Steps of Investing For High-Income Earners to Achieve Financial Independence

Recently, a doctor finishing training asked me how to start their investing path for Financial Independence (FI) even if they do not plan on Retiring Early, the RE in FIRE.

It can be quite overwhelming and frankly, it might seem like there is no light at the end of the tunnel with debt, deferred life costs, and completing your last board exams.

To go from a resident’s salary to a higher tax bracket can be disorienting, so I wrote this to give you a guide for the order to invest as you become a high earner but not rich yet (HENRY).

Knowing where to invest your money for the best return can be challenging as a high-income earner.

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Additionally, unexpected expenses can become a hurdle at any time, and having enough cash on hand can turn a potentially life-altering event into a minor inconvenience. In this article, I will share my top seven places to invest your money, starting with the importance of always holding a good amount of liquid cash.

I will also cover the benefits of investing in your 401k up to the employer match, participating in your company’s Employee Stock Purchase Plan, paying down high-interest debt, maxing out your 401k, maxing out your Health Savings Account, taking advantage of the Backdoor Roth IRA, and investing in real estate or a taxable brokerage account.

Key Takeaways

• Hold a good amount of liquid cash at all times to prepare for unexpected expenses until you achieve some security.
• Take advantage of employer-matched 401k contributions and Employee Stock Purchase Plans.
• Pay down high-interest debt, max out your 401k and Health Savings Account, and consider investing in real estate or a taxable brokerage account AFTER covering the basics.

Cash

Holding a substantial amount of cash is important. I believe that holding a good amount of liquid cash at all times is essential.

You can incur unplanned costs at any time, and having enough cash can turn these incidents into minor inconveniences rather than life-altering events. I prefer a simple checking and savings account in my bank, and I aim to hold 6 to 12 months of expenses.

With interest rates providing a real yield about inflation, you can use a fee-free treasury account like public.com, a high-yield savings account, or simply a checking account. For me, at least having a meaningful amount of money I can access at any time provides a huge peace of mind.

At some point perhaps you do not need an emergency fund for FIRE or if you have a strong second base of income. To each, their own, but I sleep much better at night knowing I can easily manage for a few months without having to sell other stocks or assets.

The most subjective part of a cash reserve is determining the amount and that is entirely up to your risk-reward tolerance.

As a doctor, you can likely get a passive gig within three months, and with an online economy flourishing, if you have a high-earning job to begin with, there are plenty of ways to find gigs on platforms like upwork even for doctors, CPAs, and MBAs.

401k Employer Match – Reduce Taxable Income

As a high-income earner, one of the best places to invest your money is in your 401k up to the employer match. The employer match is essentially free money that you can take advantage of.

For instance, if you earn an annual salary of $100,000 and your company matches your 401k contribution up to 4%, this means that when you contribute $4,000 into your 401k, your company will match you dollar for dollar with another $4,000 into your 401k.

Your $4,000 just became $8,000 instantaneously, which is a 100% return on investment.

Moreover, you can reduce your taxes by lowering your taxable income by $4,000 by investing up to the 401k employer match. It’s really a no-brainer if you’re not contributing to a 401k, at least to the match.

By investing in your 401k up to the employer match, you can make the most out of your money and secure your financial future.

It’s important to note that contributing to the employer match should be done before investing your money anywhere else. It’s a great way to maximize your returns with minimal effort.

In 2024, the contribution limit for anybody under the age of 50 is $23,000. If you’re 50 or older, the contribution limit is $30,500 – a $7,500 extra! Maxing out your 401k during your peak earning years is the best tax deduction you can get.

You get an upfront tax deduction-tax-protected growth for the duration of investment, and usually an arbitrage between the tax rate you save during contributing and the tax rate you pay upon withdrawal, which is bigger than almost any other tax deductions you can qualify for.

Therefore, if you’re a high-income earner, make sure to contribute to your 401k up to the employer match before moving on to other investments. It’s a simple and effective way to maximize your returns and reduce your taxes.

When looking at job opportunities, you will find different places have meaningfully different benefits with their employer match, and I have seen a 6% match. It’s a benefit most people do not account for, but it’s a meaningful tax-free benefit.

Employee Stock Purchase Plan (not for most doctors)

This will not apply to physicians or most healthcare workers, but for the sake of completion and giving you the best shot possible, we’re including it here.

As a high-income earner, participating in your company’s Employee Stock Purchase Plan (ESPP) can be a great way to invest your money. An ESPP is a company-run program allowing participating employees to purchase company stock at a discounted price, typically around 10-20%.

