An individual who earns a significant salary but has not yet accumulated significant assets is often referred to as a “HENRY,” which stands for High Earner, Not Rich Yet.
By Caitlin Frederick, Financial Expert
Individuals who earn significant salaries but have not yet accumulated significant assets are often referred to as “HENRYs,” which stands for High Earner, Not Rich Yet.
Despite their incomes, HENRYs face several behavioral and financial obstacles that can impede asset accumulation. When shifting focus from earning a higher income to building wealth, there are specific considerations to keep in mind.
HENRYs: Understand Your Income and Capital Gains Taxes
Building wealth requires education regarding a HENRY’s top expense: taxes. Income is taxed at the ordinary income rate. Depending on the filing election, marginal federal income tax rates for 2022 are as follows:
|Tax Rate||Single||Married Filing Jointly|
|10%||Up to $10,275||Up to $20,550|
|12%||$10,276 – $41,775||$20,551 to $83,550|
|22%||$41,776 to $89,075||$83,551 to $178,150|
|24%||$89,076 to $170,050||$178,151 to $340,100|
|32%||$170,051 to $215,950||$340,101 to $431,900|
|35%||$215,951 to $539,900||$431,901 to $647,850|
|37%||Over $539,900||Over $647,850|
Growth in assets is subject to capital gains taxes. As an example, assets sold for $10 that were purchased for $1 will be subject to capital gains taxes on the $9 of growth. Capital gains taxes vary depending on the length of time the asset is held, as well as the income and filing status. Assets held for one year or less are classified as short-term capital gains and are taxed at the ordinary income rate. Assets held for longer than a year are subject to long-term capital gains and are taxed as follows for 2022:
|Tax Filing Status||0%||15%||20%|
|Single||Up to $41,675||$41,676 to $459,750||Over $459,751|
|Married Filing Jointly||Up to $83,350||$83,351 to $517,200||Over $517,201|
Consider, for example, an attorney who has recently graduated from law school with $50,000 in debt. This individual may have accumulated no significant assets other than a few thousand dollars in a checking account and a starting salary of $200,000. With a current net worth of approximately negative $50,000, this individual would be considered “Not Rich Yet.” However, due to the high income, wages will be taxed at a marginal rate of 32 percent.
Conversely, consider Jeff Bezos, with a net worth of approximately $138 billion. If Bezos earns income below $41,675, he pays 0 percent on long-term capital gains.
Between high taxes and potentially high debt payments from student loans, it is easy for attorneys to get caught in the pattern of neglecting to invest sufficiently. “Living like a student” and paying off student loans as quickly as possible is recommended. Further, “paying yourself first” by prioritizing contributions to investment accounts prior to allowing for the lifestyle creep that often comes with higher salaries is imperative.
HENRYs: Know Where to Invest for Retirement
There are three general classifications of investment accounts: tax-deferred, tax-advantaged, and taxable accounts. Tax-deferred accounts include traditional 401ks and IRAs. These grant a tax deduction today, grow tax-deferred, and are taxed as ordinary income in retirement. For example, professionals who earn $100,000 and contribute $20,000 to a Traditional 401k are taxed as if they only earned $80,000. While this $20,000 contribution grows tax-deferred, the distributions will be taxed at the ordinary income rate in retirement.
Tax-advantaged accounts include Roth 401ks and Roth IRAs. These accounts yield no tax deduction at the point of contribution. However, contributions grow tax-deferred and are withdrawn tax-free in retirement. The maximum allowable personal contributions to a 401k are $20,500 and $22,500 for tax years 2022 and 2023, respectively. Any applicable employer matches and/or contributions further benefit professionals.
These accounts are intended to build long-term wealth for retirement. To supplement these savings and build liquidity for more near-term goals, professionals should also consider regularly contributing to a taxable brokerage account. Dividends and interest earned in a brokerage account are taxed as earned. However, distributions are subject to capital gains rates rather than ordinary income rates. By continuing to invest in a brokerage account, professionals can shift their tax structure from being solely assessed at a (likely higher) ordinary income rate to a combination of ordinary income rates and (likely lower) capital gains rates.
As professionals near retirement, their financial situations will be more akin to the Bezos example where they will have accumulated significant assets and less income, yielding a lower effective tax rate.
Don’t Forget the Brokerage Account!
In addition to diversifying the tax structure of a portfolio, brokerage accounts can also help provide liquidity both prior to and during retirement. Consider a retiree that desires to buy a boat. If the only source of funds is a traditional IRA, the entirety of the payment will be taxed at the ordinary income rate. This increase in taxable income may also impact Medicare premiums.
If funds from a brokerage account are also available, the retiree will have the flexibility to manage the tax impact. Professionals must wait until age 59.5 to distribute funds from retirement accounts without incurring a penalty. Building a brokerage account allows professionals to access liquidity to fund near-term goals, such as paying for children’s educational expenses, family weddings, and home improvements. High-earning professionals with little savings are Uncle Sam’s best customers, given that ordinary income rates generally exceed capital gains rates. A conscientious effort to diversify the tax structure of a portfolio with a dedicated savings target can improve a financial plan dramatically.
How much should professionals contribute to their investment accounts? Many professionals believe that if they maximize their contributions to their 401k plans, they will be financially secure. However, total contributions should be viewed relative to current income and desired spending levels.
Contributions to 401k contributions of $20,500 for a professional with $600,000 in earnings represent savings as a percentage of income of only 3.5%. This level of savings relative to income will not support consistent spending levels in retirement. On the other hand, $20,500 of 401k contributions for an individual with $100,000 in earnings represents savings of more than 20 percent as a percentage of income.
While maximizing personal contributions to employer retirement accounts is a worthy goal, it will not necessarily result in sufficient savings for high-earning professionals.
Make a Plan, Set a Goal to Accumulate Assets
This has been a poor performance year for markets. As a result, some high earners are weary to invest. While having significant levels of cash may feel conservative, the reality is that contributions to a savings account are almost guaranteed to lose value to any applicable inflation.
Instead, professionals should determine an appropriate financial plan to invest. While market volatility can be painful to experience, regular monthly contributions to a retirement and/or brokerage account allow for investors to buy in at various price points over time. Even in a down market, monthly contributions are purchasing funds at a low-cost basis. When the market rebounds, the return on these specific lots will be amplified.
A common mistake of professionals is to be appropriately aggressive in retirement accounts and exclusively in cash in taxable accounts. However, growth on the taxable asset side allows for the flexibility to access funds prior to age 59.5 and potentially retire sooner.
For most high earners, the road to success was filled with hard work and sacrifices. As a result, it is natural to feel the desire to reward yourself. However, conscious decisions in the early high-earning years can lead to drastically improved financial results over time.
We generally recommend that our HENRY clients set an annual savings goal. Once achieved, clients should feel empowered to treat themselves with any additional income. The golden rule is to always remember to pay yourself first.
Caitlin Frederick (CFA, CPA) is the director of financial planning and a wealth advisor for Ullmann Wealth Partners based in Jacksonville Beach, Florida. Her primary role is to lead the financial planning process for clients; she also assists clients who utilize their Divorce Advisory Services. www.ullmannwealthpartners.com
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