The Savings Hierarchy
“I know I need to be saving, but what accounts do I contribute to first?”
Get this great question a lot. Here is my off the cuff answer that you can call the waterfall or cascade approach*:
- 401(k) up to employer’s match
- HSA
- Taxable (brokerage)
- Max qualified accounts
Don’t ever leave an employer’s match on the table! At least contribute up to that amount. Think of it as a 100% return on your contribution!
If an HSA is available (need to be in a high-deductible plan), then it can be arguably better than a 401(k). It has the benefits of triple-tax savings on any qualified medical expense. Going to be important if you’ve seen the cost of healthcare. Save your medical receipts! Later on in life you can pull HSA proceeds out up to the lifetime cumulative costs you’ve paid tax free. Max HSA contribution for 2021 is $3,600 for an individual.**
I feel it’s important to start contributing to a taxable account before maxing other retirement accounts; some will disagree with me on that. Tax diversification down the road will be a great benefit; in my opinion, you want to balance your assets between pre-tax accounts (401(k)s, after-tax accounts (Roth IRAs), and taxable(brokerage).
Max out your qualified account options (mainly meaning employer retirement accounts). Does your employer have a Roth 401(k) option?*** Start contributing to that after you contribute to the percentage your employer matches. If your employer does not have that, then look to maxing out the 401(k) which is $19,500 in 2021.
This last part is where I plug keeping track of a budget. Yes, I get it; it’s annoying. But how else can we track our cash flows and figure out where you have room to squirrel away more money.
If you have questions, please reach out!
*Personal finance answers are personal. There is no one best answer, but satisficing (getting to an optimal outcome and not necessarily the best) with the one that makes you feel the best is generally a quality decision.
**More on the benefits of the HSA in another post
***This is where the personal part starts to matter. This depends on your own tax situation. Not too hard to figure out.
