I’ve had friends that have asked what my strategy is for funding my investment accounts. In other words, what order do I recommend contributing tovarious retirement accounts?
This topic’s definitely going to vary based on your own specific circ*mstances. Things like employer matches and tax-advantaged accounts make a difference in which accounts make the most sense for you to fund before others.
Depending on what your game plan is and what options are available to you can make all the difference in which investment accounts to fully fund first.
Regardless, I thought I would share the strategy I’m currently using for our own investment accounts.
Before we get rolling though, please note that I’m not a Certified Financial Planner, or a CPA, or anything fun like that. I’m just aguy (albeit an awesome guy!) trying to get to financial freedom as quickly as possible.
And by that I mean, talk to a professional before just rolling with what I say. But beforeevenconsidering a similar plan, make sure that you’re already taking care ofeliminating any debt you have and that you’ve built up a cushion with some type ofemergency savings.
Now that that’s out of the way, here’s the general rule of thumb I use on my accounts…
Contribute up to the employer match in your 401(k)/403(b)
This one’s pretty much a gimme. How anyone can pass up free money is beyond me.
My employer offers us 35 cents on the dollar with no max. In other words, I can contribute up to the federal max and I’ll get an instant 35% return on my money beforeit even has a chance to do anything in the market.
So in my circ*mstances,I’ll definitely continue to max out this account before anything else. For 2017, that means I’ll contribute $18,000 for the year and my employer will throw in an additional $6,300… that’s $6,300 of free money!
In addition, 401(k) and 403(b) plans are tax-advantaged in thatthe money is taken out of your paycheck before the government gets its share. This meansthat the amount you pay taxes on also becomes less… bonus! If hit just right,that could also drop you into a lower tax bracket.
And if you’re concerned that you’re going to retire early and can’t get to your funds, just remember that there are always ways around this. I’m planning to doa Roth IRA Conversion Ladder on my own 401(k) once I leave the corporate world. In my postHow to Access Your 401(k) Money Penalty-Free, I talk about that method as well as another couple of options for getting your money out early.
If you have an HSA, hit this one next… especially if your employer is kicking in some money
Speaking of cool accounts thatare pre-tax, a Health Savings Account (HSA) is pretty awesome. It took me a while to fully understand just howcool this type of account is, but now I getwhy this can be one of the best investment accounts out there.
Yes, it’s pre-tax like a 401(k) plan, but that’s only one important part of it. An HSA plan also gives you tax-free withdrawals when used for medical expenses. This is the only one of the investment accounts out there that I’m aware of thatcan completely eliminate Uncle Sam getting a cut!
So that’s the part of HSAs I had already understood. However, whatI recently learned is how you can actually take advantage of a type of loophole in an HSA to make them even more beneficial.
The Mad Fientist wrote a great postcalled HSA – The Ultimate Retirement Account that discusses howyou can pay for your medical expenses out-of-pocket and then pay yourself back from your HSA.
Why is that important?
Oh, I’ll tell you why! Because there’s not a deadline for paying yourself back. So if you’re able to do so, you can pay your medical bills out-of-pocket and hang onto your receipts.
In the meantime, the funds in your HSA continue to grow tax-free. Then you can basically use this as a retirement account to pay yourself backlater on… tax free (up to the totals of all those saved receipts for past years). This thenturns this account into one that allows for tax-free contributions, tax-free growth, and tax-free withdrawals.
How’s that for awesome?
That, to me, makes thisone of the best investment accounts out there. The bonus is that a lot of employers are now kicking in some amount of money when you invest in it. If that’s the case, this becomes another easy decision since you’re getting free money out of the gate.
For some folks, this can even be a better investment than your 401(k)/403(b). You have to do the math on your employer match for your 401(k) or 403(b) and figure out if it’s a better deal than the HSA with its loophole and any money your employer throwing in for it.
The federal maximum you can contribute to an HSA for 2017 is$3,400 for an individual or$6,750 for a family. This will be the first year I’m going to be maxing out this accountand my employerwill end up throwing in a little over $600 for the year for me.
Max out your Roth IRA
The Roth IRA is one of my favorite accounts. The only reason I don’t recommend it first is because accounts with free money from your employer are generally hard to beat.
But the Roth IRA has a lot of cool advantages to be aware of. One benefitis that you put your money in using after-tax dollars, soyou’re not taxed when taking it out. This might be a psychological thing, but when you look at your 401(k), 403(b), or traditional IRA, you generallythink “cool, I have a balance of $XXXX in my account.”
The problem is that we tend to pushto the back of our mindsthat we’re going to have to pay taxes when we take it out. So that balance isn’t all yours… you get to share it with the government. With a Roth IRA, what you see is what you get. I like that… very simple.
