Hi Everyone, and welcome to the Wiser Financial Advisor show with Josh Nelson, where we get real, we get honest, and we get clear about the financial world and your money. This is Josh Nelson, Certified Financial Planner and founder and CEO of Keystone Financial Services. Let the financial fun begin!
Jeremy: Welcome to the Wiser Financial Advisor. Your hosts for today are myself, Jeremy Bush, and Jen Walenter. Jen, how you doing?
Jen: I’m good, Jeremy. How you doing?
Jeremy: Fantastic. Today’s topic is on the biggest financial planning mistakes high earners make.
Jen: It’s a big topic.
Jeremy: It is a big topic with a couple key areas that we like to look at. Jen, where should we start with this one?
Jen: There are some instances where financial planning is necessary, and it certainly comes into play once you start making more money. There are a couple of areas we would like to highlight for those who are fortunate enough to need to keep them in mind. To kick it off, what about lifestyle creep with a higher income?
Jeremy: That is a good place to start, right? There’s this idea out there that the more money you make, the less problems you have. There are even songs about that, some old hip hop songs, little money more problems. But it’s really the place that a financial planner could come into play, especially with high income earners. Avoiding that one mistake is key, because all it takes is one mistake when you’re a high income earner to have to pay quite the bill.
Jen: When that happens, you’re making more but it doesn’t seem like you’re making more because you’re spending more.
Jeremy: What lifestyle creep is, you’re working and every year you get say a 2% raise or a 5% raise or a 10% raise, maybe a big bonus or something. Most people in the world tend to grow our expenses with our income. So the more you make, the more your lifestyle tends to eat it up, whether it’s due to buying more name brand things or expensive cars or even little things that come along every day. The mentality is: “Hey, I can now afford that extra subscription.” And anybody nowadays has probably 20 subscriptions to everything. After a while, you forget what you’re subscribing to, but the costs keep rolling until you cancel. It’s all part of lifestyle creep.
Jen: And how can that lead to a potential tax inefficiency?
Jeremy: Tax inefficiencies are something that can sneak up on you. For instance, if we’re thinking about a brokerage account, maybe it’s the wrong type of investments inside of that account. You go to your advisor and say, “I want this big brokerage account. I have a lot of money I can throw into it. Invest it for me and I want to see a lot of good returns.” But inside of that account, we can do tax advantage things or municipal bonds or something that’s not going to produce a ton of income, but could still get a lot of growth. Inside of an account like that, there are specific conversations you want to have with your advisor that say, “I am a high income earner and I want my account to do this, but what is the most tax advantageous way of going about that?”
Or you may be a high income earner taking advantage of your employer plan but that’s about it. So when you get to retirement, you have this huge traditional IRA and that’s it. Without additional planning, that can put you into a bad position in the future because you don’t have tax diversity. It’s about managing all of this. When we look 10, 20, 30 years out, that can become an issue down the road if you’re not doing advanced planning.
Jen: We have several cients who come to us and we’re looking at their plan and they have a relatively large 401K that they’ve rolled over to an IRA. Now we need to be strategic about looking at Roth conversions. Does that make sense for their situation? How would that impact their income taxes, because it has long-term effects as well as short-term effects.
Jeremy: A lot of times what we’ll see with high income earners is that they don’t want to work until they’re 60 or 65 and they probably don’t have to. But that brings into play the rules for IRAs: they can’t really touch the money in an IRA until age 59 and a half without heavy penalties. So, if I want to retire at 50, how am I going to bridge that gap? If you’re 50 years old and the only thing you have is your 401K and you say, I want to retire tomorrow, it won’t do you much good. What can you do about this? Do some planning in advance.
Jen: We have a lot of clients who work for big companies, well-known names, and they’ve been working there for many years, possibly decades. Maybe they’ve acquired a ton of company stock. What are the dangers with having too much company stock in a portfolio?
Jeremy: Yeah, we touched on that in various other podcasts and webinars. The emotional aspect of it comes into play here. Say you work for that company and they’ve given you restricted stock units or stock options or something of that nature. Great problem to have, don’t get me wrong. It has made millionaires of a lot of people, but it does come with risk because there’s not any company anywhere that is rock solid for the entire future. Go back and look at GE, Kodak, HP, companies that at the time were never going to fail. Enron is an example where people who worked for them had everything invested in the company. All it took was one thing that those employees didn’t see coming. Now it’s all worth zero. Not to scare people, because a company going to zero overnight is pretty rare. Still, it is kind of dangerous to be invested in only one place. The general idea is that you don’t want more than 10% of your overall portfolio in any one company, no matter how well that company’s doing. So, company stock can be a great gift along the way, but it is something you want to manage right and manage over time.
