Life is full of tough decisions. Picking the right retirement accounts doesn’t have to be one of them.

A COMMON DILEMMA

Are you unsure if you’re using the right retirement accounts? In my last post, A Mega Backdoor Roth for Mega Long-Term Wealth, I described a complex saving strategy that’s extremely effective for younger high-income earners who are looking for a tax-efficient way to save and invest after having maxed out eligible contributions to their 401k/403b, IRA, and HSA (if available) accounts. This post is for those savers who aren’t yet maxing out all of those aforementioned accounts and who need help figuring out how to most effectively split their savings among their available retirement accounts. If this describes your situation, read on.

Step one is to determine how much you can put towards retirement over the year. Once you’ve got your retirement savings budget, step two will be figuring out which accounts you have available and which you should save your retirement dollars in. Do you just put it all in your employer 401k or 403b? What about your HSA or a Roth IRA? Have you considered just splitting evenly between all three? Here, I lay out what I believe is the right approach for the majority of savers who find themselves in this situation. As with all financial planning decisions, the devil is in the details. The following won’t apply in every circumstance or for all savers. As always, you should consult with your fee-only planner before making any changes to your current plan.

LET’S TALK FREE MONEY

The first question you need to ask is: Do I have an employer matching contribution in my 401k or 403b? This is when your employer makes a contribution to your account as long as you make a contribution as well. These matching formulas can take many different forms, but in all of them your employer is essentially giving you free money with the slight inconvenience of requiring that it go directly towards your retirement savings. If your employer does offer some sort of match, your first priority for your retirement savings should be to ensure that you receive the full employer match. Even if you just get a 50% match – think about what that means. The money you contribute is essentially getting an immediate 50% return! Not a 50% annualized return (over a year), this 50% return happens the moment your investment is made! That instant “free money” then teams up with your contribution to amplify the already powerful effect of compound interest on your long-term growth. All of this is to say, your first priority should be to contribute enough to your 401k or 403b to get the full employer match.  Note, the choice between Traditional vs. Roth contributions will depend on your personal and tax circumstances and is beyond the scope of this post.

ENTER THE ROTH IRA

I’ve dedicated many hours and multiple posts extolling the benefits of Roth retirement accounts. With Roth accounts you pay income tax up-front in exchange for tax-free growth and tax-free withdrawals for any purposes once you hit 59.5 years old. I find Roth accounts to be particularly attractive these days (even for high-income earners) because of the low tax environment that we’re presently in. As such, once you’ve got 100% of your employer’s match, most savers would likely be best served by then maxing out their eligible Roth IRA contributions – $7,000 if under 50 in 2024. Note, there are income restrictions on who can contribute to a Roth IRA. If you earn too much to contribute directly to a Roth IRA and you don’t have any Traditional IRA accounts funded, you could consider executing a “Backdoor Roth IRA”. Note that performing this strategy can be a little complex. It’s best achieved with guidance from a professional if you’re not 100% confident that you know what you’re doing.

What if you can’t make Roth IRA contributions directly because your income is too high and you can’t properly execute a “Backdoor Roth IRA” because you have a Traditional IRA(s)?

HSA: A TRIPLE TAX SHELTER

You’ve contributed enough to get your full company match, have maxed out your annual IRA contribution limit by contributing to your Roth IRA, and you still have money remaining that you want to save for long-term growth. What next? Most companies these days offer High-Deductible Health Plans (HDHP) as a health insurance option. These HDHP plans allow you to tap into an incredibly powerful wealth building tool called a Health Savings Account (HSA) – boring name, incredible tax treatment! NOTE, I am not recommending you change insurance coverage to an HDHP. For this post, I’m assuming that you’ve reviewed your health insurance options and determined that a HDHP is appropriate for you based on your family’s health circumstances and cash reserves/free cash flow. A lot has been written about the power of HSAs as both a planning tool and as a long-term wealth builder and below I’ll provide a high-level summary of the wealth building benefits. HSAs are uniquely powerful in that you get an unmatched opportunity for a triple tax-shelter.

