, deductions, and so on), but a paper loss only reduces your passive income to zero, and the remaining negative amount is suspended for future years. You can convert rental losses to non-passive if you qualify as a real estate professional based on hours, or if your spouse does, but they have to genuinely be part of the business.
Self-Employment Taxes
If your business turns a net profit, that income is subject to Social Security and Medicare taxes on both the employer and employee side, roughly 15 percent. The upside for high W-2 earners: the Social Security portion is capped at $160,000 of income, so if you’re already above that, it won’t make a difference for you.
A Final Word
This is my best attempt at summarizing what I’ve learned, and I fully expect you to do more research to figure out how these strategies apply to you. I really do wish someone had made this for me ten years ago. If you know someone who’d benefit from it, pass it along, and if there’s a strategy I missed, share it in the comments so others can learn from it too.
Which of these are you already using, and which one are you going to look into first?
Let us know in the comments below!
