Tax-Sheltered Investments for High-Income Families in California and Washington

By Kevin Luu, Co-Founder and Chief Learning Officer. Reviewed on 2026-09-30.

Tax-sheltered investments are accounts where the IRS lets your money grow without an annual tax bill: workplace 401(k) plans (pre-tax and Roth), after-tax 401(k) money converted to Roth (the “mega backdoor”), backdoor Roth IRAs, health savings accounts, 529 plans, and, outside of accounts, municipal bonds and Series I savings bonds. For a two-earner family making $750,000 or more, the order matters more than the list: workplace plans first, then Roth space, then the kids’ accounts, then tax-efficient choices in a taxable brokerage account.

Most lists of “tax-sheltered investments” are written for households that qualify for everything. At this income level you are phased out of a direct Roth IRA, the Child Tax Credit and most education credits, and if you live in California, the state ignores some federal shelters entirely. What follows is the version that fits a family earning $750,000 to $3 million in wages and RSUs in California or Washington.

Which tax shelters a $750k+ W-2 household can actually use in 2026

The figures below are 2026 federal limits from the IRS (Notice 2025-67, Rev. Proc. 2025-19, Rev. Proc. 2025-32). The state columns are where most generic articles go wrong.

The California rules come from the FTB’s 2025 Schedule CA instructions: “Federal law allows a deduction for contributions to an HSA account. California law does not conform,” and HSA earnings “are taxable in the year earned.” California also taxes interest from non-California state and municipal bonds. The 529 point is confirmed by the fate of SB 529, which would have created a California deduction and died in the Legislature.

The order that usually makes sense for this family

1. Full 401(k) deferral for both spouses. $24,500 each for 2026. At this income each deferred dollar typically saves tax at your top marginal federal rate (35% or 37% for most families in this range) and, in California, at a 9.3% to 13.3% state rate.
2. Mega backdoor Roth, if a plan allows it. Many large tech and biotech plans allow after-tax contributions with in-plan Roth conversion. This is the largest Roth door open to a high earner. Room equals $72,000 minus your deferral minus employer contributions (2026).
3. Backdoor Roth IRA for each spouse. Your income is above the 2026 Roth IRA phase-out ($242,000 to $252,000 MFJ), so the route is a non-deductible traditional IRA contribution followed by a conversion. Any existing pre-tax IRA balance makes part of the conversion taxable under the pro-rata rule, so check old rollover IRAs first.
4. HSA, if you are on a high-deductible plan. Still worth it federally in California, but the benefit is smaller than most articles claim. Our guide to high-deductible plans covers when the plan itself makes sense.
5. 529 plans for each child. Best started while children are young, because tax-free growth needs time.
6. Tax-efficient taxable investing. Broad index funds, municipal bonds held where they help, and tax-loss harvesting. See how a brokerage account is taxed when you do not sell.

Two benefits sit alongside this list rather than in it. A dependent care FSA shelters up to $7,500 per household for 2026 (raised from $5,000 by the 2025 tax law, if your employer’s plan adopts it), which matters with kids under 12 in childcare. It is spending money, not an investment, but for most families it is the easiest pre-tax dollar available. Nonqualified deferred compensation, offered to some executives, can also defer income, at the cost of becoming an unsecured creditor of your employer.

Worked example: a $900,000 California household with two kids

Assumptions (illustrative): married filing jointly in the Bay Area, $900,000 of combined W-2 wages including RSU vests, children aged 3 and 7, both employers offer a 401(k), one plan allows the mega backdoor and contributes a $12,000 match, the family is on an HDHP.

What the pre-tax deferrals are worth this year: with $900,000 of wages, taxable income after deferrals and the standard deduction is still above the 2026 37% bracket start of $768,700 MFJ. California taxable income lands in the 10.3% bracket ($742,958 to $891,542 MFJ, using 2025 schedules, the latest the FTB has published). So $49,000 of deferrals cuts this year’s income tax by about $23,177 ($49,000 x 47.3%). Elective deferrals do not reduce Social Security, Medicare or California SDI, which is 1.3% on all wages for 2026 (EDD).

The HSA is smaller than it looks for this family. The $8,750 saves roughly $3,238 of federal tax (at 37%), but California adds the contribution back to income and taxes the account’s earnings every year. In Washington the full federal benefit applies with no state drag.

Then the kids. Each parent can give each child $19,000 for 2026 without touching the lifetime exemption, so $76,000 a year into two 529s fits within the annual exclusion without using any lifetime exemption. A larger option is the five-year election: up to $95,000 per child per donor, or $190,000 per child from a couple, reported on Form 709 and treated as spread over five years. For a 3-year-old, that money has about 15 years to grow before college with no tax on qualified withdrawals.

How California and Washington change the answer

California taxes every dollar of capital gain as ordinary income, up to 13.3% (12.3% plus the 1% Behavioral Health Services Tax on taxable income over $1,000,000), with no lower rate for long-term gains (FTB). Add the federal 20% long-term rate and the 3.8% Net Investment Income Tax, and a top-bracket Californian can lose about 37% of a gain to tax. That makes Roth space (mega backdoor, backdoor IRA) and 529 growth more valuable here than almost anywhere. It also makes California municipal bonds or a California municipal fund the usual muni choice for the bond portion of a taxable account. A fund qualifies for the state exemption only if at least 50% of its assets are in California or U.S. government obligations, per the FTB instructions above.

