Individuals who earn significant salaries but do not have significant assets to date are often referred to as “HENRYs.” The acronym, which stands for High Earner, Not Rich Yet, was first introduced by Shawn Tully in a 2003 Fortune magazine article. Despite their high incomes, HENRYs face several financial obstacles that can impede progress towards asset accumulation. Below is a discussion of the major themes to consider when shifting from the paycheck-to-paycheck mentality to the asset accumulation mentality.
Understanding Our Tax System and Managing Your Debt
We have all seen the flashy political commentary supporting the notion to “Tax the Rich.” However, to determine the path forward to financial prosperity, it is important for professionals to understand how our taxation system is applied in practice. Income is taxed at the ordinary income rate. Depending on the marital status and the filing preferences, the marginal federal income tax rates for 2022 are as follows:
Capital gains refer to increases in assets purchased over time. As a simple example, let's assume you purchased a stock for $1 that has increased to $10. If you were to sell your stock at $10, you would owe capital gains taxes on the $9 increase in share price. Capital gains taxes vary depending on the length of time the asset is held as well as the taxable income and filing status of the filer. Assets held for one year or less before a sale are classified as short-term capital gains and are taxed based on the ordinary income rate (per the table above). Assets held for longer than a year are subject to long-term capital gains and are taxed as follows for 2022:
Consider a single, first year attending physician in an Orthopedic practice with an initial salary of $600,000. This individual may have upwards of $200,000 in medical school debt and no significant assets other than $3,000 in a checking account after years of earning approximately $60,000 as a resident for each of the last four years. With a current net worth of approximately negative $200,000, this individual would be considered “Not Rich Yet.” However, due to a high income, the wages would be taxed at a marginal rate of 37% plus any applicable state taxes. Between debt service payments and taxes, it is easy to get caught in the pattern of neglecting to save sufficient funds for investing towards long-term goals.
Conversely, consider Jeff Bezos with a net worth of approximately $138 billion. As a single individual, if Bezos keeps his income under $41,675, he pays 0% capital gains on assets held for longer than a year. Our tax system has very little to do with “being rich” and everything to do with targeting high earners. The reality is that high earning professionals, especially those with significant student loans, are at a risk of getting stuck in their current financial situation due to large debt service payments and high taxes.
The first step in achieving long term financial goals is paying off student loans as early as possible. During residency, a practical solution may be to focus on paying the interest component of the loans to avoid increasing the principal balance prior to becoming an attending physician. Once an attending, focus on “living like a resident” and paying off the debt as quickly as possible. The same logic would apply for legal or other business professionals experiencing a similar debt situation.
Decreasing Taxable Income
Now that we understand our tax structure, how do we optimize our situation? The next goal should be reducing both current and future taxable income. Two common retirement vehicles are Traditional 401ks and Roth 401ks.Traditional 401ks grant a tax deduction today, grow tax deferred, and are taxed as ordinary income in retirement. For example, if you earn $100,000 and contribute $20,000 to a Traditional 401k, the IRS looks at you as if you earned $80,000. While this $20,000 contribution grows tax deferred, the distributions will be taxed at the ordinary income rate in retirement. Conversely, Roth 401k contributions yield no tax deduction at the point of contribution. However, these contributions grow tax deferred and are withdrawn tax free in retirement. Each of these investment vehicles present different benefits and obstacles that should be considered. 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.
Other tax advantaged retirement vehicles that may be offered through employers include deferred compensation programs and Health Savings Accounts. Deferred compensation programs typically work like Traditional 401ks in that the funds contributed reduce taxable income today and are ultimately distributed at the ordinary income rate. It is important to consider the timing of these distributions. For example, if a lump sum election is selected, the entirety of a deferred compensation balance may occur in one year, which may bring the household to the 37% marginal tax bracket. If the distributions are instead spread over time (a five-year time frame is typical), this may allow for retirees to benefit from the additional cash flow without subjecting themselves to the highest tax bracket.
A Health Savings Account (“HSA”) is a triple tax advantaged account. Contributions reduce taxes today. These contributions grow tax free and are withdrawn tax free for applicable expenses. The maximum personal and family contributions for 2022 are $3,650 and $7,300, respectively. If there is sufficient cash flow available for general living expenses, maximizing HSA contributions and investing those contributions are a great way to save for retirement and mitigate future long-term care needs.
