I'm not that old, so I was still in school when a company called The Ladders hit the scene in 2003. Marketing themselves as the premier recruiters for employees making six figures or more, their advertisements preached about just how different things were for people at this income level: they had to apply for jobs differently, they needed a certain type of visibility, and of course, The Ladders could provide all of these things to them exclusively. At the time I can remember thinking two things: 1. are there really THAT many people out there making over $100,000 a year?!!?, and 2. if there are, how can they possibly have any problems? Life should be good! Well, if you're one of those who has climbed the corporate ladder and found yourself in a position of a "highly-compensated employee", you know that I was being a little short-sighted. Sure, the more money you make, you do have access to some great things. But you also know that the more money you make, issues can pop up that weren't even relevant when you made a lower income: increased tax burdens, professional privilege fees, higher insurance needs and much more. Thankfully, working for a larger employer gives you access to certain benefits that can help you achieve your financial goals and protect yourself from loss. It is important, however, that you understand how those benefits can differ for high-income earners. So today, we're going to take a look at some common benefits offered by corporations, how they are impacted by the salary of the employee, and ways that you can use them to your advantage. Here are a few common benefits that high income-earners should review closely:
Maximum Match On 401(k) Plans
There have been a ton of articles written in recent years about a 2012 study by Fidelity on 401(k) millionaires. One of the findings of that study was that on average, 28% of the respondents' 401(k) balances - which were all over $1 million - came from matching employer contributions. That means that on average, at least $280,000 in their 401(k)s wasn't even their responsibility to save! You may work for a company that matches up to a percentage of your pay that you save in your retirement account, but it's important to understand the limitations of that match. Many companies will match up to a set percentage, as long as that percentage does not exceed a certain dollar amount. For example, let's say your company will match the first 5% of your salary contributions into your 401(k), up to a limit of $10,000. This stipulation means that any employees earning over $200,000 can't receive a full 5% match; instead, their match will stop at $10,000, because 5% of their pay exceeds the company limit. Now $10,000 is a lot of money, especially when it's free; but if you're a highly-compensated employee, your salary actually prevents you from receiving comparable benefits to those who make less than you; it's called reverse discrimination, and the 401(k) match is just one of the places impacted. Here is another ...
Maximum Contributions to Retirement Accounts
Along the same lines as the company match, the contribution limits to your company retirement plan can present another form of reverse discrimination. In 2018, employees under age 50 can contribute up to $18,500 into their company 401(k) (employees over 50 can contribute an additional $6,000 in "catch-up contributions"). For highly-compensated employees, the $18,500 limit might not allow them to contribute enough money to meet their income goals in retirement. There are a lot of schools of thought on how much we should save during our working years, but let's assume you've decided you would like to save 10% of your pay in your company plan. That percentage would mean that if you earn more than $185,000 in salary - $18,500 being 10% of $185,000 - you would not be able to put your full 10% contribution in your 401(k). You would have to find other options, be it an individual retirement account that may or may not be tax-deductible, or even settling for saving in an account that is not strictly seen as a retirement vehicle, such as a permanent life insurance policy or a non-qualified (i.e. non-retirement) investment account.
Deferred Compensation Plans and After-Tax 401(k) Contributions
To make up for the limitations that 401(k)s put on high income-earners, many corporations offer deferred compensation options to employees of a certain rank in their organization. Deferred compensation plans allow employees to defer a portion of their income, up to a certain limit, and choose a date in the future when they would like to receive those funds. The money that is deferred is invested, and since you're not receiving the income immediately, you don't have to pay taxes on it until it's paid out. There are pros and cons to deferred comp plans, but they do offer high income-earners a certain level of control over when they will pay taxes on income that may not be needed at this point in time. Additionally, some 401(k) plans allow employees to make after-tax contributions to their accounts, and by doing so, increases the amount they can put aside from $18,500 to $55,000. If you're hardcore about your retirement savings and feel that you might not be contributing enough, see if your company offers either option and ask how you can start saving the additional funds.
