Many people want to save for the future, but don't know what to do with their money. Here, I make it simple. Just follow the path below!
"401(k) equivalent" refers to all accounts that fall under the same contribution limit as the 401(k). This includes 401(k), 401(a), 403(b), and TSP accounts.
Why retirement accounts?
Your long-term savings should go in retirement accounts because of their tax advantages. If this is money that you're saving for well into the future, the tax benefits can be a game-changer for your returns. If you're worried about not being able to get the money out until later in life, consider some of the options offered in this post. The advantages of a retirement account include, but are not limited to:
Tax deferrals that can be used to control your tax rate
No capital gains taxes on the earnings from your investments
ERISA protections for some accounts -- including protection from debt collectors
#1 - 401(k) equivalent up to the employer match
Best return. Why does this come first? An employer match is free money. If you decide not to get your employer match, you're leaving part of your salary on the table.
Another way to think of it is that you're getting a 1-for-1 match of the investment, that's an immediate 100% return. There is nowhere else you will get such an amazing return on your investment. Even if you're at an employer that does a 50% match, an immediate 50% return is unbeatable with any other investment.
#2 - Health Savings Account (HSA)
Most tax advantages. The HSA comes next because it is the most tax-advantaged of all savings/investment accounts. Contributions are tax-deductible, there is no capital gains tax, and distributions for qualified health expenses are tax-free (meaning you never paid taxes on the money). Normally you hear that because of these 3 advantages, the HSA is "triple-tax advantaged", but I say that it's quadruple advantaged because contributions are not subject to FICA taxes, when your other accounts are. Unlike the Flexible Spending Accounts, your HSA money does not disappear at the end of the year if unused. The HSA is a long-term saving and investment account.
You only have access to an HSA if you have a qualifying high-deductible health plan (HDHP). If you're scared of having a high deductible, I suggest you look into it anyway because I have found that many unqualified plans have just as high, if not higher, deductibles.
#3 - Individual Retirement Account (IRA)
Control. The IRA is your personal retirement account that you control yourself. You can open one for free with a brokerage of your choice such as Vanguard, Fidelity, Charles Schwab, or M1 Finance.
This comes next because you have complete control over your IRA. You pick the investments and the fees that come along with them. You pick the brokerage and the fees that come along with it. So essentially your investments and fees are all in your hands. A 401(k) can be much more restrictive with the types of investments that are offered and the fees that are attached. You are stuck with what they offer! This is why you should go to your IRA as soon as you have gotten your employer match.
#4 - 401(k) equivalent or 457(b) to the maximum contribution limit
Next-most tax advantages. This 401(k) equivalent of 457(b) comes next because they are tax-advantaged accounts. They do not have the added benefit of possibly avoiding taxes altogether, like the HSA does, but they are still great accounts due to the reasons listed at the top of the article.
If you have access to a 457(b), you'll have to decide whether you want to fund that or another retirement vehicle. The main things you would consider are (1) investment options and (2) fees.
There is an added benefit to the 457(b) because there is no age limit for qualified withdrawals. The only thing that qualifies your withdrawals from a 457 is that you have terminated service with the employer that offers it. So as soon as you quit, retire, or are even fired, your 457(b) funds will be immediately ready for withdrawal if you please. For a 401(k) equivalent, you'll have to wait until age 59.5 for qualified distributions.
#5 - If you have access to a 457(b), max your second 401(k) equivalent or 457(b)
More space. One of the wonderful parts about having a 457(b) is that it is in a different contribution bucket than the 401(k) equivalents. That means you have another $19,500 in tax-advantaged space. So if you have the savings power, then use those tax advantages and fill the other bucket!
If you chose to fill the 401(k) equivalent first, now fill your 457(b). If you chose to fill the 457(b) first, then fill your 401(k) equivalent.
#6 - Taxable Brokerage Account
Investing is better than savings (long term). Investing the right way can earn much higher returns than just putting money in a savings account, so once all your tax-advantaged space is filled up, you should invest within your regular taxable brokerage account. Just like your IRA, you can open this with any brokerage of your choice, and the investments are completely up to you. However, there are no tax advantages to investing this way, so you will be subject to all income taxes and capital gains taxes.
Roth or Traditional?
If you have access to both Roth and traditional accounts, there are other considerations at play. See my article, "Roth or Traditional - The Simple Guide to Optimizing Your Taxes", for more information.
Don't have enough money in your budget to save in these accounts?
Consider the benefits of a financial coach. I can help you get your financial life in order and you can soon be on a path to saving for both the near- and long-term. If you're interested in learning more, follow this link to my financial coaching services page, or call 720-808-0599 to find out if your situation is a good fit for financial coaching.
Reference Table
Here is a reference table for some of the attributes of your retirement accounts.
Comments