When you pull back the curtain to see what is inside a target-date fund, there are thousands of individual companies. To help visualize some of the top holdings, we created a graph that illustrates the Vanguard Target Retirement 2045 Fund (VTIVX).
Over time, target-date funds adjust their holdings and asset allocation (stocks/bonds/cash) based on your retirement age. But for now, we hope this snapshot clarifies some of the largest companies inside the Vanguard Target Retirement 2045 Fund.
Saving for retirement can seem straightforward compared to the daunting task of converting your hard-earned savings into retirement income.
When building a retirement income plan knowing what questions to ask will potentially save you money, lower your overall tax bill, and provide you peace of mind. Here are three questions you should ask when building a retirement income plan, as well as some considerations:
There are many ways to fund retirement. Thus, no retirement plan looks the same. To begin to understand how you will fund retirement, give yourself a quick assessment. What sources are available to you and how much?
What you should consider: Simplicity in retirement. This can be achieved by consolidating retirement accounts such as your employer-sponsored retirement plans into an IRA. See - Why an IRA makes more sense in retirement than your 401(k)
There are a lot of unique planning opportunities regarding when to start receiving your sources of income. Knowing when to access these different sources can provide efficiency, lower taxes paid, and increase your retirement income.
The IRS and Social Security Administration have imposed rules that coincide with specific ages. Familiarizing yourself with these key rules and ages associated with accessing popular income sources can help you begin to answer the question of “When?”. Here are some key ages to consider when building a retirement income plan around these popular sources -
Tax-deferred accounts (401(k)/403(b)/IRAs):
Age 59.5 - you can’t access tax-deferred dollars without a 10% early withdrawal penalty before age 59.5. The IRS does highlight some exceptions to the 10% penalty for premature withdrawals.
Age 72 (or age 70.5 if you were born before 1951) – The IRS requires that an individual withdraws a minimum amount of their retirement plans (i.e. an IRA) each year starting in the year they reach age 72. This requirement is known as a required minimum distribution or an RMD. Account-holders that do not take their full RMD will be faced with a stiff excise tax equal to 50% of the RMD not withdrawn.
Social Security:
Most Americans can begin claiming Social Security retirement benefits as early as age 62, or as late as age 70. Once you stop working, it can be tempting to claim Social Security as soon as possible to subsidize your income. However, it’s often strategic to delay Social Security as long as possible. The longer you delay claiming your Social Security benefit the greater your guaranteed inflation-adjusted monthly benefit will grow (up to age 70). Factors that should be considered when creating a plan around Social Security are life expectancy, other sources of retirement income, and spousal benefits.
What you should consider:
Which sources you will draw first?
Should you delay social security as long as possible?
How long each source will last?
Not all income sources are taxed at the same rate. Take the time to understand your applicable taxes and build a tax-sensitive retirement income plan to prevent paying unnecessary amounts to the government.
What you should consider:
The tax implications of the aforementioned RMD’s. RMD’s can unknowingly force you to pay a higher than necessary tax bill once you are forced to take required withdrawals.
A tax bracket optimization strategy that provides savings on your overall retirement tax bill. This can be especially beneficial in the early years of retirement. Learn more about Tax Bracket Optimization here.
Heading into retirement without an income strategy is financially precarious. To illustrate the benefit of creating an effective plan, we are sharing a hypothetical example. Meet Charlie and Frankie:
Charlie (age 61) and Frankie (age 60) live in Oregon and each plan to retire when they turn age 62.
Charlie has $1,000,000 in a 401k/traditional IRA.
Frankie has $250,000 in a 401k/traditional IRA.
They have $150,000 in joint accounts.
At age 67 Charlie and Frankie are eligible to receive $2,990/month and $2,376/month, respectively.
Their annual income goal during retirement is $90,000.
