Episode Transcript
Brenton: [00:00:00] The employee benefits at your job can impact you in several ways, but not all of those ways are positive. In this episode, we talk about a topic called reverse discrimination and how it impacts high income earners during their open enrollment. Let's get started.
Brenton: Hello, my name is Brenton Harrison of New Money, New Problems and your host for the New Money, New Problems podcast. We are in the middle of a series on employee benefits [00:01:00] because it is open enrollment for many of our listeners. The time of the year where they pick the employee benefits that they do and don't want to take advantage of the upcoming year.
We've covered HSAs, FSAs, dependent care FSAs. And we're going to, over the next couple episodes, talk about some ways that employee benefits can negatively and positively affect high income earners specifically. And we're going to start with the negative ways. We're going to get that out the way.
I'm the type of person where if you say I got good news and bad news, I want to hear the bad news first. So today's episode is all about a concept called reverse discrimination, and reverse discrimination is the idea that the structure of employee benefits You can actually make it so that high income earners do not get to fully participate in some of those benefits as compared to some of their other coworkers.
Even though your problems may differ a little bit, they are similar, but just at a different scale, and reverse discrimination is something that attempts to at least define the concept of you getting the short end of the stick for some employee benefits.
So, let's cover some of the ways that reverse discrimination can [00:02:00] impact a high income earner as they go through open enrollment and the benefits from which they can choose.
One of the first areas you see this concept come into play is with a 401k, specifically with a 401k match. Matching contributions on a 401k are a wonderful benefit and if you're a corporate employee and have decided to go that route, it's something that you definitely want to make sure that you don't miss out on if the rest of your finances are in good shape.
We've had episodes where we've talked about making sure you have a firm foundation in terms of savings before you even dip your toe in the water of a 401k, but once you are in that 401k, the next goal would be to make sure you're contributing at least up to the match that's offered by your employer.
This is a very big deal.
As a matter of fact, a few years ago, Fidelity undertook a study where they surveyed the habits and the accounts of people who had 401ks with at least a million dollars in their account balance.
And if you're looking on screen with us, we're going through an article where they talk about some of those habits, but number three on this list in terms of what they recommend is to [00:03:00] meet your employer match.
And there's a statistic here that I found just. It's unbelievable when I read it, and I'm quoting, it says, here's a fact that drives home the importance of taking the money, the money being the match. 28 percent of contributions in the average 401k millionaire's account came from his or her employer. On an annual basis, employer contributions boosted the average 401k millionaire's savings by almost $4,600.
Now I want to go to the larger number, and keep in mind, we're talking about people who have at least a million dollars in their account. And if 28 percent on average came from company match, that means that these people have more than a quarter of a million dollars in their account on average that didn't come from their money.
It came from their company match. So taking advantage of these free dollars is a big deal even for high income earners. But unfortunately for high income earners, because of the level of income, they often don't get to participate fully in that company match. Here's what I mean. If you have a job that has a match on your 401k, they often have terms [00:04:00] that will tell you what percentage of that contribution they will allow you to have as a match.
The problem, however, is that in addition to that matching contributions, these employers also put a cap on the dollar amount that they will contribute in matching dollars towards your plans.
So for example, they may say, we'll give you a 3 percent match on contributions. As long as that 3 percent does not exceed 10, 000. 10, 000 is the most that we will contribute to your plan on behalf of the company. So if you earn enough money where your match exceeds that limit, you don't get to take advantage of the full match.
If you're following along with us on screen, let's go through an example. Let's say that we have somebody who works for a corporation and they have a 300, 000 salary and they participate in their company plan. And that plan has matching contributions.
So, for example, let's say that they have a 100 percent match on the first 3 percent of contributions. So, if you put in 3 percent of your pay, they will match dollar for dollar and they'll put in 3 percent as a match as well.
And they match [00:05:00] 50 percent on the next 2 percent that you contribute. So, essentially, if you put 5 percent of your dollars aside, they will match at 4%. But on top of this, they put a 10, 000 cap, so they're offering a 4 percent match, but that match cannot exceed that 10, 000 limit. Well, if you just do some quick math, $300,000 in salary times 4% is $12,000.
And $12,000 exceeds that cap on matching contributions from the company by $2,000. So, if this person puts aside 5 percent of their pay to the 401k, which would be 15, 000, while the rest of their coworkers at a lower income level may get the benefit of that full 4 percent match, this person would not.
They would be limited to 10, 000, even though their income says that they should get 12, 000 in company contributions to the plan. If you think that's not significant, 2, 000 over the course of 30 years growing at a rate of return could make a significant difference in this person's [00:06:00] 401k. But as a result of reverse discrimination, they are limited and cannot fully participate in this employee benefit.
