According to Fidelity, if you want to retire comfortably, you should have eight times your annual salary saved by age 60 and ten times by age 67.
But if you want to achieve—or outpace that amount—you must regularly evaluate and adjust the financial goals you set for yourself early in your career.
Earning six figures may not be the financial bellwether it used to be, thanks to rising costs in nearly every sector of the economy. But it is a sign that you may need to take a more detailed approach to managing your finances.
Unfortunately, many high-income earners put financial planning on the back burner as they deal with the day-to-day responsibilities of work and family life.
That’s a mistake that could cost you.
Failing to plan now can result in missing out on investment gains you may not be able to make up. That’s why it’s crucial to create a financial plan that will maximize your after-tax investment returns and wealth-building potential.
In this article, we’ll look at the key components we believe are essential for you to avoid falling into the trap of having a “good enough” financial plan that’s not optimized for your unique situation.
Maximize Equity Compensation
Equity compensation is undoubtedly one of the most complicated wealth management topics to understand. And it’s the one that requires the most planning to maximize your awards, minimize your tax liability and keep your retirement savings plan on track.
When making decisions about equity grants, it’s important to understand:
- Vesting requirements: One of the biggest risks of equity compensation is that it’s only as good as what’s vested. Understanding what’s at stake if you leave your position—voluntarily or involuntarily— can help you make informed career planning decisions.
- Tax planning: Different types of equity awards (e.g., RSUs, RSAs, ISOs, etc.) receive different tax treatments. Understanding how each one works can help you make better tax planning decisions so you don’t pay the IRS more than necessary.
- Asset allocation: Equity compensation can be a great way to build wealth, but it’s important to understand that it’s an asset. Looking for opportunities to diversify your portfolio can help minimize risk when you exercise shares or options so that you’re not “overinvested” in your employer’s company.
- Your long-term plan: It’s easy to panic when stock prices fluctuate. But it’s important to remember your long-term plan to avoid making rash decisions.
Engage in Regular Tax Planning
Taxes are a common area for missed opportunities. Tax planning isn’t just about filling out the appropriate paperwork and sending it to the IRS each year.
Taking a proactive approach and employing appropriate tax strategies at the right time minimizes your tax burden today and throughout your lifetime, and maximizes the after-tax value of your investment portfolio.
High earners often have complex compensation structures. Your options are limited in reducing the taxes you pay on some types of compensation, such as your base salary.
But you have more control over the taxes you pay on other types of compensation, such as equity grants. Planning for and estimating taxes has several benefits, including:
- Recognizing taxable income at more favorable tax rates
- Strategically aligning deductions, such as charitable donations, to offset high income years
- Eliminating unpleasant surprise tax bills
- Ensuring your withholdings are set up appropriately to avoid underpayment penalties and interest
Without adequate planning, you could end up paying the IRS more than you need to.
Save for Retirement
Higher compensation often goes hand-in-hand with higher expenses and doesn’t necessarily make it easier to save for retirement. As your income grows, it’s essential to balance saving for the future with your current financial responsibilities.
Max Out Your 401(k) or 403(b)
Maxing out your 401(k) or 403(b) is one of the best things you can do to reduce your taxable income for the current year and save for retirement. If that’s not possible, contribute as much as you can.
If your company offers a match, make sure you contribute at least enough to maximize the match so that you don’t leave free money on the table. Then, plan to increase your contributions as income allows until you’re maxing out your employer-sponsored retirement account and the tax deferral each year.
If your employer offers a Roth option, compare the anticipated tax savings you may achieve in the future when you contribute to a Roth vs. the benefit of a current tax deduction contributing to a traditional account.
In addition to considering potential changes in tax legislation, projecting future tax rates includes forecasting taxable income in distribution years from all sources of income (retirement accounts, taxable investment accounts, deferred compensation, Social Security, etc.).
Consider Backdoor Roth Conversions
Roth IRAs offer many benefits, including tax-free earnings and withdrawals, no required minimum distributions (RMDs), and the flexibility to withdraw funds in the most tax-efficient way during retirement.
However, Roth IRAs have income limits that high earners often exceed, making them ineligible to contribute.
A backdoor Roth conversion is a legitimate way to get the benefits of a Roth account. Here’s how it works:
First, you make an non-deductible contribution to your traditional IRA account. Then, your contribution is converted to a Roth IRA in a non-taxable Roth conversion.
If you decide a backdoor Roth conversion is right for you, you can still contribute pre-tax dollars up to the IRS contribution limit.
Contribute to a Health Savings Account (HSA)
If you participate in your employer’s high-deductible health insurance plan, you may open a health savings account. This account allows you to contribute pre-tax dollars you can use for medical expenses.
If you don’t use the money to pay for healthcare expenses during the plan year, you can invest it. All contributions grow tax-deferred, and you won’t pay taxes when you withdraw money from the account as long as you use it for eligible healthcare expenses.
Unlike FSA accounts, HSA contributions are not “use them or lose them.” You can use HSA funds at any time—even during retirement—to pay for eligible healthcare expenses, such as Medicare supplementary premiums.