In the following charts, we compare the impact of an efficient retirement income strategy to one that is not. The only thing that is different in the two scenarios is the consideration of when to draw specific sources and the associated tax implications. Unfortunately, when managed inefficiently the couple is only able to maintain their target annual income for 26 years. Additionally, the inefficient strategy forces the couple to pay an additional $129,000 tax over 30 years when compared to a more efficient strategy.
Assumptions: 4% investment rate of return on all accounts. No additional contributions are made to investment accounts. Taxes include both Federal and Oregon State income tax.
Taking the time to thoroughly answer these questions can provide long-term value.
Engaging with a financial planning firm can be helpful if you are not fully confident in making a retirement income plan. Working with the right financial planning firm for your unique situation can be the difference between a carefree retirement and a stressful one. To learn more about how we think about serving clients through comprehensive financial planning, check out our services here.
Will Kellar, CFP®
Will is motivated by the opportunity to serve hardworking people and their financial pursuits, through advocacy, problem solving and great advice. He’s a CERTIFIED FINANCIAL PLANNER™ practitioner who loves the feeling of when our team makes a positive tangible impact in someone's life. He’s also serving as an adjunct professor of Retirement Planning at George Fox University.
Oregonians are not saving enough for retirement. OregonSaves is a state-sponsored retirement plan for employers that that do not offer an employer-sponsored retirement plan for their employees.
This program is ideal for employers who wish to encourage employees to save for retirement, but do not currently sponsor a retirement plan. Since there are no employer fees involved in OregonSaves, the biggest commitment is designating time to initiate and complete the enrollment process. Overall, OregonSaves aims to lower the barrier of entry for employees and at the same time provide employers the opportunity to help champion their employee’s financial well-being.
OregonSaves is designed to combine features of employer plans with Roth Individual Retirement Accounts (IRA’s).
What It is
Employee contribution and participation is voluntary.
Self-employed individuals are also eligible for participation.
The standard contribution rate is 5% of employees’ gross pay. These dollars are contributed directly from payroll into to a Roth IRA. Note that the 5% savings rate may be adjusted up or down and savers can also elect to make contributions through a bank account or a check.
Employees first $1,000 will automatically be invested in the OregonSaves Capital Preservation Fund.
Savings over $1,000 will automatically be invested in an OregonSaves Target Retirement Fund.
There are three investment choices available through OregonSaves: Capital Preservation Fund, Target Retirement Funds, and a Growth Fund.
What It Isn’t
Employee annual contributions are limited to $6,000 (or $7,000 for those 50 years and older). This program is not meant to replace or compete with employer-sponsored 401(k) plans.
No employer contributions are permitted.
One effective way to combat a saving deficit is to automate savings through payroll. Employers are responsible for syncing payroll with OregonSaves. Once the setup is complete, the ongoing maintenance includes updating employee lists and submitting employee saving elections.
If you think your employees would benefit from participation, then visit the OregonSaves website or consult our team with questions you may have.
We frequently receive questions about which tax forms are required for a tax return. Generally speaking, most 401(k) retirement savers do not have to report anything special for taxes. Unfortunately, making generalizations about taxes is a slippery slope. We know taxes are confusing, so we have outlined some common 401(k) scenarios and their tax implications:
This scenario is true for most people. If your interaction with your 401(k) account was just saving money, then you will not receive any special tax forms for your 401(k) account. Your contributions (which are synced with payroll) will appear on your Form W-2 in box 12. Code D is for your pre-tax contributions and Code AA is for your Roth contributions. Ta-da!
If your employment status changed, there are several ways this could impact your tax return. Here are the most common situations for employees:
You did not move or make any transactions in your 401(k) account once you were terminated.
If this is the case, then your tax filing responsibility is like scenario 1) above. The information that is important for your tax filing is included in Box 12 of your Form W-2. For those readers with an old 401(k) account (like an account you haven’t touched in 5 years), you should not expect to receive a Form W-2 from your ex-employer or report anything for your current tax return.
You (or your employer) cashed out your 401(k) account.
