By: Paul Morrone
For most high earners we meet, cash isn’t a decision – it’s working capital. Just like a well-run business has a dedicated finance function to manage income, receivables, assets and liabilities, an individual’s financial statements require a similar level of due diligence. Passively managing cash looks something like this: expecting a residual balance after the mortgage, the nanny, the 401k deferral and the payroll withholding have all taken their cut. At a modest income, that residue is small and mostly spoken for. When you’re earning a large 6- or 7-figure salary, it accumulates quickly, and before long a household can be sitting on a pile of cash that nobody ever consciously decided to hold (see a previous article we wrote about the cost of inaction in a financial plan for more on this…). Some of it is needed. Some of it is owed to someone else (a lender, a relative, or even the IRS). And some of it is simply sitting there doing nothing. The problem is that, without a plan, it’s nearly impossible to tell which dollars are which.
Part of the reason is that compensation at this level rarely arrives in a straight line. For many executives and physicians, base salary is the smallest piece of the pie. The rest shows up in lumps: an annual bonus, quarterly RSU vests, partnership or practice distributions, a K-1 from a private investment, deferred compensation payouts or the occasional liquidity event. Lumpy income creates lumpy cash balances, and lumpy cash balances are easy to misread. A bank account that swells in March after a bonus and again in the fall after a vest feels like wealth. In reality, a meaningful portion of it may already belong to the IRS.
This is one of the most common surprises we see. Bonuses and RSU vests are generally withheld at the federal supplemental rate of 22%, while a taxpayer in this income range is likely sitting in the 35% or 37% bracket – before state taxes and the net investment income tax on portfolio income. Partners and business owners receiving K-1 income often have no withholding at all, and those K-1s can arrive months after year-end. The gap between what was withheld and what is actually owed can easily run into six figures, and it tends to show up in April, at the worst possible moment. Cash that looks idle in December may be earmarked for a tax bill you haven’t seen yet.
The fix isn’t complicated, but it does require intention: give every dollar of cash a job. We like to think about cash in tiers, each with a specific purpose, time horizon and home.
The first tier is operating cash – the checking account that runs the household. Clients often hear us refer to their checking account as the operating account for this very reason. This should hold roughly one to two months of spending, enough to cover bills and normal variability without overdrafts, and not much more. Anything beyond that is a candidate to move up the ladder.
The second tier is a true emergency reserve. The traditional rule of thumb is three to six months of expenses, but for households whose income is heavily variable, we generally suggest sizing it around fixed costs (mortgage, tuition, insurance premiums, childcare) and erring toward the longer end. If a bonus is cut in half or a vest is delayed, the reserve should carry the lifestyle without forcing a sale of investments at the wrong time. This money belongs somewhere safe, liquid and earning a competitive yield, such as a high-yield savings account or money market fund.
The third tier is the one most often missing: strategic or earmarked cash. These are known liabilities coming due in the next few months to two years – the estimated tax payment or April balance due, capital calls on private fund commitments, tuition, a renovation or a down payment on a second home. Because the amount and timing are reasonably predictable, these dollars can be matched to their due dates using Treasury bills, CDs or a short ladder of high-quality fixed income. For our clients in Connecticut, New York and other high-tax states, the details matter here: for those in the top brackets paying over 40% combined federal and state tax on investment income, the tax impact of interest income is a consideration worth noting.
Everything above those three tiers is long-term capital, and it should be invested according to your plan – not left to accumulate by default.
Where the cash lives matters almost as much as how much there is. Many brokerage accounts automatically sweep uninvested cash into a default bank deposit program that may pay far less than a money market fund in the same account, and a surprising number of people never check. Large balances can also exceed FDIC coverage limits, which are $250,000 per depositor, per insured bank, per ownership category. Spreading cash across too many institutions creates its own problems, so this is best handled deliberately rather than by opening a new account every time a balance gets large.
Then there is the cost of doing nothing. Cash earning little or nothing in a checking account is losing ground to inflation every year. To put a hypothetical number on it, $600,000 of excess cash sitting at near-zero interest with 3% inflation loses roughly $18,000 of purchasing power annually – and that’s before considering what those dollars might have earned if they had been put to work in a diversified portfolio over a decade or more. For a household in its peak earning years, time is the most valuable asset there is, and idle cash spends it carelessly.
Finally, the best cash management plans don’t just react to deposits; they anticipate them. Before a bonus is paid or a tranche of RSUs vests, decide in advance how the proceeds will be split – a portion set aside for taxes, a portion to top off reserves or fund earmarked goals, a portion to long-term investments and, yes, a portion to enjoy. Revisit tier targets at each liquidity event and at least annually as spending, commitments and income change. Some households also establish a securities-based line of credit or home equity line in advance, not to spend, but as a liquidity backstop that can reduce how much cash they need to hold on the sidelines. Used thoughtfully, that kind of standby flexibility can be a valuable planning tool.
None of this is particularly glamorous. But for professionals whose finances are growing more complex every year, the difference between cash that happens and cash that is managed can add up to a substantial sum over a career. A good planning team can help you size each tier, coordinate the timing with your tax projections and investment plan, and make sure every dollar knows what it’s supposed to be doing.
Tracking: T011538
