The Tax Mistake That Could Get You Booted From The 'Upper Class'

If after hearing any of the tragic stories of people who've won the lottery and still ended up dead broke you've found yourself wondering how that could happen, you're not alone. There are a number of mistakes people with upper-class lifestyles can make to lose them their class status. Spending beyond their means, poor financial literacy, or a lack of diversified investments have all humbled some upper-class individuals and booted them back down to middle-class status or worse.

One of the most overlooked reasons for being relegated back to the peasantry has to do with the management of taxes. It's perhaps no accident that most of the worst financial crimes committed by celebrities actually revolve around tax situations, where either because of poor advice, plain ignorance, or malicious intent, these rich individuals or households have lost a significant portion of their wealth, or all of it. Successful wealth management requires an understanding of the complexities of navigating strategically beneficial tax accounts and investment schedules, and the discipline to follow through.

Two of the secrets the wealthy use to protect and grow their fortune are to avoid handing over more money than they legally need to toward taxes, and by diversifying their investment portfolios in ways that are advantageous. You can actually do both at the same time by leveraging taxable and tax-advantaged accounts for investment purposes.

Taxable accounts, like brokerage accounts, can be used for investments where less returns are typically lost to taxes. For instance, taxable accounts for stocks that are meant to be held long-term — think high-quality companies with a decent track record you expect to hold for over a year — tax-managed funds including index funds, exchange traded funds (ETFs), and stocks or mutual funds that pay dividends to investors tend to lose less of their returns to taxes. Also, tax-advantaged accounts that are either exempt from taxes or defer taxes to a later date, like real estate investment trusts (REITs), IRAs and Roth IRAs, or your 401(k), which all offer ways to avoid paying taxes legally. Just make sure that, in the case of a Roth IRA, you're not taking money out of that account before you're 59 ½ years old or you'll be subject to penalties and taxes. Holding money in both sorts of accounts can be used to your tax advantage — making investments with taxable brokerage accounts while dividing up retirement-savings contributions between a tax-deferred IRA account and after tax Roth IRA account for example — if you know what you're doing.

Timing is also an important factor that has big implications where taxes are concerned. For instance, the best time to contribute to your IRA might not be what you think and could have huge implications the higher your net worth goes. Knowing when to defer income or claim income for instance — known as income deferral and income acceleration, respectively — are tried and true strategies millionaires use to avoid paying taxes without breaking the law.

They say timing is everything, and if you believed you were going to be in a lower tax bracket in 2026 for instance, you would want to defer capital gains from your investments to another year. This has the dual benefit of lowering taxable income this year, and potentially taking advantage of a lower tax rate next year. If the opposite were true, and you believed you were going to be in a higher tax bracket next year with a higher tax rate, it could make more sense to sell those investments to take advantage of a lower tax rate this year and hold on to more of your gains. 

Taking advantage of the timing around deductions like charitable donations or medical expenses is one reason why it's so hard to tax the rich. If you were going to be taxed at a higher rate this year, you could group and claim your deductions this year to offset losses on taxable income, or vice versa if the reverse were true.