If this is the case, then you will receive a 1099-R form. Additionally, your employer would indicate your gross distribution in box 2a and withhold 20% of your cashed out balance for federal taxes.
As discussed above, if you took money out of your 401(k) account then you will receive a Form 1099-R. Typically, a 401(k) withdrawal triggers income tax and a 10% penalty for individuals younger than 59.5 years old. However, the 2020 CARES Act eliminated the 10% taxation of distributions related to adverse financial consequences caused by the coronavirus.
If you rolled an old 401(k) account to your new 401(k) account, you should receive Form 1099-R. Because this is not a taxable event, the form will indicate that your gross distribution is not subject to taxes. This will appear in box 7 with a code G (pre-tax) or H (Roth) for a rollover.
If you rolled an old 401(k) account to an IRA, then you will receive a Form 5498 for proof that your dollars were moved. Again, your income tax for such transaction is $0 assuming the rollover was complete within 60 days.
If you contributed to a 401(k) account without any late-payments or defaulting, then you do not have anything special to report for your tax return. This is similar to scenario 1) above.
In this case, you will receive a Form 1099-R and pay income tax on the outstanding balance. Additionally, you will pay a 10% penalty (if applicable).
If you retired this past year, congratulations! There is nothing for you to report on your income tax return unless you took money out of your 401(k) account, in which case your taxable distributions would be included on Form 1099-R and included in your taxable income.
If you turned 72, you need to research the Required Minimum Distribution (RMD) rules. For example, if you are 72 years old and still working then you don’t have to take a RMD (unless you are a >5% owner of the organization). These rules are important to understand because the financial penalties for missing a RMD are substantial. Lastly, the 2020 CARES Act waived RMD requirements for this past year.
Taxes are complex! Please reach out to our team if you have any questions about your 401(k) account and your taxes.
According to most research, although millennials are considered the most highly educated generation, we are the least informed when it comes to our financial decisions. Not only do we lack financial literacy, but pre COVID-19, 63% of millennials felt anxious when thinking about their financial situation, and 55% felt stressed when discussing their financial situation. I imagine COVID-19 has negatively impacted those figures even further.
There are many factors that affect our personal financial stress levels, but historically, the financial industry has felt inaccessible to those who lack financial literacy and/or feel insecure about their financial situation. How are we supposed to learn if we lack access to knowledge?
I love the concept of savings apps, because it improves accessibility of investing and saving for a large population. Basically, if you have a smart phone and a few extra dollars, you can be a saver. A study conducted in 2019 found that individuals who used savings apps kept better track of their finances and were more resilient when faced with a financial shock. However, accessibility without education can be hazardous. So, here are two recommended savings apps that provide learning and saving opportunities.
Mint is a free app powered by INTUIT (think Turbo Tax) that houses all of your financial information in one place. Mint uses a holistic view and budgeting tools to find extra savings for you. Not only do they provide you with custom savings tips, but they also have a hub of resources, ranging from building a grocery budget to investing advice, so you can learn along the way!
Digit has the same philosophy as Mint: find savings within your current financial situation. With this philosophy, Digit analyzes your current income and expenses and then lets you know what you can afford to save. They invest your dollars in FDIC insured account using a portfolio based on your risk level and comfortability. You are also able to attach these savings to a specific goal – emergency savings, honeymoon, a doggo—you name it. There is a monthly cost of $5, but you do receive 1% annual bonus savings every three months.
It’s okay if you don’t vibe with the savings app world. But if you do want a better grip on your finances, follow the philosophy behind the savings apps:
Keep track of your income.
Assess your spending habits.
See where you can save.
For me, that looks like walking past the gluten-free bakery every so often instead of into it (which is usually the case) and saving the extra $5. At the end of the month it can make a difference (Don’t believe me? See how much you can save by ditching your morning coffee here).
Finally, allow yourself to interact with financial resources without being too hard on yourself. The purpose of these apps is not to be a report card. The purpose is to empower you to make thoughtful decisions that will improve your financial health. If you have questions, check out our Financial Wellness Center or reach out! We are here for you.
