Episode Transcript
There are several ways that employee benefits can be of a benefit to the tax and investment strategies of high income earners. In this episode, we're going to talk about five of those ways in particular and tell you how you can integrate them into your planning. Let's get started. Let's get some money.
From new money, new problems, it's That's the New Money, New Problems podcast, a show for successful professionals searching for the tools they need to navigate financial opportunities and obstacles they've never seen. Negotiating compensation, purchasing your first investment property, helping your family with money, the highs and lows of entrepreneurship.
New money brings new problems that require new solutions. Join us as we work through them together. I'm Brenton Harrison, and this is the New Money, New Problems podcast. Hello, my name is Brenton Harrison of New Money, New Problems, and your host for the New Money, New Problems podcast. If you've been following along the past couple episodes, you know that it is open enrollment for many people who listen to this show, the time of the year where they pick the employee benefits that they want to use for the upcoming 12 months.
And in the last episode, we talked about some of the negative ways that being a high income earner can be affected by your employee benefits. We talked about a term called reverse discrimination. Where because you earn too much, you can't fully participate in some benefits like employee matching or the percentage of your income you want to spend or save towards your retirement.
In this episode, we're going to flip the script and we're going to talk about how you can utilize some employee benefits that are specifically set aside. To be used by those who typically have a high income. So here we are with five ways that you can use your employee benefits to enhance your finances as a high income earner.
Number one, our health savings accounts, flex spending accounts, independent care, flex spending accounts. And we talked about what the health savings account, these are funds where you put them aside for your health. Pre tax, you pair it with a high deductible health plan and unused funds roll over from year to year.
And after the age 65, those funds can be used for whatever you want to, even if it's not a health expense. Now, while anybody can take advantage of a health savings account, we also covered that because it has to be paired with a high deductible health plan for families who have members of that family who may be in poor health, or maybe they don't have an emergency fund set aside.
It may not be ideal. Deal to put yourself in a position where if you have to go to the doctor, instead of maybe having to cover 1, 000 before insurance company steps in, you have to pay 5, 000 high deductible health plans are not for everybody, but because of that high deductible, you also often see this utilized by high income earners who both have the reserves to contribute without worrying about the deductible, but also are concerned about lowering that taxable income.
Now with FlexPenny accounts and dependent FlexPenny accounts, you don't have to alter any underlying coverage. So while you don't have people who are concerned about a deductible, it does just naturally lend itself to people who are of a higher income because many of the things that you would use for a dependent care FlexPenny account.
Like daycare for kids younger than kindergarten or an afterschool care or even a registration fee or a summer camp, they happen to be children of high income earners. And that pre tax deduction can be really, really powerful. If you're following along with us on screen, you're looking at a health savings account contribution limit.
For 2023 of 7, 750 for a family. We also covered that for a dependent flex spending account, it's 5, 000. So that's almost 13, 000 that can be removed from your income pre tax. So let's do some back of the napkin math and assume that we have a family who may fall into the 32 percent marginal tax bracket and they max out their health savings account and a dependent care flex spending account.
By putting that 12, 750 aside to cover expenses that they probably already had to cover, they are saving 32 cents on the dollar for those deductions, which totals out to 4, 080 in saved taxes just by utilizing these vehicles. The second benefit are Roth 401ks and 403bs. In our most recent episode, we talked about the way that your Modified Adjusted Gross Income can restrict or eliminate your ability to participate in Roth individual retirement accounts.
If you're following along with us on screen, you see a phrase that says Roth IRA phaseout. And you can see that for a single individual, that phase out range is an adjusted gross income of 138, 000 to 153, 000. For married filing jointly, it's 218, 000 to 228, 000. So if you earn above those amounts and modified adjusted gross income, you just cannot contribute to a Roth individual retirement account.
But there are many 401ks and 403bs who, in addition to having a pre tax component where you put aside those funds before they're taxed, also have a post tax or Roth version of that same 401k and 403b. And while a Roth IRA restricts the people who can contribute to people whose modified adjusted gross income are below a certain level, there are no such restrictions on Roth retirement accounts such as a 401k or 403b.
You could make a million dollars a year and still be eligible to participate in these accounts. Now, I will give you a fair warning. If you're a high income earner and you also have federal student loans that are of just a very high multiple of your income, we've covered in the past that it's highly likely you're paying those student loans back using an income driven repayment plan.
Those plans require you to pay based on a percentage of your income each year. And the way they calculate it comes from using your adjusted gross income in that calculation. So you want to be careful. While Roth retirement investing is great. Hey, I can put aside money that's already been taxed now in exchange for not having to pay those taxes in retirement.
If you're in a situation where you earn a lot and you also have student loans that are on income driven repayment plans, you want to take advantage of as many pre tax deductions as you can. Because that lowers your adjusted gross income and thus lowers your student loan payment. So even though a Roth 401k and 403b is a great benefit that you may not have in terms of a Roth IRA, you want to be careful to make sure that that strategy lines up with the rest of your financial plan as well.
The third benefit we're going to cover is along the same vein as Roth retirement accounts, and it's after tax contributions to a 401k. Now, after tax contributions work very similarly to a Roth account. With a Roth account, you put aside money that has already been taxed, and in retirement, you don't pay income taxes on either your contributions or the gains.
There are no income taxes. After tax contributions to a 401k are similar, but not exactly the same. If you're following along with us on screen and we'll put a link to this article in the show notes, I will read from a section about after tax contributions and I quote, after tax contributions to a 401k plan are similar to Roth contributions in that they're made with after tax dollars and don't reduce your taxable income in the year you make them.
