If there’s one thing we’ve noticed in our 120 years of combined experience with hands-on wealth management, it’s that high-income families often face unique challenges and opportunities. While a substantial income can provide a sense of security, it also comes with the responsibility of managing it wisely. Balancing seemingly competing priorities calls for a different approach to both budgeting and spending.
Adding to this complexity is the fact that the high-income landscape is changing. According to recent research by Deloitte, individuals increasingly seek holistic solutions that aim at more than the investment advice of the past. They want an investment plan with a long time horizon to help strive toward meeting myriad goals, some of which may appear to conflict. This article delves into effective strategies for budgeting and spending that high-income families can implement to help maximize their financial well-being.
Understand the Basics of High-Income Budgeting
One of the foundational principles in budgeting is the 50/30/20 rule, which suggests allocating 50% of your income to necessities, 30% to wants, and 20% to savings and debt repayment. However, for high-income families, this distribution can be adjusted. With more disposable income, it’s feasible to contribute a larger percentage to spend down any outstanding debt faster, plus increasing your allocation toward savings and investments. This shift could potentially skewing the ratio to something more like 40/20/40.
As we outlined in our blog on Navigating Debt Repayments in 2023, get started by understanding your debt position. Gather all of your applicable statements, including those for student and personal loans, credit cards, mortgages, and HELOCs. Make a comprehensive list, noting the outstanding balances, interest rates, minimum payments, and due dates. This assessment will give you a clear picture of the magnitude of your obligations. Since it’s the figure that many lenders use to figure out how much you can afford to spend on such large purchases such as homes and cars, you should also calculate your debt-to-income ratio. Here’s how:
- Add up your month’s debt payments, such as your mortgage, auto loans, student loans, and credit card payments.
- Divide your total debt payments by your monthly income.
For instance, dividing total monthly debt payments of $6,000 by a monthly income of $15,000 would yield a debt-to-income ratio of 0.40.
Do the same thing with just your consumer debts (excluding your mortgage). Most lenders want to see you below 36% on the first number and 20% on the second. If you’re above those targets (or even if you’re below them but want to cut your debt burden, further) we’ll be providing some tips. For now, make sure you know where your ratios stand and your credit score. You can obtain a free copy of your credit report every 12 months at AnnualCreditReport.com.
From there, high earners should customize their budget to reflect their financial goals and lifestyle. This involves a detailed understanding of income streams and expenses. A budget for a high-income family could allocate funds for travel, education, luxury purchases, and investments, in addition to the usual categories like housing, utilities, groceries, and the debt repayments mentioned above.
Manage Lifestyle Inflation
A common pitfall for high-income earners is lifestyle inflation – increasing spending as income rises. This can be a significant barrier to achieving long-term financial goals. Recognize that lifestyle inflation can erode wealth. For many adherents of the FIRE movement (whether formally or not), excessive spending can delay achieving financial independence or early retirement goals. Considering that a quarter of Generation Z plans to retire by age 55, reaching financial freedom is likely top of mind for even the youngest members of the workforce. Therefore, it is essential to be mindful of spending habits and resist the urge to upgrade lifestyles with every salary increase.
To combat lifestyle inflation, set spending limits for different categories. For example, even if you can afford a $100,000 car, decide if that’s a reasonable purchase based on your financial objectives. Research finds that even among households earning over $100,000, only about 20% spent on luxury vehicles, indicating a trend towards more prudent spending choices among high earners. It’s critical to prioritize your goals to avoid this creep – and part of the reason why it’s essential to our Envision Process.
Spend on experiences and items that genuinely bring you and your family happiness and value, rather than on every luxury or trend. The cornerstone of mindful spending is to decide on a spending limit for each category of expenses, such as food, entertainment, and transportation, and stick to it. After that, take time to think about whether a purchase is necessary or just “a want” before making it. Avoiding impulse purchases can help accelerate your savings potential. Our blog Six Principles of Financial Health for Young Professionals can provide you with more insights.
Prioritize Savings and Investments
Creating a robust savings plan is the next step. High-income families should aim to save a significant portion of their income, well above the standard recommendations. This could mean allocating 20-30% (or more) of their income to savings, depending on their financial situation and goals. The key is to automate these savings. Automatic transfers to savings accounts, investment portfolios, and retirement funds ensure that a portion of every paycheck is saved or invested before it can be spent, effectively implementing a ‘pay yourself first’ philosophy.