Employees contribute to the plan through payroll deductions, accumulating between the offering and purchase dates. At the purchase date, the company uses the accumulated funds’ pre-tax contributions to purchase stock in the company on behalf of the participating employees.

Similar to the 401k match, a 15% discount is like receiving free money. If there are no restrictions on when you can sell your ESPP stock, there is minimal risk. If you sell your shares immediately, you get to pocket the 15% discount.

A good rule of thumb with ESPP is to sell your company stock, which you bought at a 15% discount, and immediately reinvest in a broad market index fund.

This strategy has several benefits, including the ability to take advantage of the 15% discount, no capital gains, staying invested in the market, and not tying your investment to the performance of the index funds of a single company.

If your company offers an ESPP, make sure to take advantage of it. It’s not available to everyone, and the automatic 15% discount on company stock is a great opportunity for high-income, high-earners too.

After you sell your company’s stock, you can invest in a broad market index fund, get a discount, stay invested, and reduce your exposure to your company’s performance.

High-Interest Debt Payoff

As a high-income earner, one of the best places to ‘invest’ your money is in paying off high-interest debt such as auto loans, student loans, and credit card debt.

Carrying high-interest debt from one month to another means you’re making someone else rich, and that’s not a great path to FIRE.

To take on these debts, I recommend a head-on approach to triage debt. List out all your debts and start working down the list one at a time. You can use one of three debt payoff strategies we’ve covered before:

1. Debt snowball
2. Avalanche methods
3. Snow plow method

The debt snowball method involves listing out all your debts from smallest to largest and paying off the smallest debt first while making minimum payments on the rest. Once the smallest debt is paid off, move on to the next smallest debt and continue this process until all debts are paid off.

The avalanche method involves listing out all your debts from the highest to lowest interest rates and paying off the debt with the highest interest rate first while making minimum payments on the rest.

Once the debt with the highest interest rate is paid off, move on to the next highest interest rate debt and continue this process until all debts are paid off.

The snow plow method is more of a mental framework for taking on the debt you hate the most.

For many doctors, that can easily be student loan debt, given the pain and suffering we toiled through to practice. So, just plow through it because it is emotionally burdensome.

I have a friend who inherited a house from his mother’s passing. The debt was also emotional for him, so he focused on paying it off first, even though the rate was lower than that of other debts.

Whichever method you choose, the key is to stay committed and focused on paying off your debts as quickly as possible.

Once you’ve paid off your high-interest debt, you’ll have more money to invest in other areas, such as your 401k, Employee Stock Purchase Plan, or Health Savings Account.

Health Savings Accounts – Tax-Free Growth

I’ve found a Health Savings Account (HSA) to be an excellent way to invest my money as a high-income earner. If you and your family are in good health, you can choose a high-deductible healthcare plan (HDHP) and open an HSA.

An HSA is often referred to as the “ultra-secret early retirement account” in the independent world. HSAs are often marketed as tax-advantaged savings accounts for qualified medical expenses, but they offer much more than that.

The triple tax benefit of an HSA is not often discussed, but it is a significant advantage.

First, contributions to an HSA are tax-deductible, providing a tax benefit going in. Second, the money in the HSA can grow tax-free. Finally, qualified medical expenses can enable you to withdraw the money tax-free.

There is no time limit to using an HSA, meaning you can hold onto your medical receipts for ten years or more and withdraw tax-free money whenever needed.

In 2024, the contribution limit for an HSA is $4,150 for self-only coverage and the income limit is $8,300 for family plans. If you are eligible, don’t miss out on this great account that will not only reduce your tax liability but also increase your net worth.

Backdoor Roth IRA

As a high-income earner, one of the best places to invest your money is in a Backdoor Roth IRA.

A Roth IRA is a great investment because growth and withdrawals are tax-free. However, if your income level exceeds the allowable amount to qualify, you can still use the backdoor Roth strategy to contribute to a Roth IRA.

To do this, I make a non-deductible contribution for the maximum liable amount into a traditional IRA, which is $7,000 if you’re younger than 50 and $8,000 if you’re 50 and older. Then, I convert my traditional IRA into a Roth IRA.

This strategy is called a Backdoor Roth IRA, and it’s a great way to take advantage of the tax-free growth and withdrawals of a Roth IRA, even if your income level exceeds the allowable amount to qualify.

It’s important to note that this strategy may not be suitable for everyone and it’s best to consult with a financial advisor before making any investment decisions.

Mega Backdoor Roth – High-Income Retirement Options

As a high-income earner, the Mega Backdoor Roth is a great investment opportunity. This strategy allows me to contribute more than the standard limit to my 401k and then roll the amount into a Roth IRA. With this approach, you can effectively contribute more money to a Roth IRA than is traditionally allowed.

