4 Biggest Financial Mistakes High-Earners Make (and How to Avoid Them)

Key Takeaways   

• When it comes to financial planning, many executives inadvertently overpay, under-save, and don’t take advantage of all the benefits available to them.  

• High earners should minimize the impact of lifestyle creep by increasing their savings rate each time their income rises.  

• When it comes to stock options, the timing of when to exercise is just as important as the amount you receive. 

  
  

As your income grows, so does your financial complexity. And that’s why many successful professionals and business owners find themselves making costly mistakes that significantly erode their wealth. If any of these missteps below sound familiar, it might be time for a reset.

1. Lifestyle Creep 

As you start earning more, you typically find more free cash sitting in your checking and savings accounts. As a result, your spending tends to increase commensurately. Instead of letting your cash accumulate, you should increase your saving rate, so it remains a fixed percentage of your earnings. If you want to maintain your higher standard of living into retirement, then you need to increase your savings rate as well during your peak earning years. 

People typically come to us when their level of financial complexity increases, say when getting promoted from vice president to senior executive VP. Not only does their income jump dramatically, but they now have access to executive compensation such as stock options, restricted stock or other types of deferred compensation and benefits.

Higher-earners who don’t work with us might say to themselves: “Wow. My income has doubled over the past three years. Now I can spend more on cars, trips and other discretionary expenses.” Unlike our clients, they’re not prioritizing their savings when they’re in prime position to do so. When your income rises, don't leave your 401(k) contributions at the same level as before. Max them out. If your plan allows for after-tax 401(k) contributions, contribute in that manner as well. This allows you to do a tax-free rollover to a Roth IRA when you change jobs or retire. Also take advantage of any deferred compensation plans that your company offers. Sure, it’s okay to splurge from time to time, but there are many ways to maintain balance between spending and saving.  

2. Poor Tax Planning With Equity And Deferred Compensation 

When highly compensated executives start working with us, we often find they don’t understand their equity compensation and how to maximize it. The two most common types of equity compensation are non-qualified stock options (NQSOs) and restricted stock units (RSUs).  The biggest difference between these two types of options is control over when you are taxed. But first some quick definitions: 

Grant: When you receive a certain number of shares of options or stock units. 

Vesting: When you obtain control over the ability to do something with your options or stock units. Vesting can occur gradually (monthly or annually), or it can happen after several years (often over three or five years), or it can happen after an event (i.e., the company is sold). 

Exercising: This is specific to options. After your options vest, you now have control over when to take action and exercising your options means taking action. 

Non-qualified stock options are taxed as income when you exercise them.

Restricted Stock Units (RSUs) are taxed as income when they vest. This is an important distinction because with options, you have flexibility over when you receive the income and the value at which you receive it. There is less flexibility with RSUs. When they vest, the value is taxed as income to you. The downside is having less flexibility when it comes to taxes. But the upside is that you are receiving the benefit of the value of those shares on that day.   That’s why you want to have a specific tax and investment strategy in place. Once your options or RSUs vest, you know exactly how they should be handled. For example, one of our clients is a successful executive who is planning to retire in a few years. We are helping him sell his restricted stock as it vests. But we're waiting to exercise his stock options until after he stops working. He’ll be in a lower tax bracket then and we can gradually realize the income from his stock options during his first few years of retirement. 

Performance Stock Units (PSUs) are also becoming more popular as a form of equity compensation. They are very similar to RSUs except the formula to calculate their benefit is more complex. This is ironic since the whole point of equity compensation is to align company performance with employee compensation in an easy-to-understand manner! 

When executives start receiving equity compensation, they typically receive a generous salary and bonus, which puts them in the highest tax bracket. Meanwhile, they’re continuing to receive options and restricted stock as they progress in their careers. That’s great, but the stock and options can make them vulnerable to company-specific risk. If they’re not careful, their financial plan can become way too reliant on the success of their employer, and they may not reach their goals if the company falters. Many companies require executives to hold a certain multiple of their salary in company stock, say three or five times. Once that threshold is satisfied, it’s generally a good idea to sell the RSUs or PSUs as soon as they vest – because they’re taxed as income when they vest -- but you want to hold on to your options since you have more flexibility over the timing of value you receive value from them.   

