Which retirement accounts should I use? The order of investing
The Physician Philosopher teaches his audience how to properly replenish their retirement accounts by fully replenishing one account until it is full and then moving on to the next. This post is intended to help you determine the order in which you should fill your investment accounts. But before we can do that, the first thing you need to do is determine how much money you are going to save each year.
Today’s classic will be re-released from The doctor philosopher You can see the original Hise.
You may see the main picture for today’s post. It’s a free flowing waterfall. Watch as the water completely covers the first steps above before overflowing to cover the next step. And the next step. Until it finally hits the ground.
The correct order to replenish our retirement accounts each year should follow a similar pattern. We should fill one retirement account until it is full and then move on to the next. And then next time, until we hit our annual savings target. This is the order of investing, sometimes called a waterfall investing.
This post is intended to help you determine the order in which you should fill your investment accounts. But before we can do that, the first thing you need to do is determine how much money you are going to save each year.
If you don’t know your annual savings goal, click here to read a post on How Much Money You Can Save Each Year.
Waterfall investment basics
The order in which you should fill your retirement accounts until you get to your annual savings figure should have a method. I usually prefer to fill the tax-privileged space that is most easily accessible first, and then turn to the less-tax-privileged room at each step.
One caveat is that if you plan FIRE (Financial Independence Retire Early) well before the age of 59.5, you won’t be able to easily access many of your tax-privileged retirement accounts. While there are ways to work around the early retirement gap, it can change the way you invest your money.
For example, you might prefer to put a higher proportion of your money in a 457 or tax / brokerage account. Both can be accessed in early retirement and / or if you separate from your employer.
A 401K or 403B will likely go into a rollover IRA after you leave your employer and will be punished with the 10% penalty if taken out before the age of 59.5.
Further reading: Should I invest in my 457 and everything else you need to know about it?
The traditional order
Everyone has access to different plans. Because of this, I’ve tried to include everything a typical retirement doctor has access to. If anything is omitted from this list, leave it in the comments and I’ll add it to the list.
Four quick comments before we get to the list:
First, ignore all of the following information about your debt. Readers will know that I am an avid debt settlement practitioner. [You can read here about how I paid off $200,000 in student loans in 19 months]. In fact, I previously decided to pay off debt to get the maximum benefit from my Roth IRA backdoor for the year. If you have credit card or other high-interest debt, you should pay it off immediately after step 1 (get the 401K match).
Second, the order in which this list is compiled is from the most tax-privileged to the least-tax-privileged. The assumption is that most of the people reading this post are in their highest earning years during the accumulation phase. As you near retirement (the distribution phase), your investment decisions may be different.
Third, if you are married, you should duplicate each step if your spouse has access to the same type of account. For example, you should maximize both 401Ks before proceeding to the next step.
Fourth, the maximum contributions to retirement benefit plans listed below do not include any catch-up contributions. People over the age of 50 can contribute more money (typically $ 6,500 more for 401K / 403B / 457 plans).
The sequence of investing in retirement: Waterfall investing
Here are the first steps in your waterfall investment plan. You will find that all of the below offer a tax break.
To some extent – depending on your retirement plans – the order of these accounts may be a little upside down.
1. The 401K or 403B
A 401K or 403B (hereinafter referred to as a “401K” for ease of reading) is the first place your money should normally go. The reason is that the employer often offers a match. Any money that was not put into this vehicle (until the game) is lost money that could have been invested.
This is why I think you should at least invest in the game, even if you are swimming in student loan debt.
Some plans have a choice of pre-tax or Roth investing. In your peak earnings years, it is traditionally recommended that you take advantage of the pre-tax offer to reduce your tax burden.
The maximum that the employee can invest in a 401K is $ 19,500. It can receive matching or contribution funds up to $ 58,000 from the employer.
Once you’ve put your annual maximum in your 401K / 403B, it’s time to move on to the next step with our cash flow.
Note: If you have credit card or all-consuming student loan debt, you should probably work on paying it off before moving on to the next few steps.
2. Government plans 457
The second step in investing in waterfalls is to put money into a state 457 plan. I would argue that if the 401K doesn’t offer a match, you’d prefer to put your money in a state 457 in front of your 401K / 403B.