Jen: And how about when it comes to estate planning? We have these conversations with clients all the time. It’s never a fun topic that people are jumping out of their seats, excited to do. But as we have learned through our many years in the industry, it is necessary for everyone to do. Why is it important for everybody but especially maybe for high earners to do sooner rather than later?
Jeremy: You nailed it. Nobody wants to deal with it until they feel like they have to.
Jen: Or they’ve come back from a bad experience where they learned that now they absolutely need it.
Jeremy: Exactly. And usually it’s because something happened to their mom and dad and they had to go through the process themselves. And they’re like, “I don’t want my kids to go through that.” That’s always an unfortunate thing. But when it comes to estate planning, you don’t want to rely on the State to make your decisions for you. If you don’t have estate documents or some kind of plan in place for this, like proper beneficiary designations, you are letting whatever State you reside in decide for you.
Jen: I heard that if you don’t have a will, the State will decide that will for you.
Jeremy: Absolutely. And usually where people get hung up in estate planning, especially if they have young kids, is when spouses disagree on who will be named to take care of the kids or something. So, we tell them, “If you knew for a fact that you were dying tomorrow, what would you want to happen?” Also, just because you put estate documents together today doesn’t mean that they have to stay the same forever. Estate documents are something you can change as you go along. It’s recommended that every five years or so you look at them for what has changed in your circumstances, what doesn’t need to be in there anymore. Think about it as if something happened to me tomorrow or next month, what would I want to happen? It’s so much better to have some kind of plan down on paper than nothing at all. And it becomes more of an issue if you are a high-income earner, because that translates to more assets to take care of. You don’t want to have a bunch of assets and have them go somewhere you don’t want them to go. Just make sure you have a plan, even if it’s not a perfect plan. It doesn’t have to be perfect, but have something to at least guide those who come after you as to what your wishes are.
Jen: And one quick side note on that, we even recommend reviewing your beneficiaries on all your accounts, possibly once a year, just because life changes and you never know. The person assigned as your beneficiary for your 401K five years ago might be the same person now, but it might be a good moment to reflect and look back and say, “Are they still the people that I want them to be?” Now, how about assuming high income means financial independence? What do you feel like that means?
Jeremy: That is a great question because the general idea is, ”Hey, I’m making X amount of dollars per year and I’m set.” But really, the things we have to account for and the way we go about financial planning means we put a lot of focus on cash flow, right? Yes, this is what’s coming in, but how much of that is going out and where is it going? It’s not so much a matter of how much you’re earning. It’s way more a matter of how much you’re spending and how much you want to continue to spend this year, next year, the first 10 years of retirement, and when you’re 80 years old. How much of that lifestyle do you want to continue with? What we find with people is that you grow accustomed to your lifestyle. It’s a natural thing to do. If you’re a high-income earner, you’re probably growing accustomed to that lifestyle and you don’t want to step back when you’re in retirement. Most people probably think like, “Now I get to travel. I have all this time. I’ve always wanted to do this, or I’ve always wanted to have this hobby,” or whatever that is. So spending can even jump up a bit. Make sure that you optimize your earning power in your years as a high earner to fund the next 30, 40 years of your life when you’re living in retirement. That is important. We’ve seen clients with millions of dollars in retirement but based on their spending, they’re going to run out of money at some point. We also have clients with no more than a $500,000 IRA, but the lifestyle they love is sustainable with that one account. So, much of this depends on your spending and how much you want to do.
Jen: This is another big thing we talk to clients about : What happens if you wait too long to create a plan? A young gentleman came in to see us not long ago, and he felt like, “I’m only 21, is it too early to start planning for all this?” And a comment we get time and time again is: “I really wish I had started planning earlier.” So Jeremy, what can you speak to as far as why is it important to begin planning now and not wait for the future, or wait till you get more wealth, or wait till something happens. Why start that planning piece now?