Rachelle Top
Passionate about making financial wellness accessible to all through education and advocacy, Rachelle draws from her background in psychology and experience in the financial services sector to serve our credit union clients. She loves connecting with others and learning about their story.
Are you retiring from PERS soon? Provided below is a concise breakdown of the most common benefit options and what they mean.
Often it makes the most sense to receive a lesser monthly benefit while protecting your loved ones with a survivorship option. Comparatively, it is like paying insurance monthly to ensure there is income for your beneficiary if you should die prematurely.
There are many more factors to consider, but a written estimate and analysis in coordination with your financial plan will provide a platform for deciding the best option for you and your family.
In March, we were inundated with updates about the coronavirus and the unknown ramifications to follow. In the same month that the NBA was postponed, children were sent home from school, toilet paper fled the grocery store shelves, the US stock market had three of the worst days in US history.
Unlike the year 2020, your 401(k) account is routine and emotionless. If there is no user interference (yes, that is you), your account will continue to invest in the stock market every paycheck. A 401(k) account can help alleviate market-timing decisions by adopting an investment strategy called dollar-cost averaging. Instead of waking up in the morning and deciding “is today a good day to buy some stock?”, your 401(k) systematically makes those timing decisions for you.
To review the ease of these timing decisions, I wanted to show investors what happened if you made a $50.00 contribution to your 401(k) account every paycheck during 2020. In this scenario, we assume employees were paid every two-weeks (starting on January 3, 2020) and invested in the Vanguard Target Retirement 2055 (VVFVX) fund.
These dollars represent the trading value of the Vanguard Target Retirement 2055 (VVFVX) on specific days. In this exercise, the lowest trading price was $31.16 on March 20th, and the highest trading price was $48.55 on November 27th.
As you can see, the best time to invest in the stock market this year (March) was also arguably the most uncertain and scary time to be an individual investor. From a February 21st paycheck to a March 6th paycheck, the price of this target date fund dropped 9%. From a March 6th paycheck to a March 20th paycheck, the price dropped 21%.
When prices were falling, your 401(k) account bought shares at a lower price without panicking, consulting the news, or making impulsive decisions. For that reason, we should give 401(k) accounts a standing ovation for being a reliable, unemotional investment vehicle this year.
Let 2020 be a reminder that if your boxes are checked, outsourcing and automating your account is one way to ease your emotions.
Perhaps now more than ever, it makes sense to increase your deferral to the SERPLUS deferred compensation plan. The following chart compares current tax rates to the proposed tax rates by the new administration.
Though we are uncertain when the tax changes will be implemented, we do know that tax rates will increase. If taxes increase, your deferred compensation benefits may become even more important for your tax planning.
Deferred compensation plans provide an opportunity to receive less income today in order to pay less taxes on that income when received in the future. When making annual deferred compensation elections, you have the choice of a 5-year, 10-year, or lump sum payment at retirement (when employment with Intel ends). If you plan to retire at 62, you could elect to receive distributions for 10 years from your SERPLUS plan to stretch out your income and realize it in a lower tax bracket until age 72. With this plan, you have deferred compensation income providing for your first 10 years of retirement. In your early 70’s, social security and required IRA distributions will supplement your steady income stream, and eventually replace your deferred compensation income.
Spreading deferred compensation income out over 10 years allows you to take it in a lower tax bracket, like 21% for Federal and State combined or 24% combined after 2025. This tax deferral would provide for a tax reduction between 23% and 35%. In a hypothetical scenario, $50,000 contributed per year over 15 years would total $750,000 (without earnings computed). The income deferral could provide $172,500 in tax savings in a conservative example and $262,500 in savings in a more generous example. That is real money in your pocket rather than in the Federal and State governments.
In the peak earning years of your life, with your 401k maxed out and not providing enough tax deferral and future income, the SERPLUS deferred compensation plan is a great tool to help increase both.
