Most of us would love to have a high income. After all, extra money to spend on vacations, to afford housing in Boulder County, on activities for the kids, and to achieve financial independence doesn’t seem to be a bad thing. But high earners face more barriers to reaching their financial goals than the rest of us. Whether your income is in the upper echelon now or that is your aspiration. take care to avoid these pitfalls.
Retirement Plan Savings are Limited. One reasonable rule of thumb is to save fifteen percent of your earnings over your working life to achieve financial independence. If you have a healthy income of $100,000 a year, most likely you can put up $18,500 a year into a retirement plan for work. You may also qualify for a $5,500 Roth IRA contribution each year. This means you could put aside up to 24 percent of your annual pay into retirement accounts, not including the employer match.
Imagine your earnings reach a relatively stratospheric $200,000 annually. That same retirement plan now allows you to put just over 9 percent of your pay, while you don’t qualify for a Roth IRA contribution because you earn too much. Saving 9 percent over time for retirement is unlikely to be enough. This is often where high income earners veer into the traps of cash value life insurance and variable annuities, which are generally expensive and complex ways to save for your future. Instead consider automated, regular contributions into a taxable investment account at a mutual fund company such as Vanguard or low-cost brokerage firm such as Charles Schwab. By going beyond the confines of your retirement plan, you set yourself up well to reach financial independence at a reasonable age.
Disability and Life Insurance. The more income you have, the more income you must protect if you are not able to work or die before your life expectancy. Medium to large size employers often offer long-term disability insurance, which would pay your family through retirement age if you’re no longer able to work. If you have a high income, then that coverage may not extend to cover enough of your income for your family to continue to do well in case of your disability. You may need to purchase an individual disability policy on your own.
Life insurance offered through work is rarely enough to support your survivors. If you have a high income, it’s likely that your family’s needs would require the proceeds of additional life insurance coverage purchased outside of work.
Borrowing Capacity. Mortgage companies crack me up with their mandated lending standards in that they care much more about your income than your net worth. Accordingly, higher income families can qualify for a tremendous amount of mortgage debt, even with the recent increase in rates. If you have a family income of $250,000 and $200,000 in equity in your current home (or in savings), then lenders may allow you to borrow enough to purchase a $1.4 million house, if not more in some cases. The payment on this mortgage would represent 35 percent of your gross income. Just because the mortgage lenders will give you the loan, doesn’t mean it’s a good idea. We prefer that clients keep their payment at 25 percent of income or below.
Confusing High Income for Wealth. When a high income supplies big deposits into your checking twice a month, it’s easy to start feeling wealthy. The difference between income and wealth is a simple distinction but a profound one. Income while it lasts can support your current spending needs, while wealth in the form of assets is required for you to have the option to stop working. While a high income is nice, it’s much more important to chart your net worth a measuring stick to determine if you’re close to financial independence.
Harder to Retire. A $1 million net worth would put you in the upper reaches of American investors, but if you’re accustomed to a high income of $200,000 then it may not be nearly enough for you to retire. In contrast, if your family is accustomed to living off an $80,000 income, then it’s likely that Social Security will replace a much higher percentage of your income needs than those of the higher income family. Social Security and pensions do comparatively less for bigger spenders. If your income is higher, make sure you save enough to provide your family with financial security even when you’re no longer working.