THIS POST MAY CONTAIN AFFILIATE LINKS. PLEASE READ MY DISCLOSURE FOR MORE INFO.
Personal finance is my passion. So, inevitably when I meet with someone new, I usually can’t help but somehow weave personal finance into the conversation. The topic either surfaces through talk about the stock market, savings plans for college or even how much they will need in retirement. Talking about personal finance is like breathing to me. I don’t even think about doing it. It just happens.
Maxing Out vs. Contributing Up to the Match
When I talk about retirement with folks, I often hear that they max out their 401(k). That answer always seemed acceptable at face value, until I read this Vanguard study. Apparently only 10% of people contribute to the max. When I read that, I knew that I either had extremely special friends, or that they were only contributing up to the match.
After reading that study, I decided to probe a bit more when people say that they contributed to the max. Turns out, most people think they can only contribute to the max of their company match.
Just to be clear, the maximum that you can contribute to your 401(k) in 2017 is $18,000. The IRS has raised the amount to $18,500 for 2018.
According to the US Government Accountability Office (GAO), amongst households of Americans 55 and older, as many as 50% have absolutely no retirement savings at all.
Even though it may be a struggle to invest towards retirement, there are some ways to take advantage of tax-favored retirement savings accounts. These can make a huge difference for future retirees.
Step 1: Max Out Your 401(k)
The 401(k) is my favorite tax-deferred account. I am a huge proponent of first maxing out your 401(k). Most companies provide a match, the average being 3%. Having the money automatically withdrawn from your paycheck each pay period simplifies your life.
When you contribute to your 401(k), if you elect for the traditional 401(k), you will not be taxed on your contributions. The contributions will grow tax-free until you are eligible to withdraw them when you reach 59 ½. At that time, you will pay taxes when you withdraw from your account.
If you choose the Roth 401(k) option, you will pay tax upfront on your contributions. These contributions will also grow tax-free until you are eligible to withdraw the contributions when you reach 59 ½. The nice part is since you have already paid the taxes on it, you can withdraw tax-free.
Once you have fully funded your 401(k), you should then move on to the next step.
Step 2: Fund Your IRA
Once you have fully maxed out your 401(k), I recommend opening an IRA account. The contribution limits for an IRA for 2017 are $5,500. Unfortunately for 2018, that limit will not increase. The good news is if you are older than 50, you have the ability to do an additional catch up of $1,000. Then, you could contribute up to $6,500 to your IRA.
Like the 401(k), once you make a contribution, it grows tax-free until you withdraw the money. If you have contributed pre-tax dollars through your traditional IRA, you will pay taxes when you withdraw.
On the flip side, if you contribute using after-tax dollars into your Roth IRA, you will not have to pay any taxes when you withdraw.
As you may be familiar, you won’t be allowed to make traditional IRA contributions or Roth IRA if your income is above certain limits. However, there is always a way around it as the Backdoor Roth IRA loophole has not been closed.
Step 3: Fund Your HSA
Finally, if you have maxed out both your 401(k) and IRA, you may think that you have maxed out everything you can in terms of retirement.
However, if you’re itching to save even more, those that have access to a Health Savings Account (HSA) are able to set aside money towards health care expenses.
Contribution limits for 2017 are $3,400 for those with individual coverage and $6,750 for family coverage. In 2018, the individual coverage will rise to $3,450 and $6,900 for family coverage, with the ability to contribute an additional $1,000 if you are age 55 or older.
Quick side note: I’ve never understood why they use the age of 50 the cut-off limit for IRAs and 401(k) catch ups, but the age of 55 for HSA additional contributions. If you know the answer, please enlighten me!
You are able to contribute to HSAs and then use the money tax-free for incurred medical expenses. If you don’t use the whole amount, you are then able to roll the money over each year.
A really nice aspect of the HSA is that if you do not use all of the funds by the time you reach 65, you can withdraw the funds for any reason, similar to an IRA, without having to pay any penalty.
As you can see, you have a plethora of options when it comes to maxing out your retirement savings. I encourage you take advantage while you can to avoid paying more in taxes than you need to.
Thanks for sharing – I’m currently maxing out 1 and 2, with starting an HSA and working to max it in 2018.
It is definitely tough to contribute around 25K each year to retirement accounts, but love the tax benefits and the pros of doing so. Can’t wait to say I’m doing all 3 and also investing in outside account as well :D.
Chris @ Duke of Dollars recently posted…Money can buy happiness – thoughts on direct charity
If you can hit all three accounts you will definitely be way ahead of the game compared to other people. Congrats!!!
Totally agree. Your post presentation is nice and easy to understand. I like the tiered/prioritized approach since not everyone has the excess cash to maximize/use all 3 vehicles. One of the biggest personal finance mistakes I made in my 20s and 30s was to not max out my 401K. I contributed only just enough to get the maximum company match. Tom
Tom recently posted…Please Pass the Salt (Part 2)
Thanks for sharing Tom!!! Like you it took me awhile to max out my 401k. But now that I’m doing it. I am definitely happy with the results and my portfolio 🙂
For my retirement savings, my strategy is to max out all of my Accounts that allows me to get a matching. Free money is great. I think that about 33% of my retirement account value is free money. My second step is to try to maximize all of my tax sheltered accounts. I want my money to continue to earn money and not pay any taxes as long as I can.
With that being said, the most important thing to do is to develop the saving habit if you have not started. The earlier you save, the longer you have your money working for you.
Leo T. Ly @ isaved5k.com recently posted…10 Money-Saving DIY Home Renovation Projects
Thanks for sharing Leo!!! I definitely agree the early you save and the more you save the better off you are. You are doing an awesome job Leo and you are clearly well on your way 🙂
Thank you for such simple, succinct, and informative analysis! Mr. FAF and I just started maxing out our 401(k) in Sep for him and Oct for me.
