Here are 3 specific method the top 1% utilize to build and protect their wealth. These are uncommon tactics that C-suite executives and managing directors in top consulting firms employ on a regular basis to ensure than the compensation from their high paying jobs compound into even greater wealth.
There are many avenues in which the top 1% continue to build and protect their wealth. They invest, take advantage of tax loop holes and also find other wealth advantaged financial vehicles in which to grow their investments.
But did you know that there are 3 particular things that high earners utilize within their regular corporate compensation — that help them become even richer?
These are tactics that C-suite executives and managing directors in top consulting firms employ on a regular basis to ensure than the compensation from their high paying jobs compound into even greater wealth.
Curious to know what these are? That’s what we’ll get into, in this article.
Mega Backdoor Roth
The first of these 3 tactics — is called A Mega Backdoor Roth.
But in order to understand how this works, we need to first make sure we’re grounded on how 401ks and Roth IRAs work.
First, a 401k is a retirement account that’s sponsored by your employer, in which an employee can choose to have a certain amount of pre-tax dollars deducted from their paycheck, each pay period, to add into this retirement account. The money in this account is tax deferred (meaning it goes into the account pre-tax) and then it invests and grows tax free as well and you only pay taxes on it when you eventually take distributions from the account – post retirement age.
And to help even further in this retirement planning motion, most employers will actually provide a company match to the amount you contribute into your 401k as well. The amount of the match differs by employer, but most large tech companies offer about a 5% match. (Some do not offer a match at all.)
A Roth IRA is also a retirement planning vehicle — but the merit of this type of account is that you contribute after-tax money into this account and then the account invests and grows just like a 401k, but since it started with after-tax money, it grows tax free, and you also pay no taxes when you pull out the funds later in retirement — assuming, of course, that you follow the correct distribution rules.
Now that we’re versed on the basics of 401ks and Roth IRAs, there is one other important thing to note before we move onto how Mega Backdoor Roths work.
As you’ve seen, 401ks and Roth IRAs are really powerful wealth building tools, but they both come with a really big restriction — contribution limits.
The IRS limits the amount of pre-tax money you can contribute to either of these accounts each year — and in 2023, employees can contribute a maximum of $22,500 into a 401k or a max of $30,000 if you are age 50 or older. For IRAs, the contribution limit for 2023 is $6,500 or $7,500 if you’re age 50 or older — and this is across all IRAs, so if you have a Roth and a Traditional IRA, the sum of the contributions can’t exceed $6,500, in 2023.
The one other restriction that’s specific to Roth IRAs is that you can only contribute to it if you make less than $153,000 for single tax filers, or less than $228,000 for those married and filing jointly.
As you can see, if you’re a top earner in your industry, these restrictions can make it difficult for you to participate in these vehicles to build more wealth — and that’s where a Mega Backdoor Roth comes into play.
A Mega Backdoor Roth is a process in which, your employer allows you to make after-tax contributions into your 401k — which then rolls into either a Roth 401k or a Roth IRA.
Remember that the yearly pre-tax employee contribution to the 401k is $22,500 in 2023? Well, the IRS allows, other non-pretax contributions to a 401k, but only up to the limit of $66,000, or $73,500 if you are age 50 or older. So, some employers (but not all) will allow you to make post-tax contribution into your 401k that can fill up the remaining $43,500 and then allow you to transition that into one of the 2 Roth accounts (Roth IRA or Roth 401k).
Now, keep in mind that if your employer provides you a company match to your 401k contributions, that match also counts towards that $43,500 number, which means the amount of after-tax dollars you can contribute in this case needs to deduct the employer match amount — but this Roth account then behaves just like any other Roth account and grows tax-free and you can make qualified withdrawals, tax-free as well.
That means in one year, you could put away and invest as much as $66,000 of tax advantaged money.
If we assume a modest return rate of 6% compounded each year, in 10 years, your total invested amount would balloon up into $876k dollars.
Deferred Compensation Plan (Non-Qualified, Company Directed)
The second wealth building vehicle that high earners utilize is a Deferred Compensation Plan.
These types of plans are mostly originated by your company directly and are non-qualified, meaning they are typically not governed by the same types of government regulations that a 401k or Roth IRA are aligned to.
And because of that, these plans may very widely between companies — as there’s more freedom for the company to define the framework of these programs — including the contribution limit, investment avenues and distribution schedules.
Of the plans I’ve participated in, they have typically allowed the employee to defer between 25%-75% of our pre-tax salary — which means this 25%-75% amount of our pay is withheld from our paychecks and rerouted to the Deferred Compensation Plan (DCP). It is then put into a holding or investment account and you are able to choose the type of investment you want your funds to grow in.
The distribution schedules also vary with each different plan/company — but the ones I’m familiar with gives you the choice of pulling out in either 5 year, 10 year or 15 year durations after retirement — of equal monthly payments.
The downside of these company specific DCPs is that they are tied and bound to the company and it’s parameters.
For example — if you leave the company, you would be kicked out of the program and depending on how much you already have in the plan, you might be forced to take a taxable lump sum distribution immediately or be stuck with your money in the account until retirement age, without the ability to roll it over into a different retirement vehicle.
Additionally, if the company goes bankrupt, you may also not enjoy the same level of financial protection that would normally get with a 401k or Roth IRA – it just depends on the details of your company’s specific DCP. So it’s really important to fully understand all of the parameters of the Deferred Compensation Plan before you participate. But if you fully understand the risks and utilize this vehicle in the most optimized way, it can be an amazing avenue to defer your tax liability now — and build wealth into the future.
Employee Stock Purchase Program
And lastly — most high earners utilize their company’s Employee Stock Purchase Program (ESPP) to build additional wealth.
An ESPP is simply a plan that let’s you deduct money from your paycheck, to purchase shares of your company’s stock — typically at a small discount. Most publicly traded, large tech companies have a program like this and they employ payroll deductions to fund this plan and typically provide you the company’s stock at around a 10% to 15% discount.
As an example, if you work for Microsoft, you could decide to put away $500 each month into the Microsoft ESPP, and at the end of the quarter, the plan would take the $1,500 you’ve allocated, find the lowest stock price within the quarter, take the discount of 10% from that price, and purchase the appropriate number of shares for you, with your $1,500. This would then be deposited into your brokerage account giving you instant equity of at least 10% of the stock price.
And then these shares are yours to own outright, and as the stock price goes up, your wealth would increase as well.
Those are 3 of the secret/uncommon ways the top 1% accelerate their wealth while earning a full time salary.
If you’d like to learn about 5 unique side hustles you can do while working a full time job, go to this article here: 5 Realistic Side Hustles
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The content here is strictly the opinion of Daniel’s Brew and is for entertainment purposes only. It should not be considered professional financial, investment, or career advice. Investing and career decisions are personal choices that each individual must make for themselves in accordance with their situation and long term plans. Daniel’s Brew will not be held liable for any outcome as a result of anyone following the opinions provided in this content.