Investment is another area where high earners can capitalize on their income. Diversification is the cornerstone of a sound investment strategy. High-income families have the advantage of accessing a wider range of investment opportunities, including stocks, bonds, real estate, and potentially higher-risk/reward ventures like start-ups or venture capital. However, it’s crucial to seek advice from financial advisors to tailor an investment portfolio that aligns with the family’s risk tolerance, time horizon, and financial goals.
Retirement planning should be a priority, regardless of current income levels. High earners should maximize their contributions to retirement accounts such as 401(k)s, IRAs, or any employer-sponsored plans, especially if there are matching contributions. Considering additional retirement savings vehicles that cater to high-income earners can also be beneficial, ensuring a comfortable and secure retirement.
Finally, it’s important for high-income families to regularly review and adjust their investment plan. As income grows or personal circumstances change, so too should savings and investment strategies. This might involve rebalancing investment portfolios, adjusting savings rates, or redirecting funds to different types of investment accounts.
Tax Planning and Management
Effective tax management is vital for high-income families. This means understanding how different types of income are taxed and making informed decisions about investments and spending to minimize tax liabilities. Working with a tax professional alongside your financial advisor can provide valuable insights into strategies like tax-loss harvesting or the use of tax-advantaged accounts. We outline the potential benefits in more detail in our blog on the subject.
For example, the tax implications of a portfolio transition to a new advisor can often be a cause for concern. Switching firms almost always results in changes to investment holdings, even in the case of a like-for-like position swap. Especially in volatile markets with rapidly moving valuations, such changes can prompt taxes owed on any capital gains generated to date. Some costs may be unavoidable, but others aren’t. An advisor can take proactive steps to attempt to mitigate or even eliminate the costs associated with asset moves.
When evaluating a taxable investment account, Magellan Financial looks at every position and asks if we would buy, hold, or sell. If capital gains would result, we discuss our reasoning with the client. Sometimes it’s in a client’s best interest to sell over time, depending on the amount of capital gains. In any event, we develop a gameplan for managing the transition to the portfolio we want to achieve. We also use more tax-friendly investments in taxable accounts to best minimize taxes moving forward, as well as offering the ability to time when short-term & long-term gains are taken.
Finally, high-income families should also consider estate planning. This involves strategies to manage assets during one’s life and control the distribution of wealth after passing. Estate planning can include wills, trusts, and other legal tools to ensure that assets are distributed according to your wishes while minimizing tax impacts. And don’t forget to involve your family! Estate planning should be a family affair. High-income families have the opportunity to educate their children about managing wealth responsibly. This can include discussions about budgeting, the value of money, and the importance of saving and investing.
Budgeting and spending for high-income families involve a balance between enjoying the fruits of their labor and making smart financial decisions for the future. By customizing their budget, managing lifestyle inflation, prioritizing savings and investments, practicing smart spending, planning for taxes, and embracing financial education, high-income families can ensure their wealth works for them, setting a strong foundation for financial security and success.
In conclusion, the key to effective financial management for high-income families lies in a careful balance of enjoying the present while planning for the future. By implementing these strategies, such families can ensure they are not only preserving their wealth but also using it in ways that enrich their lives and the lives of others around them.
For More Tips for Budgeting and Spending for High Income Families, Contact Our Team Of Financial Advisors Today!
Investment products and services are offered through Wells Fargo Advisors Financial Network, LLC (WFAFN), Member SPIC. Magellan Financial Heirloom Wealth Advisors is a separate entity from WFAFN.
Wells Fargo Advisors Financial Network and its affiliates do not provide legal or tax advice. Transactions requiring tax consideration should be reviewed carefully with your accountant or tax advisor. Any estate plan should be reviewed by an attorney who specializes in estate planning and is licensed to practice law in your state.
- 10 Disruptive Trends in Wealth Management (Deloitte, 2024)
- Navigating Debt Repayment in 2023 (Magellan Financial, 2023)
- How Much Can I Afford To Borrow (USAA, 2023)
- Annual Credit Report (Free Credit Report.com, 2024)
- Gen Zers Have Barely Joined the Workforce… (Business Insider, 2021)
- Investment Planning – Envision Process (Magellan Financial, 2024)
- Six Principles of Financial Health for Young Professionals (Magellan Financial, 2023)
- Why Your Tax Advisor and Financial Advisor Should Work Together (Magellan Financial, 2022)