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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 Having the money automatically withdrawn from your paycheck each pay period simplifies your life.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.