The other great thing about a Roth IRA is that you can take out your contributions at any time without penalty. So if youhave $50,000 that you contributed to your Roth over the years and it’s grown to $75,000, you can take out any of that $50k without penalty (or taxes). Obviously, this isn’t something that should be taken lightly, but it’s nice to know that in a dire emergency, you have this as an option.
Roth IRAs aregenerally thought of great investment accounts for younger folks. The idea behind that has always been that they’ll pay the taxes while in a lower tax bracket beforetheir careers start escalating. Thus, they should come out ahead because they won’t have to pay taxes taking it out whenthey’re likely in a higher tax bracket.
However,a recent study by Nerd Wallet found that if youmake the maximum IRA contribution each year, you’d always come out ahead in the Roth IRA overa traditional IRA regardless of your present and future tax rates. Studies are studies, but this is good information to factor into your planning.
The maximum you can contribute to a Roth IRA for 2017 is$5,500. If you’re 50 or over, you can contribute an additional $1,000 for a total of $6,500. There are some ways around this limit, such as using a backdoor Roth, but that’s a topic for a different day.
This will be the first year I’ll be able to max out this account as well.
Finish contributing to max out your 401(k)/403(b)
After contributing to the other investment accounts, if you still have money to invest, I think it makes sense to go back to your 401(k) and finish maxing it out.
Even though you already got yourfree money out of itfrom your employer, it stillhas some juice left in it.
After all, this is still a tax-advantaged account so you want to make sure to squeeze the rest of that juice out of it. As I mentionedearlier, the federal maximum for these accounts is $18,000 for 2017.
Not much else to say on this one. Fund your 401(k) or 403(b)… do your best to max this out every year. You’ll be happy when you look back at it years from now.
Going back to my own situation, this doesn’t really apply to me. I max out my 401(k) out of the gate sincemy employer doesn’t have a limit on the match so check this one off the list for me!
Fund taxable accounts
You’re still following along and have more money left to invest? Nice job!!
Well, the last of the investment accounts I have out thereare our taxable accounts.
We currently have one taxablebrokerage account at TD Ameritrade. It’s not a Roth IRAand it’snot a traditional IRA– it’sjust an account we have to hold investments outside of those tax-advantaged accounts. Currently, we don’t have a lot in this accountbut that should change in a couple years.
Additionally, we have our joint savings account (borrrrrring!!). Ok, well, that’s the whole point of a savings account – it’s supposed to be boring.
We keep building itup and then tearing it downwith funding ourrental properties. We’re actually “shopping” now and hoping tobe pick up another duplex in the very near future.
After that purchase, we’ll probably get one more next yearand then we shouldbe done acquiring properties. At that time, we’ll plan on building up our joint savings again as well as our taxable brokerage accounts for our early retirement.
In the meantime, our savings has been kind of a tweener account for us as to our funding order. Because we want to keep building up our rental property portfolio, we currently put about $1,500/month into the account.
That’s a good portion of why we haven’t been able to fully max out some of our other accounts in the past. Once we’re good on the rental properties, we’ll probably decrease this slightly and start contributing more to our taxable brokerage accounts.
Solo 401(k) plan anyone?
Here’s another one I’m hoping to throw into my mix in the near future. I’m still learning the ins and outs of this type of account, but I do know that it can be a great opportunity as an entrepreneur.
Between a few of my small businesses (including this one and the real estate rental properties LLC), this could be a smart way to use some tax strategy to increase our wealth even more.
What I need to work on now is learning the details of the account and how to best fit it into our strategy. I’lldo another post on this once Ifigure out how to work this into ourgame plan.
In the meantime, if I’ve got your curiosity peaked, Financial Pantherhas written a couple recent posts on this subject that should help quench a little bit of that thirst:
- The Solo 401k: The Side Hustler’s Bonus Retirement Account
- Fidelity Solo 401k: A Step By Step Guide To Setting Up Your Self-Employed Retirement Plan
So that’s about it for the time being, but obviously, as time goes on, this will change.
Now remember, this is my funding strategy based onmy currentinvestment accounts. Your circ*mstancesare probably somewhat or completely different. And even if they’re not,maybe your strategy might be a little different for other reasons.
Maybe you have the option for a 457 plan or a Thrift Savings Plan (TSP) or even a Roth 401(k) (I wish I had that one!!).
Or, maybe you have a 529 plan for your kids that you want totake a little more priority. We have a 529 plan for our daughter, but we don’t contribute a ton to it.
In fact, our regular scheduled contributions are only $125 a month. I’m a believer in the school of thought – “your kids can get loans for college, but you can’t get loans for retirement.” We’ll probably be able to help her out more as our income increases throughout our game plan, but for now, that’s where my mind’s at.
However, you might disagree and that obviously will change your funding strategy from mine. Either way, I’d love to hear your thoughts on your investments accounts.
Is my strategy on funding my investment accounts similar to yours? What do you do differently?
Thanks for reading!!
— Jim