We currently contribute $3,500 pre-tax to our 401(k) and 403(b) each month in 2017. We will contribute $37,000 in 2018, so I guess we can legitimately say that we’re maxing out our retirement accounts hehe.
I honestly didn’t really understand HSA and never looked up info about it until I read your post. Great article!
Ms. Frugal Asian Finance recently posted…How To Get Over A (Personal Finance) Blogger Burnout
Thanks for stopping by Ms. FAF!!! You all are CRUSHING it!!! I would love to be able to contribute $37,000 to our 401k each year. I wish the government allowed us to defer as much money as we wanted without any limitations 🙂
I tried explaining this to a friend and he kept saying yeah I’m contributing the max 10% 10% 10%. I’m not sure if he got it or not. This is such an important topic and because people are living longer than ever, we all need to plan (and use all the options we have available) more in advance than ever as well 🙂
SMM recently posted…From Target Date Funds To Lower Cost Index Funds
Thanks for sharing SMM!!! It’s really unfortunate that people don’t completely grasp this concept. The match is definitely not the max 🙂
We currently Max out our 401K and Roth IRAs. This will be the first year hitting both of those goals. Hollla.
Instead of going to the HSA we are going to start attacking the mortgage starting next year.
Grant @ Life Prep Couple recently posted…Why I’m Not Buying The Mutual Fund of The Future
That’s awesome to hear Grant!!! Maxing out your 401k and Roth IRA is huge!!! There are definitely days I wish I had maxed out my 401k and IRA instead of paying off my mortgage. But it is really nice not having a mortgage anymore and now using the money to max out my 401k and Roth IRA.
Good tips, though I think there is one you missed that is ultimately almost never utilized. The after-tax 401k allows you to add additional money to your account to a total contribution for the year of $54,000 if you can make it. That includes the company match. Once you leave the company your 401k is with, you can then roll it over to a Roth IRA and only pay taxes on the gains once. At that point, it can grow tax-free forever! I have personally maxed out the 401k, Traditional IRA, HSA and am working towards about $40,000 total in the 401k this year. If you are planning to retire early, then the after-tax 401k is an excellent vehicle to boost your retirement savings. I contribute here, over my brokerage account since it grows tax-free inside the account.
Justin @ Atypical Life recently posted…How To Make Money From Nothing With Ethereum Mining
Thanks for sharing Justin!!! I have to admit since not every company offers the ability to invest in the after-401k that it wasn’t on the forefront of my mind but you make great points. It’s definitely another tool if your company offers it!!!
We’ve been maxing out our 401(k) accounts for the last 10 years or so. We also max out our HSA account and have built up a nice account balance in the HSA.
We can’t get a tax reduction for a Traditional IRA and we can’t contribute directly to a Roth. So instead, we direct a good portion of our income to taxable brokerage accounts.
Mr. Need2Save recently posted…Crafting Your Exit Plan
Thanks for sharing Mr. Need2Save. Sounds like you are really maxing out every tax advantaged account that you can. Awesome work!!!
Yep – hitting all three of these on the head is important. I’m not maxing everything out, but I am taking advantage of these deductions in a significant way. I’m balancing investing and paying down some debt, so I will likely increase my contributions to the max once our final student loans are paid off. But you can hand this to every single person who is looking for a place to start and it will get them moving in the right direction.
Take care and thanks for the great read!
Bert
Dividend Diplomats recently posted…Lanny’s October Dividend Income Summary
Thanks for stopping by Bert!!! Sounds like you have a great balance between planning for the future and paying down your debt today 🙂 Keep up the great work!!!
Wait, HSA rolls over? I always thought it was use it or lose it, so I quit funding it 15 year ago.
Yeah HSA’s allow you to use the money for anything when you reach 65 🙂
http://www.hsaedge.com/2017/10/28/using-hsa-funds-once-you-turn-65-years-old/
Brad, you may be confusing HSAs with FSAs? FSAs are use or lose, HSAs are not. HSAs started in 2003 so you may not have got them mixed up.
In any case, they are great for building funds for healthcare during retirement.
Mr. Widget
Nice article but I think you have the priorities a bit off. For me it’s:
1. 401k up to the match because it’s free money
2. HSA because it’s triple tax advantaged, if you contribute through payroll deductions it’s the only way to avoid FICA and it becomes an IRA
3. IRA because many 401k plans have limited choices while an IRA can be opened wherever you want
4. 401k to the max
Thanks for sharing Jeff!!! Through my work HSAs aren’t available so it’s always been a little lower on my list but I totally understand why it’s higher on your side 🙂
Great post MSM! We max out the 401k and HSA, and are working on the IRA. I like the HSA slightly more than the IRA since it is triple tax advantaged whereas the IRA is only double. Only downside is investment options in my HSA are limited.
Great site!
Mr. WIdget
You don’t have to leave your HSA with the provider your employer chose. The lowest cost one I’ve come across for investment is Saturna. With a single transfer from my employer’s provider to Saturna and a single purchase of a low cost ETF the cost is $15 per year. I put half in 2 different ETFs so my cost is $30. There’s no monthly fees at all.
Thanks for sharing Mr. Widget!!! That’s awesome to hear that you are maxing things out. Sounds like you are well on your way to FIRE!!!
Indeed these ways can be very useful to max out retirement savings. You should follow them for your own benefit but start as early as possible. Because once you get to retirement then you can only use the savings.
I definitely agree Paul!!! The earlier you start the earlier you can start retirement 🙂