How Should We Be Saving?
By: Cameron Diehl, CFP®
Friends – Last November the IRS announced a number of changes to retirement accounts for 2019, increasing the limits on contributions to 401(k)s, IRAs (for the first time since 2013), HSAs and more.
With so many ways to save for financial goals, decisions about how much to save and where can be extremely confusing. With that in mind, I wanted to share a basic hierarchy I use with clients to thoughtfully guide their saving and investing decisions while weighing the tradeoffs between each.
A major caveat: this is a generic framework. Everyone’s situations and priorities are different and extremely personal and any investment decisions should be fully informed by both.
- Foundational – The first few places to save are almost no-brainers. If you have an employer retirement plan where they match contributions, you should almost always take full advantage of that match. From there it is important to build a cash reserve or emergency fund. The often quoted 3-6 months of living expenses can be aspirational for many and is something to work toward over time, but it’s important to set aside some immediately accessible savings for unforeseen expenses. Finally, tackle any high-interest debt immediately (and sometimes possibly first).
- Health Savings Accounts – Triple-tax advantaged health savings accounts (HSAs) hold a special place on this list as one of the best opportunities for saving and investing for those who are eligible. You can read more about this increasingly popular type of account in my previous blog post here.
- Roth IRAs – Roth IRAs have a number of unique benefits for savers, namely the ability to withdraw funds tax-free in retirement, no required minimum distributions and the opportunity to withdraw your contributed principal at any time.
- Other Retirement Accounts – Double-tax advantaged traditional IRAs, 401(k)s, 403(b)s, etc. are the next best place to save from a purely tax perspective. However, with increasing contribution limits and some liquidity constraints, maxing out these accounts may not be practical. This is where an informed conversation about priorities and tradeoffs is important.
- Saving With Kids – This one’s a bit of a wildcard and can fall higher or lower on this list depending on your priorities. For parents, specialized tax-advantaged accounts can be extremely beneficial. Dependent Care Flexible Spending Accounts provide a way to save pre-tax dollars toward childcare (this is another no-brainer for parents with these expenses) and 529 Savings Plans offer a tax-advantaged way to save toward a child’s college education (and now some K-12 expenses).
- Taxable Accounts – Saving for intermediate-term goals (vacations, home purchases / improvements, weddings, other major purchases, etc.) often takes place in standard taxable brokerage accounts. These accounts are less limited than others, but are fully taxable, meaning tax efficiency is especially important.
- Other Debt – Accelerating payments on other debt such as student loans, auto loans or even extra mortgage payments can additionally help build wealth. These decisions depend on your balances, interest rates and tax considerations.
- Insurance & Annuities – Accumulation within life insurance and annuity products is lower on my list but can be valuable in the right circumstances.
- Gifting & Trusts – At a certain point for some the focus shifts to efficiently gifting assets to save on income, gift or estate taxes. Specialized vehicles such as trusts, donor-advised funds, fully-funded 529s and more can be extremely useful in these cases.
If you have any questions about this hierarchy or how it applies to your personal circumstances, please don’t hesitate to reach out. I’m always happy to help.
Disclosure: Any opinions are those of Cameron Diehl and not necessarily those of Raymond James. While we are familiar with the tax provisions of the issues presented herein, as financial advisors of RJ&A, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional. Like traditional IRAs, contribution limits apply to Roth IRAs. In addition, with a Roth IRA, your allowable contribution may be reduced or eliminated if your annual income exceeds certain limits. Contributions to a Roth IRA are never tax deductible, but if certain conditions are met, distributions will be completely income tax free. IRA tax deductibility and contribution eligibility may be restricted if your income exceeds certain limits, please consult with a financial professional for more information. Withdrawals from HSAs can only be used for qualified healthcare expenses. There are contribution limits set.