To maximize the benefit of the HSA, it is best to pay current medical expenses from cash flows and retain funds in the HSA to invest for retirement medical expenses.
Consider Taxable Investment Accounts
Once you’ve maxed out your 401k and HSA (if available), contributing to a taxable brokerage account is the next step. Even though you’ll be contributing after-tax dollars, taxable accounts have advantages qualified accounts don’t.
You don’t have to wait until you’re 59 ½ to withdraw your money penalty-free, which can help fund an early retirement. Additionally, realized gains on appreciated investments within taxable accounts are taxed at the capital gains tax rate, which is much lower than the ordinary income tax rate when holding positions greater than a year.
Establish an Emergency Fund
An emergency fund may seem like a no-brainer for someone with a six-figure income. However, high earners with substantial retirement savings sometimes lose sight of how important an emergency fund can be.
Even if you have a healthy investment portfolio, you could be forced to make less-than-ideal money moves if you don’t have enough liquid savings.
Having a financial cushion provides flexibility and can alleviate headaches and potential tax consequences if you need cash quickly.
We recommend keeping your emergency fund in a high-yield savings account offering competitive interest rates, typically offered by online savings accounts.
Maintaining an emergency fund with three to six months of living expenses is generally recommended. But you may want to save more if you work in a field where jobs are scarce, a significant portion of your income is commission or bonus-based, or you’re the sole source of income for your spouse or dependent children.
Plan for Current Expenses and Longer-Term Goals
Your highest earning years are also usually your highest spending years. If you're earning well over six figures, you may easily be able to cover recurring expenses, such as your mortgage, tuition payments or financial support for aging parents or other relatives.
However, it’s important that you understand the impact your current spending has on your ability to save for retirement and not lose sight of your longer-term goals.
Working with a financial advisor to review your current cash flow and build out longer-term goal-based planning can help you determine whether you can make your goals a reality while meeting your current financial responsibilities.
Once you identify your mid- and long-term goals, it’s important to review them regularly to consider inevitable life changes.
Create and Update Your Estate Plan
Estate planning doesn’t always come to mind when thinking about retirement planning. Because there isn’t a deadline to complete it like there is for making health insurance elections or 401(k) contributions, it’s a to-do item that often doesn’t get crossed off the list.
But it’s crucial for nearly everyone, especially well-compensated employees. High earners often have multiple asset types, and the more complex your estate is, the more important it is to have an estate plan.
Estate plans allow your heirs to avoid probate, keep the distribution of your assets private and minimize estate taxes—if you’re subject to them.
But estate planning isn’t just about what happens after you die. It also allows you to give someone the authority to make medical and financial decisions on your behalf while you’re alive—if you’re unable to.
Once you create an estate plan, it’s essential to review it from time to time as family and personal relationships evolve and laws that can significantly impact your overall strategy change regularly.
Each time you review your plan, check to make sure your beneficiary designations are accurate, and your assets are titled correctly.
Understand Insurance Needs & Review Coverage
Having adequate insurance coverage is an essential part of a comprehensive financial plan. And it’s one of the simplest ways to protect yourself and your family before and after your death.
Policies that highly compensated employees should consider include life, disability, homeowner’s/renter’s, auto and umbrella insurance.
Disability and life insurance are crucial if you have a spouse or dependent children who rely on your income.
When evaluating your coverage needs, take a deep dive into your finances to determine what assets would be available and what additional expenses your family might incur if something happened to you.
Purchase enough coverage so that your family would be able to maintain their current lifestyle if your income was no longer available. Make sure you name the appropriate beneficiaries for each of your policies.
Having adequate insurance coverage isn’t just about death and disability. The more assets you have, the more you have to lose. Having adequate property and casualty insurance can help mitigate that risk.
When purchasing or reviewing P&C coverage, you need to understand what’s covered and what isn’t. For example, as housing prices have risen and inflation has made it more expensive to rebuild, some people don’t have enough homeowner’s insurance coverage.
When purchasing auto insurance, don’t settle for your state’s minimum coverage. It won’t be enough if you’re in a serious accident.
If the liability limits on your auto and homeowner’s policies aren’t equal to or more than your assets, consider purchasing an umbrella policy for greater protection.
Know Your Employee Benefits
If someone asked about your employee benefits, you’d probably be able to list things like health, life and disability insurance, paid time off and 401(k) matching contributions. But what about gym memberships, tuition reimbursement or legal assistance plans?
Many employers offer fringe benefits at low or no cost to attract and retain top talent. But employees often don’t even know they’re available.
Being aware of what your employer offers is a great way to enhance your overall benefits package and save money on services you’d otherwise pay for out of pocket. You can use the money you save to achieve your short- or mid-term financial goals or invest it for retirement.
Next Steps
Many people who reach a six-figure income milestone often fall into one of two buckets:
They’re either DIYing their financial plan or they’re wishing they were getting more from their current investment adviser who helped them get started. They feel like they’re missing opportunities and need more sophisticated financial advice.
If this sounds familiar, our advisors can create a comprehensive wealth management plan tailored to your unique situation and goals for the future.
Take our two-minute financial analysis to find out if your existing financial plan needs an upgrade and get individualized suggestions based on your answers.