If you do participate in the plan, your current take-home pay will decrease. If cash flow becomes tight, there are opportunities within your employee benefits that could help provide the needed funds. It may be advisable to sell some company stock (ESPP, RSUs) to supplement your monthly income so that you can participate in the plan and defer income. Keep in mind, your election made in 2020 on salary is for the 2021 income year, whereas the bonus election is for the bonus paid in 2022. A portion of the bonus could be especially important to defer in 2022 considering the proposed tax changes.
If you have questions about making deferred compensation elections, please schedule a call.
Clayton Phillips, CFP®
Clayton is a CERTIFIED FINANCIAL PLANNER™ practitioner with a focus of financial planning and advising clients transitioning to retirement. He brings experience in managing income from investments, social security, pensions, and other sources to ensure clients make the most of what they have while minimizing taxes. Questions answered, proactive advice, and peace of mind are just part of the great experience provided by Clayton and his team.
Recently I received a note from a longtime Human Investing client. He was following up on a discussion we had back in March, where he, like others, was concerned about where the market was headed. Here is a mostly intact version of what he said:
I just wanted to thank you and acknowledge your sound advice eight months ago when everything was running off the edge. Since then, we are up more than $250K (17%) and above where we were then. The reality is that had I pulled out, I would not have gotten back in before missing most of the bounce back. Hindsight can be wonderful when you do not make the wrong decision! My friend, who sold out in March, is still hanging onto the belief that we are headed down again. Who knows the future.
The purpose of this note is not to take a victory lap for the advice we dispensed. Instead, it highlights how a discussion can help put investing in perspective in a tense market moment. This client has 50% of their portfolio in safe investments, like high-credit quality bonds and cash. The remaining portion is in broadly diversified equities. Despite having enough cash and bonds on hand to live a decade without having to touch their equities, they had a concern. The discussion with this client revolved around whether they needed more than ten years of cash and bonds to live and focused less on market timing. In the end, it was the client who decided to hold tight, not me. I was the one who removed myself from the emotion of the situation and was there to ask the right questions.
Throughout my career, my role in the client’s life has evolved. In the mid-90s, we were providing stock recommendations and picking money managers. Today, we rely on trading algorithms from Morningstar and low-cost index funds from Vanguard and Barclay’s. The quantitative work has shifted from money management to financial planning and tax planning/compliance. This work is done by my colleagues at Human Investing: Andrew Gladhill, CFA, Marc Kadomatsu, CFP, Amber Jones, CPA, and Luke Schultz, CPA. On the flip side of the quantitative work is qualitative research, which involves non-numerical data. Qualitative research comes from our interaction with clients and hearing about their feelings, emotions, and opinions. These qualitative insights are paramount to a successful retirement plan. Some might argue that emotion and opinion can derail the best of financial plans. This is at the heart of the above quote. Quantitatively, the client was in great shape, but their “in the moment emotions” almost derailed a great retirement plan.
Dalbar Inc. provides performance information on the “average investor”. Figure 1 is a chart I have tracked for years. One of the many reasons why the “average investor” does so poorly versus the returns of various asset classes and stock/bond mixes is due to their emotions. Having someone to talk to about these thoughts and feelings can be helpful. If the plan permits and valid concerns arise from the discussion, then changes can be made. However, if the change is not rooted in probability and the financial plan, there is the potential that the decision being made can be harmful.
Figure 1
It is interesting to see the S&P 500, dating back to the year I started in the financial services profession. Figure 2 depicts much relevant information. Most notably is the long term upward trending line during my career. If we went back to the early 1900s, the chart would look similar—lots of ups and downs with a trend line that moves up over time.
