In today’s episode we are going to talk about what investment vehicles aka accounts are available to you.   We will discuss how you can navigate which one is best for you and where to initially start.  Towards the end we will discuss some self-employed accounts as well.

Show Notes:

#1 – 401(k) or 403(b) up to the full employer match.  Other be 457 or TSP

  • 401k Offered by most for profit businesses / private employers
  • 403b Offered by public schools many non-profits (schools, churches, hospitals)
  • 457 Offered by state and local governments and some non-profit employers
  • TSP Offered to federal employees

 

  • 2020 contributions for those under 50 = 19,500. Over 50 25,500
  • What does your employer match
  • Is there a roth option available? Should you choose the roth option? 
  • Matching money always goes traditional.  Roth highly consider if in 12% or below federal

Traditional Pre-tax account. Your contributions are not taxed in the year you contribute.  This reduces your gross adjusted income. Example, it may help take you from 22% to 12% marginal federal tax bracket

Roth – After-tax account.  Your contributions are taxed in the year you contribute.

Some employers may have 403b or 401k and 457b and allow you to contribute to both plans.

Some employers may have after-tax contribution option and in-service distribution option where you could move the money to Roth IRA in the same year.  

 

#2 – HSA, if you are eligible.  Does company match?

High Deductible Health Plan

  • A higher deductible than your traditional plan
  • Lower premiums 
  • Minimum deductible $1,400 (single) or $2,800 (family)
  • Eligible for HSA (Health Savings Account) 

HSA

  • Self-Only Coverage
    • Maximum annual contribution – $3,550
    • The minimum annual deductible for HDHP – $1,400
    • Maximum annual out-of-pocket expense limit for HDHP – $6,900 (includes the deductible, copays, coinsurance, not premiums)
    • Multiple by 2 for family in each area
    • 55+ add $1,000 to annual contribution
  • Triple tax benefit for federal taxes
    • Contributions are pre-tax
    • Tax-free earnings
    • Tax-free withdrawals for qualified medical expenses
  • Penalty-free withdrawals for non-qualified expenses 65+
  • Combination of Traditional and Roth benefits
  • Annual rollover of funds
  • Portability of HSA on job change or retire
  • High deductible with a lower premium than a traditional plan
  • Record-Keeping – Receipts
  • 20% early withdrawal penalty + taxes before 65 for non-qualified expenses
  • 65+ for non-health expenses treated like IRA
  • No RMD rules

Record-Keeping – Receipts –  Yes, as long as the IRS-qualified medical expenses were incurred after your HSA was established, you can pay them or reimburse yourself with HSA funds at any time.  Just be sure to keep sufficient records to show that these expenses were not previously paid for by another source or taken as an itemized deduction in any prior tax year.

 

Some qualified medical expenses

  • Co-pays or deductibles
  • dental services
  • vision care
  • prescription drugs
  • psychiatric treatments
  • Other qualified medical expenses not covered by a health insurance plan

Rollover of Funds:

  1. HealthEquity
  2. Lively
  3. HealthSavings 

 

#3 – Employer’s plan if it has good investment options and low fees. Adding more than the match

 

  • Easy to get started. Contributions are taken directly out of your paycheck.
  • In general, your contributions are tax-deductible in the current year, meaning you will get an immediate tax break. Your eventual withdrawals will then be taxed.
  • These accounts may also offer a Roth option, which would not give you a current tax deduction but would allow you to eventually withdraw the money tax-free.
  • High annual contribution limit ($19,500 for 2020). If you are 50 or older, you can contribute an additional $6,000 per year.
  • May offer high-quality, low-cost investment options you can’t find on your own.
  • When you leave your job, you can take this money with you by either rolling it over into your new employer plan or into an IRA (we’ll talk about IRAs just below).

 

  • Some plans have high fees, which will drag down your returns.
  • Your investment options are limited to what your employer chooses to include in the plan. In some cases these options may not be great.
  • Technically, your money is supposed to stay in the account until age 59.5, but there are some ways around that rule.

 

  1. Take full advantage of the employer match first, no matter what the plan looks like.
  2. If your plan offers low-cost investment options that fit your desired investment strategy, this is a good option for your additional savings above that match.
  3. If your plan has a lot of fees, or if the investment options don’t fit your desired strategy, you might want to contribute additional money elsewhere first. Like an IRA discussed below.

#4 – IRA, either Roth or Traditional.

An IRA gives you more control than an employer plan.

You have more investment options, meaning you can definitely implement your desired investment strategy.

