Typically, investors are often neck-deep into searching for the ideal stocks, ETFs, or mutual funds. But figuring out the best type of retirement account you should be funding and in what order is just as important, especially if you’re fortunate to have access to an employer 401(k) plan, Roth IRA, and healthcare savings accounts.
Carrying out a personal analysis can go a long way in helping you get a handle on things. But if you want a solid retirement contribution strategy to adapt for 2021, then you should check out the framework below.
It prioritizes contributions based on account types in a waterfall format. This means that you’ll start at the top and continue down the list until you have exhausted all the funds budgeted for retirement savings this year.
1. Contribute Enough to Earn Your Employers Match
If you have access to a workplace 401(k) plan and your employer offers matching contributions, then do all you can to earn that match. Plan Sponsors Council of America reported the average employee 401(k) match in 2019 to be around 5.3%. If your salary is $50,000, that will amount to an additional $2,650 you can add to your nest egg.
Ask the human resources manager at your company or the plan administrator about the matching rules. Some employers may match you dollar for dollar, while some may match $0.50 for each dollar you contribute. Typically, there’s a cap to the percentage of your salary your employer will fund. As mentioned previously, your goal should be to contribute as much as is required to get every dollar available from the matching.
2. Max out your Health Savings Account (HSA)
The next step is to save up to an HSA account if you are eligible for it. HSAs offer triple tax benefits, which makes it an attractive long-term savings plan. Contributions to HSAs are tax-deductible, earnings from the accounts are tax-deferred, and withdrawals used to pay medical expenses are also tax-free.
Furthermore, once you hit age 65, you can make penalty-free but taxed withdrawals for non-medical expenses. That means there’s no risk of over-funding an HSA. If you don’t use the funds in the account for medical expenses, you can withdraw them to supplement your retirement savings. The 2021 contribution limit for HSA is $3,600 for individual plans and $7,200 for a family health plan.
3. Contribute to Roth
If you still have cash left after maxing out your HSA, check if you qualify to contribute to a Roth IRA. The eligibility for a Roth IRA is dependent on your income. To be eligible as a single filer, you should make less than $125,000 annually. Married filers, on the other hand, should earn less than $198,000 annually to qualify. The 2021 contribution limit for Roth IRA is $6,000. However, individuals aged 50 and above can contribute an additional $1,000. If you make less than $140,000 as a single filer or less than $208,000 as a married filer, you may be eligible to contribute a lower amount than the original contribution limit.
Contributions to Roth IRAs are not tax-deductible, but qualified distributions during retirement are tax-free. This provides a very effective retirement withdrawal strategy. Since 401(k)s and non-medical withdrawals from HSAs are taxable, contributing to Roth accounts will be more advisable if you expect to be in a higher tax bracket in the future.
4. Max Out Your 401(k)
Individuals with 401(k)s can contribute to Roth without any income limits. Inquire from your plan administrator if you have the feature and how to set it up. The 2021 contribution to 401(k) Roth, including regular contributions, is $19,500 and $26,000 for individuals aged 50 and older.
5. Save to Traditional IRA or Standard Brokerage
After capturing your employer’s match, contributing to HSA, Roth, and 401(k), consider investing in a traditional IRA or brokerage account. You’ll get tax-breaks when you invest in a traditional IRA. But while there are no tax-breaks with brokerages, you will be able to use your money whenever and however you want.
While you may not have $25,000 to $30,000 to save each year, you shouldn’t let it dissuade you. You can still build a large retirement that will enable you to retire comfortably. Just start by contributing enough to capture your full employers’ match, and then consider diversifying across other accounts as your income increases.