Figure 2
Sometimes, the drops in the market happen gradually—as do their recoveries (as was the case in 2000). Other times, market volatility stems from “counterparty risk,” which was the case in 2007 when the housing market and credit created uncertainty. In the most recent case, the severe volatility was brought upon by fear from a pandemic and an uncertain future. Regardless of the reason, volatility is a natural part of investing in the stock market. My observation is that volatility is permanent. Surprises (both up and down) are common. The financial plan, which is a quantitative document developed by credentialed experts, can be worth its weight in gold. It can act as a financial roadmap when you feel lost—and provide an advisor like me the data-points to dispense proper advice during anxious moments.
Dr. Peter Fisher
Peter Fisher is the founding partner and CEO of Human Investing, an Oregon headquartered, employee-owned financial management company. Dr. Fisher’s research focuses on consumer financial literacy and behavior. He is the author of Becoming a 401(k) Millionaire (2024), and his doctoral dissertation is titled Financial Literacy and Behavior in Credit Unions.
On September 1st, my beautiful wife and I welcomed our new son into the world. His arrival has brought our family much joy during this season. Like all newborns, he has also brought sleepless nights, an abundance of comfort food, and disruption to our schedules and disciplines. As a result, I am here to tell you from personal experience the “dad bod” is real (find out if you have a dad bod here).
As I begin the journey to get back in shape, exercise and clean eating seem more difficult than ever before. Had I maintained my regimented sleep, diet, and exercise schedule throughout the entire pregnancy, returning to my baseline wouldn’t be as challenging. In physics, we call this inertia. In finance, we call this the compounding effect.
Like most things in life, there is a compounding effect on our actions.
Consistency in showing up to work → proficiency at your job.
Consistency in showing up in the lives of loved ones → richer relationships.
Consistency with a sustainable diet and exercise plan → greater physical health.
Consistency in following a prudent investment strategy → increased net worth.
The inverse is also true. Disruption is a detriment to the compounding effect, a truth for our fitness as well as our investment accounts. To quote Charlie Munger, Warren Buffet's partner at Berkshire Hathaway —“The first rule of compounding is to never interrupt it unnecessarily”.
I would argue that someone’s consistency often has a greater impact than their effort and resources. Take the following example of two investors:
Investor A - saves $2K/year from age 26-65.
Investor B - saves $2K/year from age 19-26 and stops there.
Both achieve a 10% annual return.*
At age 65, who ends up with more money?
Investor A: $883,185
Investor B: $941,054
By saving and investing $2,000 at the beginning of each year from age 26 to 65 (39 total years), Investor A can expect to have a final balance of $883,185. Investor B only saves for 8 years but starts to save earlier in life than Investor A. Investor B benefits by taking advantage of 46 years of compounding growth, finishing with a balance of $941,054.
What Investor B lacks in consistency of contributions, they make up for in consistency of not interrupting the compounding effect on their investment account. I know you are probably curious, what would happen if Investor B did not stop contributing at age 26? Investor B’s account balance would be $1,902,309. Once again consistency wins out.
There are no shortcuts to saving for retirement and fighting the "dad bod". Starting can be difficult and sometimes painfully slow, however, the long-term results can be powerful.
The easiest advice to give is “never get off track.” However, like your sleep schedule with a newborn, there are some things you cannot control. It is important to know how to reassess and get back to work.
Building anything valuable and defensible takes time, effort, and energy. Build a plan today.
If you want to compare notes on raising a newborn, see baby photos, or discuss the impact of consistency when building a prudent financial plan, please reach out. We are here for you.
*This is for illustrative and discussion purposes only. Investment results will vary.
Will Kellar, CFP®
Will is motivated by the opportunity to serve hardworking people and their financial pursuits, through advocacy, problem solving and great advice. He’s a CERTIFIED FINANCIAL PLANNER™ practitioner who loves the feeling of when our team makes a positive tangible impact in someone's life. He’s also serving as an adjunct professor of Retirement Planning at George Fox University.
A lot has changed in 2020, but contributions limits will remain relatively consistent going forward. The IRS recently announced the 2021 contribution limits. The most notable change specific to retirement plans is that the annual deferred contribution limit will increase from $57,000 in 2020 to $58,000 in 2021.