Jeremy: Well, whether someone’s 25 or 55, time is the one thing you don’t get back. And when it comes to financial planning, the more time you have, the easier it is to make these decisions and optimize things to work to your best advantage for a long period of time. So that is key. You can’t get it started too soon. Sometimes someone young will come into the office or we’ll have a conversation and they’ll ask, “Hey, what can I do right now?” And it may be as simple as maximize your 401K, control your spending, use a budget. Do you need a lot of advance planning at that time? No, but it’s going to come up eventually, and there are things you can do to put yourself in that better position along the way. The more time you have with that, the better off you are.
The other big part of this is the coordination of benefits over time. Let’s say you retire at 55. You can’t touch IRAs until you’re 59 and a half unless you use specific knowledge which is another podcast entirely. We’re not going to get into that. But think about when you want Social Security benefits to turn on. You have several years to choose from. Do I wait until 70 to maximize it? Do I take it at full retirement age? What is that full retirement age? Medicare, age 65. How will that affect things? How do I plan for my medical premiums and everything and my medical coverage until I get to that age? All these things are interconnected. So if someone retires at say 55, and all they have is a traditional IRA, there are a couple things right off the bat. How are we going to bridge that gap to Medicare until you can start pulling from the IRA funds?
Other things to consider when coordination of benefits happens is if you have all that figured out and things are going great but you have this huge IRA. You have plenty of money in the cash flow projections, so you think you have nothing to worry about. Then all of a sudden we start talking about Medicare and IRMAA brackets and required minimum distributions. That is where we see that a lot of clients do not really understand the impact of RMDs and Medicare brackets. Let’s say you have a massive IRA and you’re fine with it, but you’re in the lowest Medicare bracket, and then you turn 73, 74, 75. Depending on when your RMD age is, you’re needing to take out money every year according to IRS rules. Then, instead of paying that minimum for Medicare, you’ve jumped up into a bigger Medicare bracket. Now your expenses are directly influenced. You have no choice. You have to do this and there’s no way around the IRS rules. If we’ve given enough time to plan accordingly on this, we can help with that by talking about things like Roth conversions. We know that tax brackets are probably going to be higher in the future. So maybe let’s take advantage of that 12 and 22% tax bracket right now so we aren’t forced into something higher in the future. All of these things come together as part of your financial plan. You might be blessed with having a high income and having RSUs, things like that. But just know that there are things to be considering at the age of 40, 50, 60, things to do now so that when I am 75, 80, I’m not going to be thrown into this crazy boat and put myself into a bad spot because of expenses or because I didn’t take something into account.
Jen: Starting a plan earlier is ideal, but just because you feel like it’s too late doesn’t mean it’s actually too late. Start that plan. Come talk to us. We’re happy to map that out for you, knowing life changes will happen and we can adjust accordingly. Even if it feels like it’s too late, please come talk to us. We can see how things look and we can try to put a plan together that makes sense.
Jeremy: The sooner you start makes it that much easier on you. And like Jen said, if you feel it’s too late, it probably isn’t. If you’re already in that position where you have RMDs, things like that, there are still things you can do to lessen the blow. It’s not like everybody gets to 75 and all the financial planning levers out there are just preset, right? That’s definitely not the case. There’s always something you can do. It just may be more limited later on in life. So yes, it’s never too late to make sure that this stuff is in order.
Jen: Well, I think this has been super helpful. We encourage everyone to look beyond the investments that you hold within your accounts. Really consider your whole financial picture because it’s important to look at it regularly, thoroughly, and completely.
Jeremy: This has been Jeremy Bush and Jen Walenter come to you from the Innovation Lab at Keystone Financial Services. Thank you for listening to the Wiser Financial Advisor. And of course, as always, if anybody has any questions, you can find us at www.keystonefinancial.com . Give us a call at 970-744-5408. If you have questions about your specific situation, we’re always happy to help. Otherwise, take care and we will catch you next time.
Jen: Bye.
Josh: We love feedback, and we’d love it if you would pass it on to me directly at josh@keystonefinancial.com. Also, please stay plugged in with us, get updates on episodes, and help us promote the podcast by rating us five stars and also subscribing to us at Apple Podcasts, Spotify, or your favorite podcast service.
This podcast is for general educational purposes only. It is not personalized investment, tax, or legal advice. Investing involves risk, including the loss of principal. Keystone Financial is an SEC-registered investment adviser, and registration does noEt imply a certain level of skill or training. Please see our Form ADV and Form CRS at https://adviserinfo.sec.gov/firm/summary/310623 for full disclosures.