Target Overall Savings Rate and Shifting from the Ordinary Income to Capital Gains Bucket
Is maximizing retirement contributions sufficient? Assume that same Orthopedic surgeon is now at the point where all student loans are paid and contributions to the 401k are currently maximized. At a salary of $600,000 and retirement contributions of $20,500, savings as a percentage of income are approximately only 3.5%. Consider another professional earning $100,000 who is also maximizing personal contributions to the 401k. Savings as a percentage of income is over 20% for this individual. A savings goal of 20% is desirable for most households in order to be able to maintain the same level of spending during retirement.
While maximizing personal contributions to employer retirement accounts is certainly a worthy goal, it will not necessarily result in sufficient savings for a high earning professional. To supplement retirement savings, high earners should also consider investing in a brokerage account. Dividends and interest earned in a brokerage account are taxed as income. However, withdrawals from a brokerage account are subject to capital gains rates rather than ordinary income rates. As noted in the tables in the Understanding Our Taxation System and Managing Your Debt section, the capital gains rate is typically lower than the ordinary income marginal tax rate, depending on the level of taxable income. Therefore, by continuing to save in a brokerage account, professionals can shift their tax structure from being solely assessed 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 significant assets and less income, yielding a lower effective tax rate overall.
In addition to diversifying the tax structure of a portfolio, brokerage accounts can also help provide liquidity both prior to and during retirement. When professionals only save to a 401k, this may be the only source of funds in retirement. Consider a retiree that desires to buy a boat in retirement. If the only source of funds available are in a traditional IRA, the entirety of the boat payment proceeds will be treated as income and 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 increased flexibility to manage the tax impact of the purchase. Further, professionals must wait until age 59.5 to distribute funds from retirement accounts without incurring a penalty. Building a brokerage account allows for professionals to access liquidity prior to retirement to help fund more 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 are higher than 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.
Investing Versus Saving and Reliance on Insurance
Consider the same Orthopedic professional is now maximizing the traditional 401k contributions and saving $10,000/ month to a checking account. Now the savings as a percentage of income is 23.4%; however, these funds are not expected to earn any investment return sitting in cash and are guaranteed to lose value to any applicable inflation. Instead, this professional should determine an appropriate manner to invest these funds. The best factor for an investor is a long-term time horizon. The earlier that professionals can invest their money, the better. 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 prices points over time. Even in a down market, monthly contributions are purchasing funds at low-cost basis. When the market rebounds, the return on these specific lots will be relatively higher. 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) and to decrease reliance on disability and life insurance policies.
Like the difficulties of managing a significant debt burden, many high earning families have difficulty saving due to their reliance on high premium life and disability policies. If a family is accustomed to a high expense lifestyle due to a high family income but has limited assets, a disability policy is likely a necessity to mitigate the risk of the inability to work. However, the necessity to pay expensive disability premiums further diminishes the family’s ability to save and grow the investment accounts. Prioritizing saving and investing prior to locking in a “lifestyle creep” will help minimize the necessity of insurance policies and will increase the household’s financial flexibility.
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 for our clients to set an annual savings goal. Once this goal is met, clients should feel good about treating themselves with any additional dollars earned. An apple a day keeps the doctor away but eating too many apples all day every day will drive anyone crazy. Step one is understanding the “why” for the saving and investing recommendations. Step two is execution.
If you have any questions on this important topic, and how to best implement these recommendations into your long term wealth management plans, please contact us.
 Fortune Archive. “Taxpayer, Beware! Washington Will Soon Be Taking Back a Good Chunk of That New Tax Cut.”
 According to the 2021 Physician Compensation Report conducted by Doximity, the average salary for an orthopedic surgeon is $633,620.
 Forbes Advisor. “What’s The Average Medical School Debt in 2022?” notes that for the class of 2021, the AAMC found that the average medical school debt among students attending a public school was $194,280. Further, the AAMC found that the average stipend in a resident or fellow’s first year after medical school is $57,863.