Here are the applicable updates for the coming year.
Please let us know if you have any questions. We look forward to working with you in 2021. Take good care.
Health Savings Accounts (HSA) made the roster of tax-deferred accounts. For this reason, these accounts can be a favorable component in a financial plan both today and in the future (65+ years old). HSA accounts were first introduced in 2003, and since then, their utilization among employees and employers has grown meaningfully. In order to be eligible to participate in an HSA – an employee must be covered by a High-Deductible Health Plan (HDHP) and not be enrolled in Medicare or other health coverage. Like an employer-sponsored retirement plan, a Health Savings Account offers benefits for both employees and employers. As such, their increased popularity is hardly surprising.
While there are many benefits of HSA accounts, we must also recognize that switching from a PPO plan to an HSA often results in more out-of-pocket medical expenses during the year. Yes, we agree that sounds unappealing. However, there is always more to the story.
The account is portable. Contributions to HSA need not be used in the tax year they are made. Additionally, if an employee changes jobs, the account is still accessible.
Health Savings Accounts do not impose income limitations. Unlike IRAs, highly compensated individuals are still eligible to participate in these tax-deferred accounts.
Health Savings Accounts provide a trifecta of tax savings:
Employee contributions are federal-tax deductible.
Federal tax on investment earnings is deferred until withdrawal.
All withdrawals (including earnings) used to pay for qualified healthcare costs are free from federal taxes regardless of when they are made.
Dollars contributed to an HSA are both literally and psychologically compartmentalized for medical expenses.
The time and money employees spend on healthcare is often more efficient with an HSA. This seems intuitive because unlike an FSA, employees have ‘skin in the game’.
Employer contributions to their employees’ HSA accounts are exempt from FICA taxes. In 2020, the combined FICA rate is 7.65% which is not insignificant.
Offering an HSA plan further diversifies the benefit offerings for their employees.
For those with an employer-sponsored retirement plan and an HSA account, there is a hierarchy for where to best save one’s dollars. This hierarchy assumes the employee does not have significant debt and has also created an emergency savings fund.
First Priority: Take full advantage of the 401k employer match. Free money!
Second Priority: Maximize your HSA contributes and invest your dollars for the future.
Final Priority: If you have extra earnings, contribute the maximum to a 401k plan or a Roth IRA.
Here is an example scenario of the three-step hierarchy above:
Sophia’s employer matches 50% up to 6%. Melissa should contribute 6% to her 401k plan, and her employer will contribute 3%. Free money – check.
Next, Sophia should maximize her annual HSA contribution. Trifecta of tax savings – check!
Finally, Sophia can contribute additional funds to her 401k plan to maximize her annual contribution and/or contribute to a Roth IRA.
There are early withdrawal restrictions for Health Savings Accounts to ensure individuals are using their account for the intended purpose: paying for medical expenses. Specifically, HSA’s incur a 20% penalty and income tax on any amount withdrawn before age 65 that is not used for medical expenses. That said, an HSA account should be opened with the pure objective of saving and paying for inevitable health expenses throughout one’s life.
When you have your inevitable health care expenses, you can also pay out-of-pocket and keep the receipts for tracking your deductible. From a long-term growth and tax perspective, this may be advantageous if you have extra savings in your bank account.
Most HSA accounts have a minimum cash balance required. Once you have saved the minimum cash balance, the additional dollars can be invested. The investment strategy within your HSA account will vary depending on your financial landscape, but often the investment strategy is aligned with your other retirement accounts – like a 401k or an IRA.
It is absolutely imperative to acknowledge that HSA dollars should be spent on health and wellbeing as needed. As exciting and opportunistic it is to imagine a future tax-deferred balance, health today must be prioritized. We do not work in the health sector, but at Human Investing we have a team of financial advisors who are committed to ensuring your medical costs are accounted for in a strategic manner.