You can keep costs low.

You have the option of using a Roth IRA, which may be beneficial depending on your situation.

You have until April 15 of the next year to make your contributions for the current year. For example, you have until April 15, 2021 to make your 2020 contributions.

As of 2020, your annual contribution is limited to $6,000. If you are 50 or older, you can contribute an additional $1,000 per year.

That contribution is further limited, and potentially even eliminated, for high-income earners. Here’s an overview of those income limits: IRS – IRA Contribution Limits.

#5- Backdoor Roth IRA, if you’re not eligible for a regular IRA contribution.

Here’s a basic overview of how it works:

  1. Open a Traditional IRA.
  2. Contribute to the Traditional IRA up to the annual max.
  3. Convert the Traditional IRA to a Roth IRA anywhere from one month to one year after making the contribution.

Now, there are a few potential pitfalls to watch out for.

The biggest is that there could be unintended tax consequences if you have other Traditional IRAs. Because even if you make your non-deductible contribution to a brand new IRA, the IRS considers all of the money inside all of your Traditional IRAs to be part of one big pot. And it considers any Roth IRA conversion to be a pro-rata distribution of pre-tax and post-tax money from that single pot, meaning that significant pre-tax savings in other Traditional IRAs could cause most of your conversion to be taxed.

The bottom line is that you need to be careful before executing a Backdoor Roth IRA, but that when it’s done right it’s a great way for high-income earners to get tax-free money in retirement.

For more detail, including how to avoid the biggest pitfalls, here’s some additional guidance: The Backdoor Roth IRA.

Roth IRA contributions are made on an after-tax basis. However, keep in mind that your eligibility to contribute to a Roth IRA is based on your income level. If you file taxes as a single person, your Modified Adjusted Gross Income (MAGI) must be under $139,000 for the tax year 2020 to contribute to a Roth IRA, and if you’re married and file jointly, your MAGI must be under 206,000 for the tax year 2020. 

Pros

  • High earners ineligible for direct Roth IRA contributions can take advantage of tax-free growth and tax-free withdrawals.
  • You get all the other advantages of IRAs, including the ability to minimize costs and choose from a wide range of investment options.

Cons

  • It’s a more complicated strategy with more room for error.
  • There are potential unintended tax consequences if you have existing Traditional IRAs, though there are ways around that.

#6- Taxable account.

The first is that you can invest in pretty much whatever you want. It’s similar to an IRA in that the whole world of options is open to you.

The second is that, again like an IRA, you have a lot of control over how much you pay. You can keep costs to a minimum, leaving more of your money for yourself.

While you won’t get any tax breaks, you can still make efforts to minimize the taxes you pay inside the account. Some examples of that include:

  • Using tax-efficient investments like index funds (we’ll talk more about these below).
  • Using a buy-and-hold strategy to minimize the number of transactions that might be subject to taxes.
  • Tax loss harvesting.
  • Tax gain harvesting.

Pros

  • Full control over your investment options.
  • The ability to minimize costs.
  • No restrictions on when you can access the money.

Cons

  • No tax breaks.

Self-Employed

  • IRA – The contribution limits, income restrictions, and everything else are the same whether you’re self-employed or an employee.  Look above for details
  • HSA – Again, this works exactly the same for a self-employed individual as it does for a regular employee. If your health insurance allows it and if you don’t need the money for medical expenses, this would be a good first or second step. Look above for details.
  • Solo 401(k) – This is a 401(k) specifically designed for people who work for themselves and don’t have any employees (other than a spouse). For 2020, you can contribute up to $19,500 per year as an employee AND up to 25% of your net income as an employer, with a combined $57,000 max. 
  • SEP IRA – Employer contribution of up to 25% of net income, up to a $57,000 annual max (as of 2020). One other advantage is that you have until April 15 of the following year to make a contribution, whereas Solo 401(k)s have a December 31 deadline.
  • SIMPLE IRA – These allow for up to $13,500 in employee contributions (for 2020) and EITHER a 3% employer match OR a 2% automatic employer contribution. 

Summary of the order

  • 401(k) or 403(b) up to the full employer match.
  • HSA, if you are eligible.
  • Employer’s plan if it has good investment options and low fees.
  • IRA, either Roth or Traditional.
  • Backdoor Roth IRA, if you’re not eligible for a regular IRA contribution.
  • Taxable account

Call to Action:

  • Look to see what investment account that you have available to you, what are you contributing to those in terms of dollar amount, what are you invested in, and was it planned at all or recently?

Resources: