For those who do the extra credit assignment, literally run the extra mile at the gym, and always strive for more, your financial life is probably no different. You’ve mastered the basics such as creating a solid emergency fund, always paying off your credit card in full, and taking full advantage of your employer’s retirement match. So now what?
If you are a financial overachiever, here are five advanced money strategies to consider incorporating into your financial plan.
a) Invest Health Savings Account (HSA) contributions instead of withdrawing funds over the course of the year
Health Savings Accounts are available to individuals with a high-deductible insurance plan. They allow the use of pre-tax dollars to pay for approved medical expenses like doctor co-payments, contact lenses, and flu shots. Moreover, unlike a Flexible Spending Account (FSA) where the funds are “use it or lose it”, an HSA is portable, allowing you to leave money in the account on an ongoing basis. According to Kaiser, the percentage of employees enrolled in HSA-qualified plans has grown quickly, reaching a new high of 19% in 2016, up from 11% in 2013.
The number of workers enrolled in an HSA-qualified plan, as well as the assets invested in HSA accounts, continues to grow quickly.
The prudent first step for anyone eligible for an HSA is to contribute at least enough to pay for your estimated medical expenses that year. For example, if you forecast having $1,000 worth of medical expenses such as doctor’s visits and prescriptions, you would want to contribute at least $1,000 to your HSA. Assuming you are in the 25% tax bracket, this would equate to $250 in savings as you would avoid paying taxes on the $1,000.
What would an overachiever do instead?
An overachiever would seek to wring additional benefits from an HSA. A key insight stems from the fact that “HSAs can be used to ‘save now and cash in later’,” according to Dr. Stephen Neeleman, founder and vice chairman of HealthEquity, one of the largest HSA administrators. According to Dr. Neeleman, “many account holders are using an HSA to save for retirement. . . [because] an HSA has no time limit for reimbursements when qualified medical expenses are paid out-of-pocket. You can pay for qualified medical expenses now and reimburse yourself any time in the future.” In other words, if you open and fund an HSA today and then go buy contact lenses, you could reimburse yourself for this expense in 20 years.
Tweaking the example from earlier, an overachiever would contribute the $1,000 pre-tax to her HSA, pocket the $250 in savings, but pay the $1,000 in medical expenses from her regular checking or savings account. Instead of reimbursing herself from the HSA, she would invest the $1,000, allow it to grow over time, and use it to pay for future medical expenses. By treating HSA accounts as investment vehicles, overachievers can put their contributions to work just like a retirement account, creating what I call a “Health 401(k).”
Why would an overachiever do this?
In addition to allowing pre-tax contributions, HSAs also offer two other types of tax advantages. First, money you invest grows tax-free, which means you don’t pay any capital gains taxes on profits. Second, you can withdraw the money tax-free as long as it is to reimburse yourself for an approved medical expense, even if you incurred that expense many years ago.
This triple advantage – contributions, earnings, and distributions are all tax-free – is better than what a single retirement vehicle, like an IRA or a Roth IRA, can offer. Moreover, while both retirement and HSA contributions may avoid state and federal taxes, only HSAs are not subject to Social Security and Medicare (“FICA”) withholding if contributed via payroll deduction. That, coupled with more favorable rules around distributions and withdrawals, support Dr. Neeleman’s contention that, “for certain individuals, an HSA may even be a better investment option than a 401(k).”
With a 65-year-old couple retiring this year projected to need an average of $260,000 to cover medical expenses throughout retirement, HSAs should be a valuable component of everyone’s retirement strategy. Overachievers should start contributing to an HSA early in life – especially when they are younger, generally healthier, and less likely to need the money for medical expenses – to harness the power of compound interest and build up a reserve.
One final tip if you are planning to invest your HSA funds: keep detailed records of your medical expenses. Among other obligations, the IRS requires you to “keep records sufficient to show that. . . the distributions were exclusively to pay or reimburse qualified medical expenses.” As Dr. Neeleman points out, “many administrators, like HealthEquity, offer a documentation library where you can upload a receipt via your desktop or mobile app. The receipts will be stored and account holders can link to reimbursements or claims to keep track of expenses.”
b) Open and contribute to a 529 college savings account when children are young (or even before they are born)
A college education has never been more expensive in the U.S.; nor has it ever been more important. Confronted with rising tuition—and motivated by their own experiences with student debt—many parents are committed to paying at least a portion of their children’s college costs.
Overall, parents surveyed by Fidelity plan to cover 70% of the total cost of college, with 43% planning to pay all costs; however, Fidelity found that parents are on track to “cover only 29% of that college funding goal by the time their child reaches college age.” The prior year’s survey also identified interesting generational differences with millennial parents planning to cover, on average, 74% of college costs versus 64% and 60% for Generation X and baby boomer parents, respectively.
In the most recent survey, parents with children in 10th grade and higher were also asked what they wish they had done 10 years earlier to prepare for college costs better. The most frequent answer, given by 24% of parents, was “opened a 529 college savings account earlier.”
It’s not hard to understand why. A 529 account can be opened with as little as $25 and contributions not only grow tax-free, but can also be withdrawn tax-free when used for qualified education expenses, such as tuition and textbooks. Moreover, while contributions are not free from federal income tax, 34 states currently offer a full or partial state income tax deduction for contributions to their state 529 plans.
Financial overachievers will start saving far in advance of their children’s college years. They recognize that they can exploit time value of money and allow their contributions to compound over and over by starting to invest early. The truly visionary ones, like Dan Egan, managing director of behavioral finance and investing at Betterment, will open an account before their children are even born. Plus, with the many demands of parenthood, opening an account before a child is born ensures the task doesn’t get crowded out by diaper changes and attempts to catch up on sleep. As Egan put it, “I realized I should do it, and wanted to get it done with. If I waited, I might have forgotten.”
c) Take advantage of the rewards bonanza in the credit card market
Competition among credit card issuers such as Chase, American Express, and Citi has intensified in the past few years. “There’s certainly a competitive dynamic in the marketplace that’s focusing on rewards points,” according to American Express’ Howard Grosfield, executive vice president of U.S. consumer marketing. (Disclosure: I was employed by American Express between 2011 and early 2016.)
Issuers are competing to be “top of wallet” and to acquire profitable customers, especially millennials, by offering larger sign-up bonuses and enticing perks. This is especially true at the higher end of the market. New premium products, like the Chase Sapphire Reserve card or Citibank’s Prestige card, have put pressure on the value proposition of AmEx’s Platinum card, encroaching on its traditional stronghold. This has created many opportunities for shrewd consumers to reap rewards that are more valuable than the fees associated with each card.
First and foremost, financial overachievers get the basics right. This includes making sure they:
- Pay off their balance in full each and every month, knowing that the interest charges incurred if they don’t will dwarf even the highest valued rewards
- Create and keep a financial plan and resist the temptation to spend more than they can afford to pay off.
- Do not spend frivolously just to hit the minimum spend required to earn a sign up bonus
- Guard their credit score zealously and don’t apply for many cards if they are planning to apply for a mortgage or auto loan in the near future
- Ensure enough slack in their budget to absorb the sometimes hefty annual fees, which are usually charged upfront, knowing that it may take longer for some benefits to materialize.
But financial overachievers go beyond these foundational elements. Realizing that the largest opportunity to earn rewards usually resides with the initial sign-up bonuses that banks dangle, they aren’t afraid to apply for several cards at once. They time applications strategically, knowing that issuers occasionally increase sign-up bonuses. Finally, they are deal seekers who frequent sites like The Points Guy to stay current on the rules of specific programs, like Chase’s 5/24 rule, and learn how to take full advantage of the benefits each card offers.
The current “it” card for many is the Chase Sapphire Reserve. Chase approved so many applications in the first few days after the card launched that it ran out of the newly created metal Reserve card, forcing the company to send out temporary plastic versions to keep up with demand. The 100,000-point sign up offer, redeemable for $1,500 in travel spend, and $300 calendar-year travel credit that’s much less strict that the AmEx Platinum or Citi Prestige cards, make it easier to justify the hefty $450 annual fee on the card (Note: Starting tomorrow, the 100,000 point online sign-up offer will be replaced by a 50,000 point offer; however, you can still obtain the 100,000 offer until March 12, 2017 by applying at a physical Chase branch).
As one of my favorite personal finance writers (and presumed financial overachiever), Ron Lieber, quipped,
“I do want to thank Mr. Dimon on behalf of credit-card reward junkies everywhere for giving us the Chase Sapphire Reserve credit card in 2016. By next month, I’ll have extracted over $2,100 in value in exchange for my $450 annual fee. At that point, we’ll put my card aside, my wife will get her own, and we’ll do the same thing all over again.”
Finally, financial overachievers keep in mind social psychology research showing that “experiences bring people more happiness than do possessions.” To maximize their return, they parlay accrued credit card rewards to indulge on experiential items rather than material goods.
d) Employ Tax Loss Harvesting for investment accounts
When it comes to investing, getting the basics right is the most important thing. As Harold Pollack, co-author with Helaine Olen, of “The Index Card: Why Personal Finance Doesn't Have to Be Complicated,” summarizes: buy inexpensive, well-diversified mutual funds, pay attention to fees, and avoid actively managed funds. If those terms sound foreign, there are many good primers on how to start investing, including great information on Vanguard’s Investor Education section.
Overachievers can go beyond the basics and augment their overall investment returns, without taking on significant additional risk. One way is to consider Tax Loss Harvesting, a tax-deferral strategy that involves “selling a security that has experienced a loss and then buying a correlated asset (i.e., one that provides similar exposure) to replace it.”
The automated investing service Betterment has an easy-to-read white paper providing a good overview of the strategy including its potential benefits. It behooves financial overachievers to learn about these benefits and determine whether they could gain from deploying the strategy. The potential upside from Tax Loss Harvesting includes tax deferral, shifting capital gains into a lower tax rate, the ability to offset up to $3,000 of ordinary income each year and most likely pay long-term capital gains tax on it later on, and the potential for permanent tax avoidance in certain cases like philanthropic activity or bequests to heirs.
Tax Loss Harvesting used to be done manually at the end of the year by advisors to high-net worth individuals, but with the proliferation of automated investment platforms there is an opportunity for more individuals to maximize this benefit. Tax Loss Harvesting wasn’t “discussed in the personal finance mainstream until two or three years ago” according to Joe Ziemer, vice president of communications for Betterment. “It could be done manually, but there is almost no reason to do so when technology can do it for you at almost no cost.” Betterment estimates that its proprietary, automated approach to Tax Loss Harvesting “would have provided an estimated 0.77% to a typical customer’s after-tax returns, annually.”
Before utilizing a Tax Loss Harvesting strategy, there are a few important considerations, such as steering clear of the IRS wash rule. The wash rule prevents an investor from claiming a loss from selling a security if the investor purchased a “substantially identical” security 30 days before or after the sale. The “rationale is that a taxpayer should not enjoy the benefit of deducting a loss if he did not truly dispose of the security.” Additionally, graduate students or younger investors should ensure that they are deferring taxes from a higher tax bracket to a lower one and not vice versa.
e) Donate money and do so strategically
If you’re overachieving financially, you’ve probably worked hard to get to where you are. But it’s also important to take stock of your luck and give back to those less fortunate or to causes that are meaningful to you. “Life’s outcomes, while not entirely random, have a huge amount of luck baked into them,” Michael Lewis once told graduating Princeton students. “Above all, recognize that if you have had success, you have also had luck — and with luck comes obligation."
Financial overachievers should take this obligation seriously, but also look to deploy their money effectively. This means amplifying the value of their donations whenever possible by. For example, they should check for and utilize any employer-matching initiatives. It also means ensuring that they receive appropriate tax deductions, which might allow them to have a larger impact in subsequent years.
At the end of the day, no one should really need any additional incentive to give; however, if you do need an extra nudge, consider the research findings of Michael Norton and Elizabeth Dunn, authors of “Happy Money." They found that everywhere in the world giving is associated with increased happiness. As they put it, “we’ve found that asking people to spend money on others — from giving to charity to buying gifts for friends and family — reliably makes them happier than spending that same money on themselves.” Finding ways to be happy while simultaneously making others happy, now that’s overachieving.
A special thank you to Sunny Stroeer for generously allowing the use of her photos in this column.