Everybody knows that in order to enjoy a comfortable retirement you need to be saving during your working years. However, a question that we get a lot is where should I prioritize my savings? With so many different investment vehicles with different benefits out there, this can be a difficult decision at times.
Maximizing Your Savings
First and foremost, it is imperative that you get the 401(k) company match if it is offered. Not getting the company match is essentially the same as turning down a percentage of your salary because the match is free money. All you have to do is save a small portion of your paycheck to get it.
The next place to save would be an HSA if you are eligible. An HSA is only available to people who are enrolled in a high deductible health plan, so you should check to see if your plan is eligible. The great part about using an HSA is that it is triple tax free, and has no limits as to when you can make a withdrawal. The money goes into the HSA pre-tax, you can then invest the money and it grows tax deferred, and all withdrawals are tax-free. Once you contribute to an HSA it is imperative that you transfer some of the funds from HSAbank to an HSA investment account, because otherwise the HSA money will not be invested. The requirement on withdrawals is that it must be for a medical expense. The catch is that you are allowed to start saving medical receipts from the day that you open the account, and can use those receipts to justify a withdrawal decades later. This is the only plan that is triple tax-free, so it is a nice benefit to having a high deductible health plan.
After the match and HSA, you should save to a Roth IRA if you are eligible. For a Roth IRA the money goes in after tax, but it grows tax free and withdrawals are also tax free. This double tax free benefit is substantial because the compounding growth over years, and potentially decades, of investing can allow for a substantial tax free benefit. Additionally, Roth’s do not have a required minimum distribution so they can continue to grow unencumbered for life, and even post-death. Roth IRA’s follow the age 59.5 rule, and they also have a rule that you cannot make a withdrawal until 5 years after January 1st of the year that you made your initial contribution. For example, if you make your initial contribution on October 1st, 2022 then you could not make your first withdrawal until January 1st, 2027. There are a handful of exceptions that would allow you to make early withdrawals if you fit the criteria.
Both the HSA and Roth IRA have the additional bonus of having many more investment options and investment strategies than a standard 401k will allow.
Back to the 401k
After you have exhausted all 3 of the above options, then it is time to turn back to the 401k. If your company offers a Roth 401k, then that is the preferred method because it will have the same double tax free growth as the Roth IRA. The Roth 401k will have higher limits than the Roth IRA as well. Because it is a 401k it abides by the same contribution limits as the standard 401k which for 2022 is $20,500, or $27,000 if you are age 50 or older. Finally, if your company does not offer the Roth 401k, then the traditional 401k is a good savings option as well.
Type of Account
Roth IRA/Roth 401k
Up to employer
$3,650 for single, $7,300 for married
IRA: $6,000 with a $1,000 catch up if age 50+
401k: $20,500 with a $6,500 catch up if age 50+
$20,500 with a $6,500 catch up if age 50+
There are numerous ways to save and invest for your future, and all of them are fantastic options. However, just like all things, there is a hierarchy as to what options are better than the others. Getting the company match is far and away the most important thing you can do, and I would argue it is a necessity. Once you get the match, taking advantage of tax favored accounts such as the HSA and Roth IRA should be the next step. Finally, contributing to a Roth 401k, and if it isn’t offered then a traditional 401k, are great places to continue your retirement savings journey. If you would like to further discuss how you can most effectively save for your future, please call me at (734) 681-7575 or email me at email@example.com.