By Blaine Thiederman MBA, CFP
Founder and Principal Advisor, Progress Wealth Management
So, you’re part of the lucky few that make well over what they need and you’re not sure what to do with the extra cash? This article will explain how to think about what you should do next with the extra money you have every month and in doing so, we hope to help you understand what your next step forward looks like.
Before reading this, make sure you check out our disclosures here.
What we’ll be reviewing includes:
- Start here – how to make sure you’re not being less than prudent
- Don’t miss out on the free money
- Don’t guarantee an audit by the IRS by avoiding these mistakes as you save
- How you might want to consider prioritizing saving for retirement
- How to get money into a Roth even if you make a LOT of money
- How to invest in brokerage accounts when you earn a LOT (and it’s not in mutual funds or ETFs)
Throughout the last decade in finance, I’ve reviewed the financial lives of literally thousands of people and I’ve found a few consistent mistakes.
- Most non-professionals have no idea how to put together a strategy to afford each financial goal they have efficiently meaning they make a lot and save but aren’t really sure what account to use, how much they should be saving, and why.
- Typically a lot of the high-earning individuals I’ve worked with have semi-ridiculous bank account balances for no good reason.
- Oftentimes these people don’t have a budget or a will despite desperately needing one.
- They oftentimes don’t analyze their compensation, either so they think they’re paid well but aren’t sure if they can get more (and want more).
- They don’t know what employee benefits to choose including ESOPs, ESPP, NSOs, ISOs, etc. and they’re oftentimes afraid to use them because they’ve heard of massive tax bills resulting.
Needless to say, those are huge problems that probably are costing them tens of thousands of dollars per year (potentially more). That’s no good!
How to structure financial goals:
- List out everything you want to be able to afford in the next 1-5 years (short term), 5-10 years (mid-term), and 10+ years (long term).
- Once you’ve done this… ask yourself what goals you’ve listed are ABSOLUTELY necessary (think retirement, Paying for kids’ college, etc.)
- Once you’ve figured out what things you NEED to be able to afford, you’ll need a financial plan and investment plan to ensure you’re being prudent with your strategy to afford these. Personal Capital has a great mobile application (just be careful; they’ll call you and try to sell you on using them for investing) and some people appreciate using a spreadsheet as well (if you know how).
- Figure out how much you have to save to be on track for those NECESSARY goals before moving on to the unnecessary ones and then, ask yourself how much room you have in your budget to save for other goals that are less expensive. A great calculator for this is included here.
The rule of thumb in financial planning is 3-6 months of fixed expenses in savings in your bank account at all times. 3 months if you have a double-income household and 6 months if you have a single-income household, however, there’s more to it than this.
Some people I’ve worked with say “Blaine I make a lot and spend a little. I feel like a good-looking person on tinder every time I open up LinkedIn because of how often I get recruiters contacting me. Do I really need to have 6 months of fixed expenses?”
The easy answer is, probably not.
Still, it’s important to be careful. Why? Medical costs can suck and no one can forecast when they’re going to get sick. In the United States, that gets pricey.
Hospital costs averaged $2,607 per day throughout the U.S., with California ($3,726 per day) just edging out Oregon ($3,271) for the most expensive. Wyoming ($1,383) has the cheapest with Iowa ($1,606) a distant second.
- Overall, premiums in employer plans averaged $21,342 for family coverage and $7,470 for individual-only coverage.
- For HDHPs, average annual premiums were somewhat lower—$20,359 for family coverage and $6,890 for individual-only coverage.
The 4 percent premium increase in 2020 was only slightly higher than the year-to-year rise in workers’ earnings (3.4 percent) and inflation (2.1 percent). Since 2010, however, average family premiums have increased 55 percent, at least twice as fast as wages (27 percent) and inflation (19 percent), KFF reported.
Employer Premiums and Deductibles Rose Much Faster than Wages Since 2010
Deductibles are for single coverage among insured workers.
So, what should this tell you?
Be careful. If you think you’re at risk of a medical bill, keep enough in savings to at least pay your max out of pocket and 2-3 months of fixed expenses (AKA, you’re NEEDS… insurance, housing, utilities, food, etc.)
Don’t miss out on Free Money
If you have a 401k and an HSA (because you’re on a high deductible healthcare plan), you may get an employer match. This is effectively free money so missing out on this isn’t smart.
If you have multiple employers, you may have the opportunity to get free money in 2 or 3 different 401k’s. Just be careful to not exceed the annual contribution limit ($20,500 for those of us under 50 and $25,500 if you’re over) between all your different 401k plans.
There are oftentimes some additional opportunities as well for free money. Your employer probably sponsors life insurance up to a limit. They help to pay for it for you so might as well get as much as you can at little to no cost to you. If you intend to switch employers regularly, you may want to forego this and instead buy life insurance through quotacy.com or policygenius.com to avoid having to reapply over and over and over again.