1. You can deduct your HSA contribution (max of $4,150/Single and $8,300/Family in 2023) from your federally taxable income (and state income in most states) for the up-front tax break.

2. You can invest the money in your HSA (much like you would in an IRA) for tax-free long-term growth of your money.

3. You can withdrawal money from your HSA tax-free as long as you use it for a qualified medical expense – at any time – though given the tax benefits, it’s best to let it grow for the long-run. Why? According to a recent Fidelity study, healthcare expenses in retirement are expected to average $315,000 per couple in today’s dollars!

In terms of wealth building, this is truly an unrivaled account! If used correctly, the IRS could very conceivably never be able to tax a material portion of your income and you could use those never-taxed dollars to pre-fund a known, and substantial, cost in your retirement. As such, your next priority should probably be to max out your eligible HSA contributions assuming you’ve already determined a HDHP to be appropriate for you.

BACK TO THE 401K/403B

If you have retirement savings left after getting the full employer match in your 401k/403b, maxing out your Roth IRA, and after maxing out your eligible HSA contributions, you’re likely best off putting your remaining savings back into your 401k/403b until you hit the maximum allowed annual contribution limit, $23,500 in 2025. The automated nature of saving and investing every paycheck without having to do anything, coupled with the low cost associated with most employer plans makes this an appealing final option. Again, the choice of Traditional vs. Roth contributions will depend on your personal circumstances.

MEGA BACKDOOR ROTH

You’ve done all of the above and you still have funds left that you’d like to save for retirement. If your 401k plan offers after-tax (different than Roth) contributions and they allow for in-service conversions, you should consider looking at executing what is commonly referred to as a “Mega Backdoor Roth” strategy. I’ve written a lengthier post about this exact strategy here, but in short, this is when you make additional contributions, above and beyond the $23,500 401k contribution maximum for 2025, to this after-tax account within your 401k and then you convert those after-tax dollars as quickly as possible to your Roth account to invest for decades of tax-free growth and eventually 100% tax-free withdrawal. A key element of this strategy is getting the money converted from your after-tax account into your Roth account so there is little to no tax bill associated with putting this strategy in place. The absolute maximum amount a saver can put into a 401k in 2025 is $70,000. This amount includes the $23,500 employee contribution limit, the employer matching dollars, and any additional dollars added to the after-tax account. If we assume that your employer match is 50% of every dollar you contribute, and that you made the maximum $23,500 contribution to your Traditional 401k, you would have a total overall annual contribution of $35,250 in 2025. This means that you would be eligible to contribute an additional $34,750 to your after-tax account. If you plan allowed for immediate conversions of after-tax contributions to your Roth account, if you had the funds to support such a lofty savings goal, you would be able to get that additional $34,750 into your Roth 401k at zero additional tax cost, and without cannibalizing your ability to enjoy the upfront tax savings associated with making your $23,500 in Traditional 401k contributions. This truly is a wonderful strategy to build long-term wealth on a tax-free basis!

TO SUMMARIZE

Every person’s situation and circumstances are unique. Accordingly, this advice certainly doesn’t apply to all retirement savers however, most people would be well-served to save for retirement in the following manner:

First – Contribute enough to your 401k/403b to get 100% of your Employer Match “free money”. 

Second – Max out eligible contributions to your Roth IRA, or look to make backdoor Roth contributions if you are positioned to do so.

Third – If you have a HDHP, max out eligible contributions to your HSA.

Fourth – Contribute any remaining savings to your Traditional or Roth 401k.

Fifth – If your plan allows for it, contribute any remaining savings to the after-tax account within your 401k and convert those dollars to your Roth account ASAP.

Now that you’ve got your retirement budget set and you know you’re saving in the right retirement accounts, your last step is to pick the right investments for your long-term growth in those accounts. If you’re looking for help with that, check out my post on the importance of having an Investment Philosophy here.

If you’d like to schedule a time to chat about your financial situation, you can do so here.

Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Robert Stromberg, and all rights are reserved. Read the full Disclaimer