The reason is that 457 money can be used when you retire regardless of your age.
Note that this is a government plan that we are talking about. No non-government plan. Read this post on 457 if you don’t know the difference.
The maximum you can put on a 457 plan is also $ 19,500. And yes, you can get the most out of both your 401K and 457. This is not a problem (on the other hand, you CANNOT get the most out of both a 401K and a 403B).
3. Maximize Your Health Account (HSA)
The HSA plan is the only triple tax-free plan in existence (some call it the stealth IRA). They put money in the account before taxes. It grows tax-free. And as long as it is used for medical expenses, it will never be taxed on extraction.
In all fairness, it’s the best investment plan out there as long as it offers affordable index funds. However, you shouldn’t choose an HSA plan just for retirement if the insurance plan actually offered doesn’t meet your family’s needs.
If the HSA works well for you and your family, it can accommodate up to $ 7,100 for families ($ 3,600 for individuals). And it may never be taxed again!
4. Cash Balance Plans
Some practices offer cash balance plans, which are another way to protect money from taxes. I’m not going to pretend to be an expert on this type of plan. They can get complicated, and the rules are different for each partner depending on their age.
As far as I know, most plans don’t last long, and having one is more beneficial if you are older than younger in your career.
The amount of money you can deposit into this type of account depends on age. It is said on the street that for most doctors, it can be deposited into this account (pre-tax) between $ 10,000 and $ 100,000 annually.
Of course, make sure the plan is right for you. If your administrator invests in a high expense ratio of actively managed funds, you should probably put your money elsewhere.
Here are some posts to help you read more about cash balance plans.
5. Backdoor Roth IRA
If you still haven’t reached your annual savings number (or don’t have some of the accounts listed above available), the Roth IRA backdoor is the next step.
This is protected differently than the accounts listed above. This account offers after-tax benefits. The money brought in has already been taxed.
However, unlike a regular tax / brokerage account, the contribution and capital gains are not taxed again.
This is often the last account you touch in retirement. Roth money is also the best way to give money to your heirs because of the Stretch Roth IRA.
Further reading: Step by step tutorial for First Backdoor Roth IRA on Vanguard
6. Non-governmental 457 plans
Non-governmental 457 plans (NG 457) are not as simple as government plans. I have dedicated an entire post to this topic and linked to it at the top of this post.
The reason it’s so much lower on this list is because it’s not actually “your” money. It belongs to your employer until you get the money back after you leave your job or retire.
However, it is the investment money that is paid in before taxes. This will reduce your overall tax burden. So, if you have a good NG-457 plan, this account should probably be invested in before you start doing non-tax-privileged things.
This account has a maximum annual contribution of $ 19,500.
7. Taxable Accounts
This is the big pool at the end of the investment savings ladder. Once you have occupied all of the above available space, the rest of your money will go here until you meet or exceed your annual savings goals.
These accounts can be opened with any of the major investment companies (Avantgarde, Treue, Charles Schwab, etc.).
A case study
For example, let’s say you’ve found that you want to save $ 125,000 every year. What is available to you?
Well, if you get the maximum out of your 401K, your employer will contribute / raise up to $ 45,000. You also have an HSA and NG-457 plan available. Your spouse works and has access to a state 457.
For the example below, let’s say the NG-457 plan is a good plan that is worth investing in in retirement.
So, in the order above, we would do the following:
- Contribute $ 19,500 to $ 401,000 + employer match / contribution (employer selected) = $ 45,000
- Max out of government 457 = $ 19,500
- Contribute maximum to HSA for Family = $ 7,100
- For each spouse, maximum Roth IRA money behind the door = 6,000 USD x 2 = 12,000 USD
- Max out of non-state 457 = $ 19,500
To date, we’ve saved $ 103,100. However, our goal is $ 125,000 per year. We would then deposit the remaining $ 21,900 per year into a taxable account to help achieve our goal.
Take it home with you
The takeaway here is to invest intentionally. The order in which you should invest in for retirement should make sense and follow a logical order.
First, determine your annual savings goals. Then fill up the buckets one at a time.
And don’t forget your other financial goals either! This post does not include a conversation about when to repay your student loans or invest for your child’s college.
What do you think of the order of investing in your retirement? Is there anything you do differently? Leave a comment below.