Now, let's stay on that same thread with 401ks and talk about how the contribution limits to a 401k for the employee can even be a case of reverse discrimination. We're going to stay with our person with a 300, 000 salary and we're going to assume that this person is a super saver.
Maybe they read articles online that say that you're not going to be able to make it in retirement unless you save at least 10 percent of your income in your working years or 15 percent or 20%.
Well, if this person with a 300, 000 salary has a 10 percent retirement savings goal, that would mean that if they had their rathers, they would be able to put 30, 000 a year towards their retirement. But a 401k does not allow an endless or an infinite amount of contributions.
As a matter of fact, in 2023, the contribution limit for 401k is 22, 500. So even though this person wants to put aside 30, 000 towards their retirement, at least in this particular [00:07:00] account, they're going to be limited. And if you compare that to their actual salary, instead of 10%, they would be restricted to a 7. 5 percent savings rate. Now, in the next episode, we're going to talk about some positive ways that being a high income earner can be impacted by employee benefits. And there are several ways that you can get around this, depending on the structure of your 401k. There's things like after tax contributions.
We'll talk about a mega backdoor Roth, which is something that you might have heard of, but that has to have a particular type of 401k to be eligible. If you don't have those eligibility structures in place, then you would be in the scenario where you want to save more but when it comes to this plan, you are prevented from doing so all because you earn too much money.
After the break, we'll go even further down this wormhole and we'll see what this person's options are if they don't have a 401k that allows them to make extra contributions. And maybe they wanted to find an account outside of their employer, but even that amount of income will restrict them from doing so.
And when we get to the other side of the break, [00:08:00] we'll show you how.
[00:09:00]
Brenton: Before the break we gave a couple examples of a person who earns 300, 000 who is restricted by the rules of their employee benefits, both in terms of the amount of their company contributions they can have in their 401k as a company match, and also the percentage of their income that they can put towards their 401k in the first place.
Now we're going to go further along that thread and we're going to say what if that person said I don't have the ability to put the money that I want to in my 401k, one of the first places they would probably go is to either an individual retirement account or a Roth individual retirement account. You will recall that with an individual retirement account, you're putting money aside that is pre taxed. You are deducting that amount that you contribute from your taxable income which means you're paying lower taxes on the front end, but in retirement, when you take those funds out, you pay taxes on those dollars as if you [00:10:00] earned them. Conversely, with a Roth IRA, you're putting money aside that has already been taxed in exchange for being able to withdraw any amount of funds you want to in retirement without paying income taxes on those funds.
So whichever way this person wants to contribute, those are two options that they might consider. Either a pre tax or traditional IRA or a post tax or Roth IRA. Let's first start with a Roth IRA and what you're looking at on screen if you're following along with us are the tax tables from the Certified Financial Planner exam.
And what you're looking at on screen is a phrase that says Roth IRA phase out.
This is the amount of money where if you earn more than these amounts, you cannot contribute to a Roth IRA. Now, we have a person who earns 300, 000. If they are single, then there is a range that's listed on this sheet from 138, 000 to 153, 000.
This is referring to this person's modified adjusted gross income, a tax term that we've covered in previous episodes. But essentially what they're saying is [00:11:00] if this person earns with. In the range of 138, 000 to 153, 000 in adjusted gross income, then the amount that they can contribute to a Roth IRA is reduced.
So maybe instead of the traditional 6, 500 limit, they would be limited to 3, 000 or 2, 000 or 4, 000. But if their modified adjusted gross income falls within this range, they're basically saying the amount that you can contribute is reduced. Now, if it goes above 153, 000, you can't contribute at all.
So at a 300, 000 salary, even if this person has a ton of deductions, they may not be able to get down in terms of their adjusted gross income below this range, which means that they cannot contribute to a Roth IRA at all.
In the next episode, we'll also talk about some options for people who want to do Roth investing who earn too much, but in terms of the Roth IRA, the person in our example would be prohibited from contributing. Now, let's assume that instead of the Roth IRA, they say, okay, I can't do that.
Maybe I will [00:12:00] now put the extra funds into a traditional or pre tax IRA. But even with the pre tax IRA, based on what a person earns and what employee benefits they have at their job, they may be limited in how much they can contribute or deduct from that contribution as well.
What you're looking at on screen is a phrase that says IRA deduction phase out for active participants. An active participant is a person who has a retirement plan available to them at their employer like a 401k or 403b.