But unlike with Roth contributions, 22, 500 limit. End quote. Let's first start with what they're talking about there. There is a contribution limit that the IRS sets every single year to what you can put into your 401k and 403b. In the tax year 2023, that limit is 22, 500. But there's a second, much higher limit.
That comprises a number of other things such as profit sharing contributions that your employer might put into your account on your behalf, such as the match that that might put into your 401k or your 403b. And when you look at that limit, it's significantly higher. That limit is 66, 000 as compared to 22, 500.
And one of the things that you can use to get you up to that 66, 000 limit is an after tax contribution to a 401k. And these contributions are unique because as it stated in the article, they do not use it to count what goes up to your 22, 500 limit. The only things that count in that number are your actual pre tax contributions or your actual Roth contributions.
And you cannot double up. You can't put 22, 500 in the Roth. 22, 500 in the pre tax in total between those two accounts. Even if you mix and mingle, it cannot exceed 22, 500. But after tax contributions can go above that number without counting because they work a little differently. And going back to the article, it says, and I quote, the tax treatment of after tax contributions comes with a catch.
Unlike with Roth contributions, your withdrawals during retirement aren't tax free. Instead, your investment gains at the time of withdrawal will be taxed as ordinary income. Remember, with Roth retirement accounts, you put aside money that's already been taxed, and in retirement, you can take out what you've contributed.
and the gain's income tax free. What they're saying with after tax contributions is if you put aside 100, 000 after tax and it grows to 500, 000, that 400, 000 of growth will be taxed as ordinary income if you leave it in that version of the account. But in the next episode, we're going to cover a strategy called Mega Backdoor Roth IRA Contributions.
And this is something where you use after tax contributions to a 401k to eventually make their way into a Roth IRA, skirting the income limits that we've seen on these previous tax tables. So that's another episode for another day, but for today, know that after tax contributions are the first step in a strategy that could benefit your taxes and your investments as a high income earner.
This is the New Money, New Problems Podcast, a show for successful professionals. Searching for the tools they need to navigate financial opportunities, obstacles they've never seen. We'll be right back.
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your list. Thank you for listening to the New Money, New Problems Podcast. Subscribe now at NewMoneyNewProblems. com. Welcome back. The fourth benefit that gives unique advantages to high income earners are 457 plans. We've talked about 401ks, we've talked about 403b's. 457 plans are another plan that share similar features to these accounts with a couple extra benefits.
Similar to a 401k or a 403b, the contribution limit to a 457 plan is 22, 500 for the year. This is a retirement plan that you typically see for like a government or a non profit, a health organization like a hospital. The employees of these organizations may have access to this 457 and if they do, they can put up to 22, 500 in the account.
But unlike with the 401k and Roth 401k, where the combined amount that you put in these tools can't exceed 22, 500, you can put an additional 22, 500 in the 457 plan on top of what you've done in those previous vehicles. This presents a really unique opportunity to those high income earners who are trying to lower that taxable income.
Oftentimes for student loan purposes, because now instead of 22, 500, they can put up to 45, 000 in these two different accounts and lower their taxable income by that amount. And by lowering that adjusted gross income, they also lower their student loan payment. Again, going back to that back of the napkin math, let's assume that we have a couple who puts 45, 000 into their pre tax 401k and into a 457 plan.
Let's also assume that they are in a position where they're in the 32 percent marginal tax bracket. By maxing out those two accounts, they are saving themselves 14, 400 worth of taxes. And not only that. If they're also paying their student loans back using an income driven repayment plan, they could save themselves almost 400 a month on that income driven repayment.
But there's a whole second benefit to 457 plans. With 401ks and 403bs, the age that you can access these accounts without penalty is in some cases 55, but in most cases 59 and a half. But with a 457 plan, as long as you separate it from employment, you can access this account Any age you choose, this makes it a great tool for people who are either trying to retire early or put themselves in a position where they can choose the type of work that they want to do before traditional retirement age.
And as such, when I have people I work with who do have. Entrepreneurial aspirations who do want to be able to work part time starting at age 50, a 457 plan is a great tool to get them closer to that objective. The fifth and final benefit we'll discuss are Deferred Compensation Plans or Executive Bonus You see this in many types of tools like a 401 A permanent life insurance policy that's owned by the employer on the life of the executive.
Whichever form it takes, the concept is essentially either a company is putting aside money on your behalf or you're deferring a portion of your salary in exchange for receiving those funds at a later point in time. Maybe it's in your 50s, maybe it's in your 60s, but it is an executive retirement plan that's set aside for a specific purpose.
Special class of employees. It's not just your income. It may be a C-suite level person or a director level employee, or ASVP or an EVP where you have access to a different set of retirement vehicles in addition to what the rank and file employees may have as well. So whatever form it may take, this is just another structure of a retirement plan where you reach a certain point and your company may be able to put aside money even above and beyond a profit share or above and beyond a company match to make sure that you have those things in your retirement plan that will buffer the amount that you can live off of in your golden years.
We covered five things, but these are just a few of the ways that you can see your income and your retirement investments buffeted just by the fact that you happen to have reached a certain point in your career. We haven't even talked about equity compensation like RSUs and stock options. Those are for another day, but I hope this was helpful.
And giving you a primer on some of these executive benefits. And in next week's episode, we're going to cover in detail the mega backdoor Roth IRA. From New Money, New Problems. This was the New Money, New Problems podcast, a show for successful professionals searching for the tools they need to navigate financial opportunities and obstacles they've never seen.
