Maxing Out: Which retirement account should I max out first?

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401(k)s, HSAs, IRAs - all of these accounts have a limit to how much you can contribute to them in the span of one year. IF you have multiple retirement accounts, which one should you choose to hit the limit first?

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Saving for retirement isn’t a simple one-and-done exercise. There are a handful of ways you can save for retirement.

You may have a workplace retirement account such as an 401(k) or 403(b), an individual retirement account (IRA) you have parked at a brokerage, and if you have a health savings account (HSA) you can also use that as a stealth retirement plan. Money you save in an HSA today can be used decades from now to cover retirement health care costs. As long as the money is used for a qualified medical expense it will be 100% tax free.

All are great options, but it’s smart to have a strategy for which account you fund to the maximum first.

Goal 1: Grab the maximum matching contribution offered on a workplace retirement plan.

If your employer offers a matching contribution, you always want to make sure you contribute enough to earn the maximum match. That money that your employer is contributing is free money for your future. That said, you may not want to add additional savings to your accounts beyond what is needed to receive a matching contribution from your employer. It all depends on what other savings options you have available to you.

Goal 2: Max out an HSA if you intend to use it for retirement medical expenses.

Money you save in your HSA can be used to cover current medical costs, or you can let your savings accumulate interest for years with the intention that in retirement you will use the account to pay medical expenses with tax-free dollars. (All withdrawals from an HSA used to pay for qualified medical expenses are tax free.)

That makes an HSA you are using for retirement savings, even more valuable than any other type of savings account. With a traditional retirement account you get a tax break on your contributions but owe tax on your withdrawals. With all Roth retirement accounts you don’t get any upfront tax break on contributions, but will be able to make tax-free withdrawals in retirement. Only an HSA offers both tax breaks: what you contribute in any year reduces your taxable income, and in retirement you will owe no tax on withdrawals used for qualified medical expenses.

In 2020, individuals with a high deductible health plan can contribute a maximum of $3,550 to their HSA. If the HDHP covers your family, the HSA contribution limit is $7,100. If you are at least 55 years old —or will turn 55 during the calendar year — you are permitted to make an additional $1,000 catch up contribution.

Goal 3: Fund a Roth IRA. If you are juggling saving for retirement and building up your emergency cash fund, a Roth IRA can be a smart way to tackle both.

Money you contribute to a Roth IRA has already been taxed —you don’t get to deduct your contribution from this year’s income — which means that you can use that money any time, without owing any tax or being subject to the 10% early withdrawal penalty that is charged if you make a withdrawal from a traditional IRA before age 59 ½.

The only tax strings attached to a Roth IRA are in regard to the earnings on the account. For example, if you have contributed $15,000 to Roth IRAs over the years and your account is worth $22,000 you could withdraw $15,000 without any tax or penalty at any age and any time. It’s only the $7,0000 in earnings that could be hit with a tax and penalty based on when you make the withdrawal.

The best move is to leave Roth savings untouched until retirement. But if you have yet to build up an emergency cash account to a level that makes for peaceful sleeping, a Roth IRA that can –in a dire pinch – be used as a backup emergency fund.

In 2020, individuals with modified adjusted gross income below $124,000 and married couples filing a joint tax return with income below $193,000 can contribute $6,000 to a Roth IRA. If you’re at least 50 you can make an additional $1,000 “catch up” contribution .

Goal 4: Max Out your Workplace retirement plan.

Manage to max out on your HSA and the Roth IRA? Okay, circle back to your workplace retirement plan and increase your contribution rate. In 2020, the maximum contribution is $19,500 if you are younger than 50, and $25,000 if you are at least 50 years old.

Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.