Even if they choose not to take advantage of those plans because they have access to it, they are considered an active participant. And if you are an active participant and you earn too much in adjusted gross income, you can contribute to a pre tax IRA. You can even max out those contributions, but you may not be able to deduct all or any of what you contribute, which is a big reason people put money in these accounts in the first place to get that tax deduction. As an example, for a single person or someone who files head of household, that phase out range for active participants is [00:13:00] 73, 000 to 83, 000 of modified adjusted gross income.
So a person in our example is far above that, married filing jointly, it's from 116, 000 to 136, 000, again, the person in our example is far above that.
So, what they're saying to this person is, even if you've maxed out the 401k at your job and you said, I wanted to put aside an extra 6, 500 towards my retirement, you can put that 6, 500 into a pre tax IRA if you want to, but you may not be able to deduct those contributions by doing so. And it gets even worse.
Let's say that you have a stay at home spouse and that spouse wants to put money aside in their own retirement accounts. They don't want to just say, Hey, at least my husband or at least my wife is putting money in their retirement account. They want a retirement account with dollars that are in their own name, which is completely understandable.
So they may say, I want to open up an IRA. But when it comes to a traditional IRA, you have to make contributions based on your earned income and you cannot [00:14:00] contribute more than 100 percent of what you earn. So if the contribution limit to an IRA is 6, 500, but you only earned 2, 000 for the year, you're going to be limited and you cannot contribute that 6, 500.
It's more than 100 percent of what you earned in the taxable year. Now that differs when you have a spouse that earns income. And if you do, you can use their income to justify your maxing out an IRA. And when you do that, it's what's called a spousal IRA. I am using my spouse's income to justify my contribution to my retirement account.
But even if you're the spouse of an active participant, you could be limited to how much you can deduct by putting money into these pre tax accounts.
To finish, let's talk about reverse discrimination in insurance. We've done enough about retirement accounts, but I want to show you how even when it comes to protecting your income, reverse discrimination can have an outsized impact when it comes to employee benefits and high income earners. We're going to cover disability [00:15:00] insurance, and disability insurance is something that we haven't talked about a ton on the podcast.
But the premise of disability insurance is it's paycheck protection. It makes sure that if something happens and you're ill or unable to work, that there's a percentage of your income that's replaced by that insurance company that offers you the coverage. Now, oftentimes when you have coverage through your employer, it's called group disability coverage, and they will replace a certain percentage of your income.
You might have a policy that replaces 60 percent of your base pay, but they also often partner that percentage with a cap, just like with the 401k match. So for example, they may say, In terms of your benefits for disability insurance, if you're totally disabled, we will give you back 60 percent of your base pay up to a cap of 10, 000 a month.
So let's go back to our example of a person with a 300, 000 salary and their group disability policy at their job says exactly that. We'll cover or replace 60 percent of your base pay up to a cap of 10, 000 a month in the event of a [00:16:00] total disability. Now, if you look at 60 percent of 300, 000 a year, it's 180, 000, and that's 15, 000 a month.
But 15, 000 a month far exceeds the 10, 000 cap offered by that group disability policy. So if you subtract the two, you would find that this person in this example has 5, 000 a month of uncovered base pay because of the limits of their disability policy. So if this person's depending on that extra $5,000 a month as most of us are during our working years, they would have to supplement their coverage at work with an individually owned disability policy to make up that gap.
But it's not just that, because remember I said that most of these policies replace only your base pay. And it's highly likely if you're a high income earner that you not only receive bonuses, but those bonuses might be substantial. And depending on where you live or your financial situation, you might depend on those bonuses.
You might even depend on the bonuses that are tied to equity compensation, like with restricted stock [00:17:00] units or stock options. And if you're not working, maybe you're ineligible to receive those equity benefits or those bonuses in general. But even if you are working, the limitations of your disability policy will say that they do not cover bonuses when it comes to calculating your total earnings.
So if you're working for a tech company like a Meta or an Amazon or an Alphabet, and not only are you used to getting restricted stock units, but you and several of your coworkers may regularly cash out that stock in order to pay for the high cost of living in the areas in which you may live.
If you were to be disabled, you may not be able to receive that equity compensation in terms of the percentage of your income they replace with your disability benefit. I know this is really deep stuff, but the whole point of this podcast is new money, new problems.
You're making more money than you ever thought you'd make before, but it comes with a whole host of other considerations that you have to be aware of. And employee benefits is just one area where that income can come with a need for more financial literacy and understanding of what's in front of you so that you're not [00:18:00] shortchanged in a period where you really, really need all the change you can get.
Next week we're going to talk about some of the ways your high income can be positively impacted by your employee benefits, and I look forward to seeing you then.