Deferred compensation plans are another area where we see execs making tax planning mistakes. Deferred comp plans can be great, especially if planning to retire early. Instead of receiving more income on top of your high salary and bonus, you can defer a portion of that income until after your early retirement, when you’re likely in a lower tax bracket. Just try to avoid having payments being made while you are still working. Another common mistake we see execs make in this area is receiving lump sums instead of spreading out the payments. Many deferred compensation plans allow you to spread out the payments over several years of retirement when you are likely in a lower tax bracket. Since deferred comp plans are not fully guaranteed, there is some risk. But, if you work at a financially stable company, the risk of loss might be worth the reward. 

3. Not taking advantage of ESPP and top hat plans 

Employee Stock Purchase Plans (ESPP) allow you to buy your company stock at a discount, typically 15%. Many executives participate in these plans but make the mistake of holding onto their company stock indefinitely. A better strategy is to sell the stock as soon as the lock up period expires. Yes, you’ll pay short-term capital gains on the sale, so it will count as regular income. However, since there is a 15% discount on the purchase price, this is an opportunity to pick up additional compensation for relatively low risk.  

A top hat plan allows high-income executives to continue contributing to a deferred-tax retirement saving plan after they have maxed out their contribution to the company 401(k) ($23,500 in 2025, or $31,000 if over age 50). Like 401(k)s, top hot plans often provide a company match as well. But many highly compensated executives either aren't aware of their company’s top hat plan or aren’t comfortable with how they work.  

Let’s say your salary is $300,000 and you want to contribute 10% ($30,000) to your 401(k)retirement account. Without the top hat plan, if you’re under age 50, your contributions would be capped at $23,500 (7.8%). With the top hat plan, however, you could max out your 401(k) at $23,500 and then put the remaining $6,500 into the top hat plan -- and continue receiving a match of X% from the company. This enables high-income professionals to save appropriately for retirement without being subject to government restriction on 401(k)s. 

4. Being underinsured  

One of the biggest insurance gaps we see among high-earning professionals is not having umbrella insurance – or not having enough of it. An umbrella insurance policy is extra liability insurance coverage that goes beyond the limits of your homeowners, auto, or watercraft insurance. Umbrella insurance is highly recommended if you own a swimming pool, rent out your property, or have a dog or teenage driver living in your house, but generally anyone with more than $1 million in assets should own an umbrella policy. Umbrella liability insurance is surprisingly affordable and is a smart extra layer of protection for higher earners to have since they’re at greater risk of being sued for damages to other people's property or for injuries caused to others in an accident.    

Life insurance is another area where we see high earners make mistakes. Many are paying way too much for permanent insurance when term insurance is more appropriate for their financial situation. They are also relying upon life insurance through work when they should own their own policy outright. You never want to be tethered to a job just because of the insurance benefits. For younger executives, disability insurance is often neglected due to its complexity and cost. There are so many different terms and decision points to decide upon. A fee-only advisor, like the ones here at Novi, can help you wade through the complexity, make appropriate recommendations and ensure you have the proper coverage in place. And since we don’t sell insurance, we can also ensure that the cost is appropriate based on your insurance needs and your spending plans.  

Conclusion 

When it comes to financial planning, many executives are inadvertently overpaying, under-saving, and not taking advantage of all the benefits available to them. We’re happy to help you develop a plan based on your goals and to make sure you are taking full advantage of all the benefits you have earned through your work. Understanding and taking advantage of these benefits will help you grow your wealth and allow you to find that balance of enjoying today while saving for tomorrow. high-earners financial mistake

RYAN M. VOGEL, CFP® is the CHIEF PLANNING OFFICER, PARTNER at Novi Wealth