We believe navigating the complexities of income sources and investment options during the prime earning years is crucial for mid-career professionals. With unique potential challenges like equity compensation, maximizing retirement contributions, tax-efficient strategies, and diversification, the choices made in this phase can impact long-term financial success.
This guide outlines financial strategies and challenges that professionals may face during the middle of their career. Whether you are a small business owner, someone working for equity compensation, or an executive of a small to mid-size company, there can be complexities that are hard to navigate on your own. Below is an overview of planning topics for mid-career professionals to consider.
1. Restricted Stock Units (RSUs)
RSUs are a common form of equity compensation, especially in industries like tech and finance. These units are granted to employees and typically vest over a specific period.
- Taxation: RSUs are taxed as ordinary income upon vesting. Consider setting aside a portion of vested shares or cash for taxes¹².
- Diversification: Often, employees that believe in the company they work for will hold on to the company shares. This can lead to wealth concentrated in one company, and more specifically the company that also provides a salary for that employee. Understanding the risks of concentrated stock and managing that risk can be important for achieving long-term goals¹.
Consider your tax burden, concentrated stock exposure, and portfolio diversification when you receive RSUs. Understanding your strategy before vesting can help you manage this type of compensation.
2. Stock Options
Stock options provide an opportunity for significant financial gain. The two common types are Incentive Stock Options (ISOs) and Non-Qualified Stock Options (NSOs). With a stock option, the stock must be purchased with savings, so cash needs to be available to exercise. The tax burden differs between the two¹².
- ISOs: Favorable tax treatment if held for more than one year after exercising. Gains taxed as capital gains. Can be subject to additional tax at exercise².
- NSOs: The spread between exercise price and market value is taxed as ordinary income upon exercising².
Stock options are potentially lucrative but one of the more complicated compensation types to work with. The risk of AMT (Alternative Minimum Tax) is a key consideration for exercising granted options².
3. Employee Stock Ownership Plans (ESOP)
ESOPs allow employees to acquire shares, creating additional retirement wealth. However, it is crucial to balance liquidity needs and diversification³.
- Tax Deferral: ESOP contributions grow tax-deferred like a 401(k)³.
- Liquidity: This type of equity is often difficult to sell and has specified guidelines. Understanding the liquidity is important³.
Consider periodically selling shares to diversify your portfolio and manage risks if possible. This type of account can be harder to diversify away from than a publicly traded company if there is not a market for the shares³.
4. Real Estate in Your Investment Portfolio
Real estate can play a role in your portfolio. Investors may opt for active management or passive real estate exposure. Common Real Estate investments include:
- Investment Properties: Typically, direct investment in real estate is made to generate income and hopefully benefit from growth that paces inflation. With direct investment, it can be helpful to manage your costs associated with the property⁴.
- Private REITS and Investment Products: These can offer passive exposure to real estate and will vary in risk and income depending on the type of real estate and number of properties in the investment⁴.
Consider aligning any real estate investments with your long-term goals and liquidity needs. Real estate can be illiquid and will often have longer time horizons⁴.
5. Cash Management
We feel cash flow management is essential, especially during high-earning years. Here are strategies to help manage it effectively:
- Emergency Fund: Consider maintaining 3-6 months of expenses in liquid accounts⁵.
- High Yield Savings: Consider focusing on a high-yield savings account to maximize return on liquid assets⁵.
Business owners especially have a cash management need for their operating capital. There can be an increase in income from better managing cash to have a higher yield⁵.
6. Tax-Efficient Investing
We think maximizing returns by minimizing taxes is key to long-term success. Many times, people will start to reach their contribution limits in their retirement accounts and will begin investing in a taxable position⁶.
- Asset Location: Consider placing investments in different accounts based on their taxability. Think of net worth as a whole and invest as if all accounts were combined to maximize tax efficiency⁶.
- Tax-Loss Harvesting: Consider offsetting gains with losses to minimize taxable income⁶.
It can be important to ensure your financial advisor is conscious of where you are investing each account and focusing on investing taxable money in the most efficient way⁶.
7. Mega Backdoor Roth 401k
For those who max out traditional contributions, the mega backdoor Roth allows you to contribute extra funds to a Roth 401k. Often this is a feature available with large corporations that have sophisticated 401k plans⁷.
- Eligibility: Check if your employer’s 401(k) plan allows after-tax contributions. Some companies will have after-tax contributions and immediate rollovers to Roth 401k all within the plan automatically⁷.
- Tax-Free Growth: Grow contributions tax-free within the Roth 401k above and beyond traditional 401k employee limits⁷.
This strategy is not available to everyone, but we feel it’s a very powerful strategy to deploy if it is available⁷.
8. Private Investments
Private investments may offer higher returns and further diversification from public markets. Considering the complexity, understanding the product you invest in can be difficult. Working with an advisor can help you better navigate this market⁸.
- Liquidity: Many private investments require long-term commitments that could lock up the investment for multiple years. Others can have monthly, quarterly, or annual liquidity. Understanding the structure helps to determine the best investment⁸.
- Accredited Investor/Qualified Purchaser: Many of the best investment products can require a certain level of wealth or income to qualify for investment⁸.
While many of the best private investments are closed off for smaller investors, if you are qualified to invest, private products may be a great supplement to public investments⁸.
9. Estate Planning
Consider ensuring your assets are distributed according to your wishes while minimizing estate taxes⁹. Work closely with a qualified lawyer to help ensure proper strategy.
- Wills, Health Directive, POA: Consider a typical estate planning package from a lawyer to help prepare for the unexpected and make sure you are organized⁹.
- Estate Tax Considerations Early: Depending on your wealth trajectory, having some estate planning early can help to avoid estate tax issues down the road⁹.
While your financial advisor isn’t likely a lawyer as well, they will work together to help ensure the family is properly taken care of⁹.
For mid-career professionals, financial success may depend on a careful balance of risk, reward, and tax efficiency. From maximizing equity compensation to strategic retirement planning, each decision made now may have an impact on your financial future. We believe that by working with experienced advisors and staying proactive in managing your wealth, you can build a strategy that helps ensure both growth and security.
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1. Mercer, "Stock-Based Compensation: Tax and Valuation Considerations."
2. IRS Publication 525, "Taxable and Nontaxable Income."
3. National Center for Employee Ownership, "Employee Stock Ownership Plan (ESOP) Facts."
4 IRS Publication 523, "Selling Your Home."
5. Consumer Financial Protection Bureau, "Building Emergency Savings."
6. IRS Publication 550, "Investment Income and Expenses."
7. IRS, "Retirement Topics – IRA and 401(k) Contribution Limits."
8. U.S. Securities and Exchange Commission, "Accredited Investor Definition."
9. IRS, "Estate and Gift Taxes."
10. National Association of Insurance Commissioners, "Types of Life Insurance."