Don’t guarantee an audit by making sure you avoid these mistakes
If you make a lot, the IRS pays more attention to you and your likelihood of an audit is MUCH higher.
Few key areas people get audited:
- Overcontributing to an IRA when they have access to a 401k
- Overcontributing to multiple 401ks
- Overcontributing to a Roth IRA
- Over-claiming itemized deductions or claiming a deduction for expenses that are non-deductible
- Over-contributing to an HSA or contributing to one when they’re on a low deductible plan, somewhere.
Refer to our table, below if you’re not sure if you’re permitted to contribute to an IRA.
How you might want to consider prioritizing saving for retirement
So, you have a lot of extra income and you’re not sure what to do with it. We get it! We’ve helped a lot of people in your scenario. Here’s how we typically prioritize saving for retirement.
You’ll notice a few things that you may not fully understand.
- Why pay off high-interest rate credit cards (maybe a 20% APR) before building an HSA (deductible and grow tax-free)? Because it’s a guaranteed loss. HSAs have to be invested and we don’t know what they’ll return.
- HSA’s as a retirement account? WHAT? I thought that was for medical bills? IT IS… but not for today’s medical bills. They can also be used in retirement to pay for Medicare and other medical costs. By not touching them until retirement, you’ll get years of tax-free growth that can help pay for your retirement medical costs.
- A Backdoor Roth? What’s that? (We’ll get into that in our next section)
- Invest in a brokerage account? How? It depends on your goals, risk tolerance, and a slew of other things. If you’d like help, schedule an appointment by clicking here.
- Pay off debt (even my mortgage)? Sounds dumb! I can get more in the markets! You’re probably not wrong! But if you’re saving more than enough to afford literally every goal in life… why not? Nice to eliminate risk in the event you lost your job or died prematurely. Nice to know your family’s gonna be fine no matter what.
How to get money into a Roth even if you make a LOT of money
Many of you may earn well over the income limit for Roth Contributions and you may have thrown in the towel saying “I guess I’m not permitted to.”
For your reference:
Roth IRA contributions income phase-out ranges for 2022 are:
- $129,000 to $144,000 – Single taxpayers and heads of household
- $204,000 to $214,000- Married, filing jointly
- $0 to $10,000 – Married, filing separately
The question is, how do people get money into those things, anyways?
The simple way is to use the “backdoor”. Since the verbiage says “no contributions”, you have to ask yourself, “is there another way to get money in other than contributing it?”.
There absolutely is.
How do you do it?
Step 1. You make a nondeductible contribution to an IRA.
Step 2. You file a form called a “Roth Conversion” form and convert those funds from the IRA you established to the Roth.
Step 3. Success.
Sounds simple, right? Unfortunately, there’s more to it.
You’ll have to file form 8606 with the IRS for the non-deductible contribution and you’ll have to ensure you have no other IRAs when you process this due to a rule called the pro-rata rule.
How to invest in brokerage accounts when you earn a LOT (and it’s not in mutual funds or ETFs)
If you earn well over 200k a year as a household (or expect to in the near future), you’re gonna be paying a small fortune every year in income taxes. If you live in Colorado and file single, technically the total amount of taxes you’ll pay is well over 32% of your income (FICA, state insurance, State income, and federal income taxes combined). That’s a LOT.
Add to the mix a 500k or higher non-retirement account being rebalanced once or twice a year? All of sudden you might have an additional 20-40k in taxable income (meaning a 6-12k tax bill, OUCH).
What if you could lower that? You absolutely can and without sacrificing returns.
If an investment advisor charges 1% to help with this, that means it pays for itself right then and there. Add on financial planning, tax preparation, and planning as well as compensation analysis and and and…
Needless to say, it gets harder to neglect the fact that it’s worth it to hire on a professional when you’re in a high tax bracket to manage your assets.
So, you make a lot of money and aren’t exactly sure what to do with it. We can help.
Progress Wealth Management is a fee-only financial planning firm specializing in helping high-earning individuals who aren’t rich, yet. Our goal is to make you happier, healthier, and (most importantly) wealthier so you can retire young and live out the rest of your life without a worry in the world.
We differentiate ourselves by employing a team of specialized professionals to help you ascend towards your goals faster by employing expert financial planning, investment management, tax planning, and a thorough analysis of every aspect of your financial life. By working with us, you’ll get a tax professional, an estate planner, a team of non-commissioned insurance experts, and your own CFP.
You’ll know as a result of hiring us that you’re growing your life savings as fast as prudently possible because every aspect of your financial life is well-thought-out with an empirical science behind why you’re doing what you are. No more “I hope that’s right” so much as “Blaine and his team have my back”.