Washington has no wage income tax in 2026 (WA DOR), so the 401(k) deferral is worth only the federal rate. Washington does tax long-term capital gains at 7% above the standard deduction ($278,000 for 2025, the latest published) and 9.9% on taxable gains above $1,000,000, with retirement accounts exempt (WA DOR). Washington has also enacted a 9.9% income tax on AGI over $1,000,000 starting January 1, 2028. A household that expects to be over that line should treat today’s Roth conversions and Roth contributions as more valuable than they were a year ago. And because Washington’s estate tax exclusion is about $3 million in 2026 (WA DOR), far below the federal $15 million, where assets sit matters for estate planning too.

Municipal bonds, I bonds and life insurance: where they fit

Municipal bonds make sense for the bond portion of a taxable account, not as a replacement for retirement plans. The test is the taxable-equivalent yield. For illustration only: a California muni fund yielding 3.0%, held by a family at 37% federal, 3.8% NIIT and 10.3% California, is comparable to a fully taxable bond yielding about 6.1% (3.0% divided by 0.489, which is 1 minus the combined 51.1% rate). Out-of-state munis lose the California piece of that math.

Series I bonds are exempt from state income tax and defer federal tax until you cash them, but the cap of $10,000 per Social Security number per year makes them a rounding error at this income (TreasuryDirect). They cannot be redeemed for 12 months and lose the last 3 months of interest if cashed within 5 years. The education exclusion for savings bond interest has an income limit this household is far above (IRS Form 8815).

Permanent life insurance grows cash value tax-deferred, but it is insurance first. Costs are high, and for most families at this stage term coverage plus the accounts above does the job. It can earn a place later, for example to provide estate liquidity in Washington, after the cheaper shelters are full.

Custodial accounts are not a tax shelter. A UTMA account’s investment income above $2,700 is taxed at the parents’ rate for 2026 under the kiddie tax, and the money legally belongs to the child from the day it is given, with the child taking control at 18 to 25 depending on state and how the account was set up. See our UTMA tax rules. A custodial Roth IRA requires the child to have real earned income, which few children under 12 have.

Common mistakes we see at this income level

• Contributing to a Roth IRA directly. Above the phase-out, that is an excess contribution, subject to a 6% tax for each year it stays in the account unless withdrawn, with its earnings, by the tax-return due date (IRS). Use the backdoor route.
• Converting with a rollover IRA still open. The pro-rata rule on Form 8606 makes much of the backdoor conversion taxable. Rolling old IRA money into a current 401(k) first, if the plan accepts it, usually fixes this.
• Not checking whether the plan allows after-tax contributions. Many families leave tens of thousands of dollars of yearly Roth room unused because nobody read the plan document.
• Treating the HSA as a California deduction. It is not. Plan the state tax on contributions and earnings.
• Holding national muni funds in California. Unless a fund has at least 50% of its assets in California or U.S. government obligations, California taxes its federally exempt dividends, and most national funds do not meet that test.
• Letting RSUs pile up in the taxable account. Every vest is taxed as wages; the shelter question is about what you do with the after-tax shares next. Our investment risk management work starts there.

What to write down for your kids

A 7-year-old will not understand a mega backdoor Roth. They can understand that their parents decided, on purpose, to put money where it grows for decades, and why they chose the 529 over spending it now. Write a one-page note each year: which accounts you funded, what you gave up to do it, and the reason. Conversations fade. Documentation compounds. That note becomes part of your FamilyKnowledge® Library, and it is the record your children will read when the 529 and the Roth accounts eventually become theirs to manage.

Frequently asked questions

What is the best tax-sheltered investment for a high-income family?

For most W-2 households above $750,000, the 401(k) deferral and the mega backdoor Roth (if the plan offers it) shelter the most money per year. Together with employer contributions they can hold up to $72,000 per employee for 2026. Backdoor Roth IRAs, an HSA and 529 plans come next. The right mix depends on your plan documents, your state and when you need the money.

Are tax-sheltered accounts worth it if I live in Washington?

Yes, though the math is different. With no wage income tax in 2026, a pre-tax deferral saves only federal tax. Roth accounts look relatively better, especially for households that expect AGI over $1,000,000 when Washington’s new 9.9% income tax starts in 2028. Retirement accounts are also exempt from Washington’s capital gains tax.

Does California give a tax break for 529 contributions?

No. California allows no deduction for 529 contributions, and a 2025 bill that would have added one died. Growth is still free of California tax when used for qualified education costs. You can use another state’s plan, but without a California deduction the choice comes down to fees and investment options.

Next step

Pull your 401(k) summary plan description and look for two phrases: “after-tax contributions” and “in-plan Roth conversion.” If both are there, the mega backdoor is likely the largest unused shelter in your household. If you want a second set of eyes on the full picture, including RSUs, state residency and the kids’ accounts, our tax management and retirement and employee benefits teams at Age Five Family Office™ start with a Tax & Wealth Assessment.

This is general education, not individual tax advice. The right move depends on the family’s full picture.

Written by

Kevin Luu

Co-Founder and Chief Learning Officer, Bright Advisers

Kevin has advised high-income W-2 tech and biotech families since 2015, and leads the education-first Age Five Family Office from Brea, California.

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