I've written in the past about the limitations of traditional, pretax 401(k)s; it's not that I don't think they're great tools, but I do think there is a case to be made for spreading your wealth across different types of plans. With traditional 401(k)s, you do not pay taxes on the money you contribute now, but any withdrawals from these accounts in retirement will be treated as income when you file your taxes. It is my opinion that too many people underestimate the impact of these taxes on your retirement income. Now many of you as residents contributed to a Roth IRA, where you put money aside for retirement AFTER it has been taxed, in exchange for not paying income taxes on those monies when you use them in retirement. You did this as residents because some financial advisor probably told you that once you leave residency/fellowship, you won't be able to use Roth accounts anymore. That statement is actually only partially true. It IS accurate that once you cannot contribute directly to Roth IRAs once you exceed a certain income (in 2018, $135,000 for individuals, $199,000 for married couples filing taxes jointly), but there is also a place where you can contribute to Roth accounts no matter how much you make: the Roth 401(k). For investors who prefer to get their taxes out of the way now in exchange for not paying them later, the Roth 401(k) is a ground-breaking tool. It not only allows you to contribute regardless of income, it also allows you to take advantage of your company match while still using a Roth. How this would work is that your employer would contribute their matching funds into a traditional 401(k) account, while your contributions would go into a Roth account. You might find that you can even split your contributions between the two plans!
Group Disability Limits
I cannot overemphasize how often I find myself in this scenario: I meet with a highly-compensated employee to review their benefits, and the topic of disability insurance comes up. I ask them, "do you have an insurance policy that provides an income to you in the event of a disability?", and their response more often than not is "yea, I have that covered through my job". And they truly think that they do. But when I ask to see their benefits plan, they find out an important but often overlooked component of their plan; it caps how much you will be paid. To provide some context, long-term disability insurance is insurance that provides a a percentage of your income to you in the event of a disability. Most disability carriers aim to replace 60% to 70% of your take-home pay if you meet their definition of being totally disabled. But many employer plans say that, similar to the language in your 401(k) match, they will pay that percentage of your income as long as it does not exceed a certain amount. For example, if your group plan states that it replaces 60% of your salary, up to a maximum benefit of $5,000/month, this means that you will NOT receive your full 60% of your salary if that exceeds the $5,000 limit. Depending on how much you're earning, the gap between how much coverage you need and how much coverage you actually have at your job can be pretty steep. But that's not all. Oftentimes group plans don't cover bonuses, profit-sharing distributions or overtime pay, things that many corporate employees count on from year to year. If any of this sounds like it might be applicable to you, go to your company benefits page or ask your HR representative for a full-description of your policy specifications, and make sure that what you think you have is actually there for you in a time of need.
HSAs, FSAs, and Dependent Care FSAs
I will state my bias right here and now: I think HSAs, FSAs, and Dependent Care FSAs are some of the most under-utilized tools in the financial realm of high income-earners (in fact, we gave them their own video!). Health Savings Accounts, or HSAs, are accounts where you can save pretax dollars to pay for certain medical expenses. In order to utilize an HSA, you have to pair it with a High-Deductible Health Plan (HDHP) through your employer. If you do so, you can save up to $3,450 in pretax HSA dollars as an individual, and up to $6,900 for families in 2018. Flex Spending Accounts are also accounts that can be used to pay for medical expenses, but without the requirement of having a particular type of health insurance plan. This flexibility does come with a lower contribution limit ($2,650 in 2018), but it is still worth evaluating. Last but certainly not least, the Dependent Care FSA. Dependent Care FSAs are accounts funded with pretax dollars that can pay for a surprisingly-large number of expenses related to your dependents. If you're a young parent, you can use Dependent Care FSA funds to pay for babysitting, or after-school care, even summer camps! And for those who might be responsible for a parent of diminished health, these plans can provide for expenses such as adult day care and home healthcare professionals. In 2018, individuals can contribute up to $2,500 pretax in Dependent Care FSAs, while married couples filing jointly can deposit up to $5,000. Now let's say that you're a married parent of a young child, and you're a highly-compensated employee of a company that offers an HSA and a Dependent Care FSA. That means you would have up to $11,900 in pretax contributions that could be made for things that you already pay for, reducing your tax burden along the way. In other words, it's worth looking into!
These are just a few of the ways that highly-compensated employees are not only impacted by their benefits at work, but can use them to their advantages. While it may seem illogical, the less money you make, the more likely it is that your company benefits cover a significant portion of your insurance and investment needs. But the higher your salary climbs, you must pay close attention to make sure that your income is protected and you're able to put aside enough for a comfortable retirement. By doing a deep dive into your benefits, you might find a few shortfalls, or you might find that there are plans available to you that actually enhance your ability to build wealth during your working years. So do your research, be informed, and keep growing!