You have to meet three conditions:

1. Allow 401k after-tax contributions
2. You can not contribute to a Roth IRA because of your high income
3. You maxed out traditional 401k contributions

If your employer allows 401k for a Megabackdoor Roth, consult the documents to implement it. However, as I’ve mentioned above, always consult with a financial advisor before making investment decisions.

529 Education Savings Plan

As a high-income earner, investing in a 529 Education Savings Plan can be a smart move for your children.

A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. The plan is named after Section 529 of the Internal Revenue Code, which created these types of savings plans in 1996.

Here are some key benefits of investing in a 529 plan:

• Tax benefits: Contributions to a 529 plan are made with after-tax dollars, but the earnings grow tax-free. Withdrawals are also tax-free when used for qualified education expenses, such as tuition, books, and room and board.
• Flexibility: 529 plans can be used to pay for qualified education expenses at any eligible institution in the United States and some abroad. This includes colleges, universities, vocational schools, and even some K-12 schools.
• High annual contribution limits: 529 plans are considered gifts from a federal perspective. Most plans have high annual contribution limits, often over $18,000 in 2024 per donor per beneficiary, qualifying for annual gift tax exclusion.

It’s important to note that each state has its own 529 plan, and some plans offer additional tax advantages and benefits for residents of that state. It’s also important to consider various investment strategies, options, and fees associated with each plan before choosing one.

A 529 Education Savings Plan can be a great way for high-income earners to save for their children’s education while taking advantage of tax benefits and flexibility.

Taxable Brokerage Account

Once you have maxed out the other tax-advantaged accounts, a taxable brokerage account is yet another great way to invest taxable income.

This type of investment account allows you to buy and sell stocks, bonds, mutual funds, and other securities.

Unlike a 401k or IRA, there are no restrictions on when you can withdraw your money from a taxable brokerage account, making it a flexible investment option for after-tax dollars.

However, selling at a profit is subject to short-term or long-term capital gains tax. VSTAX is a great place to start investing in a broad-based index fund. We’ve written about many other ETFs, too.

Here are some key things to keep in mind when opening a taxable brokerage account:

• Choose a reputable brokerage firm: Look for a brokerage firm that has a good reputation and offers low fees. Some popular options include Vanguard, Fidelity, and Charles Schwab.

• Consider your risk tolerance: When choosing investments for your taxable brokerage account, consider your risk tolerance. If you’re comfortable with higher-risk investments, consider investing in individual stocks. If you prefer lower-risk investments, try out bonds or mutual funds.

• Be mindful of taxes: Unlike retirement accounts, you’ll be taxed on any gains you make in your taxable brokerage account. It’s important to be mindful of the tax implications of your investments and to consult with a tax professional if you have any questions.

Overall, a taxable brokerage account can be a great way for high-income earners to diversify their investments and build wealth over time.

Be careful, though. Selling stocks or exchange-traded funds (ETFs) from these accounts will be subject to capital gains taxes.

Real Estate – Mitigage Federal Income Tax

Real estate is a great way to build wealth because it can mitigate federal taxes and generate income. We’ve covered real estate crowdfunding options and annual portfolio updates on the passive real estate return potential.

Passive investing in real estate does not provide leverage but does offer tax benefits from cost segregations or 1031s if the fund qualifies.

For active real estate, you can achieve significant reductions and eventually non-recourse lending with leverage on multifamily deals with real estate professional status (REP).

With REP I was able to use cost segregations to depreciate income and have a negative balance sheet from a tax perspective that carries forward against income in the years to come. This is essentially a long-term strategy you’d want to opt for.

Using a self-directed IRA is another way to mitigate taxes for real estate, too.

Low-Interest Debt

Given that we came out of a zero-interest rate environment, taking care of low-interest debt can be freeing.

While many people disagree on this, as it is possible to mentally arbitrage low debt vs slightly higher yield, for me, it was psychologically burdensome to have debt at all.

However, everyone’s path to FIRE is different, especially because it’s personal finance.

I know people who sleep just fine with the knowledge that they have significant low-interest debt. Still, perhaps because of my immigrant upbringing, it was harder for me to feel comfortable carrying debt, even though I knew rationally paying down my low-interest debt was not the best move.

With the personal freedom of knowing I am debt-free, I have been able to take significant risks elsewhere in investing in higher-risk assets and adding to an emergency fund. Which is all you can wish for when you’re a part of an intense profession.

Happy investing, HENRYs, and good luck getting to FIRE!