Editor's Note: This story originally appeared on Boldin.
Save, save, save! You may feel like that’s all you hear when you’re researching how to plan for your retirement while you are still working.
It’s good, simple advice, but there is so much more to savings than to “just save more”. What accounts should you save to? What are the benefits of saving to one vs. the other? What tax implications should you be aware of? How much should you be saving?
In order to optimize your savings while you are still in the accumulation phase (i.e., working and still contributing to your investments), it’s essential to think through these types of questions so you can have the best plan tailored to your unique financial situation.
1. Build a Strong Financial Foundation
Before we dive deeper into optimizing your savings, it’s essential that you have a solid financial foundation in place. Although these suggestions may seem as basic as ABC, your personal finances are off to a strong start if you can check these three items off your list.
A) Maintain a stash of emergency savings: This might surprise you, but before you save for retirement, you should build up a stash of emergency savings. Emergency savings are the foundation of financial security. An emergency fund, money typically held in easily accessible accounts like a high-yield online savings account or money market fund, is essential for dealing with unanticipated expenses.
B) Get the FREE money, capture employer match: Employer match refers to a benefit offered by some employers wherein they contribute a certain amount of money to their employees’ retirement savings plans. The employer typically matches a percentage of the employee’s contributions, up to a certain limit. Employer match is essentially free money.
C) Pay off high-interest debts: Wait, paying off debt isn’t saving. True, but if you have emergency savings and are capturing employer match, your next priority really should be paying off high-interest debt. When you’re investing in the stock market, nothing is a guarantee. Meanwhile, paying off high-interest rate debt is a guaranteed investment return.
2. Save and Invest
It isn’t enough to just save. For everything but your emergency savings (which should be held in a liquid or easily accessible account), you will want to invest.
Investing allows you to take advantage of compounding returns. Your money will grow without any additional work from yourself.
3. Consider Following the Savings Playbook
Look, there is a lot to consider when it comes to saving. You have competing goals. To make it simple, start with the ABCs listed previously and then proceed to knock off other savings goals.
- Build an emergency fund
- Capture employer match
- Pay down high interest debt
- Contribute max to a health savings account (HSA)
- Contribute max to an IRA (evaluate the merits of Roth or traditional contributions in your own personal situation)
- Contribute max to employer plan
- Contribute to an after-tax account or 529 account
- Pay off low interest debt
4. Have a Solid Idea of How Much Retirement Savings You’ll Need
You’ve likely encountered various rules of thumb regarding retirement savings and needs, such as saving 15% to 20% of your gross income or amassing 25 times your planned annual spending.
The rules of thumb are great starting points and simplify whether you are on track or not. But to answer the question for yourself, it pays to dig deeper.
There’s so many different variables to consider based on your unique situation, such as when you started saving, your spending habits, and your investment mix.
5. Automate Your Savings
Automating savings refers to the practice of setting up automatic transfers or contributions from your paycheck into your savings accounts. Automating your savings is a good idea because it ensures:
Consistency: By automating your savings, you ensure a regular savings habit, making it easier to achieve your financial goals over time.
Discipline: Automation removes the temptation to spend the money earmarked for savings. Since the funds are transferred automatically before you have a chance to spend them, you’re less likely to dip into your savings for discretionary expenses.
Goal achievement: Regular contributions add up over time, helping you reach your targets faster.
6. Take Advantage of Different Tax Buckets
Now that we have the basics out of the way, it’s time to delve deeper into the many different types of accounts you may have access to as part of your retirement savings.
A) Know your tax buckets: You can think of taxable, tax-deferred and tax-exempt accounts as three tax buckets:
- Taxable accounts: Taxable accounts may include individual and joint brokerage accounts or trusts and do not have specific tax advantages. The money you put into a taxable account is after-tax money.
- Tax-deferred accounts: Tax-deferred accounts include traditional IRAs, 401(k)s and more. These savings vehicles give you immediate tax advantages. They are funded with pre-tax money.
- Tax-exempt accounts: Tax-exempt accounts include Roth IRAs, Roth 401(k)s, and others. These accounts give you future tax advantages. They are funded with after-tax money, meaning money you have paid taxes on.
B) Diversity across taxable, tax-deferred and tax-exempt accounts: Of course, taxes are always important to keep in mind when you are making decisions about optimizing your savings. Maintaining a diversified portfolio of taxable, tax-deferred and tax-exempt accounts provides flexibility in how your withdrawals are taxed during retirement.
7. Get Triple-Tax Advantages With an HSA
Once you have a fully funded emergency fund, paid off costly high-interest debt, and are taking advantage of your employer match, a health savings account may be your next best option to optimize your retirement savings.
HSAs offer a triple tax advantage: contributions are tax-deductible, growth is tax-free, and withdrawals for qualified medical expenses are tax-free.
If you treat it as a retirement investment vehicle rather than a spending account, it can become a powerful tool for covering healthcare costs in retirement.
8. Know Whether to Save in Pre-Tax or Roth
Deciding between traditional (pre-tax) and Roth accounts is a critical tax planning decision.
- Contribute on a pre-tax basis: If you believe you will be in a lower tax bracket when withdrawing money in retirement versus now.
- Contribute on a Roth basis: If you believe you will be in a higher tax bracket when withdrawing money in retirement versus now.
Given we don’t know what the future holds exactly for tax legislation, brackets and rates, deciding whether it makes sense to make pre-tax or Roth contributions can be difficult. However, it doesn’t have to be an either/or decision.
You can do both, as well (assuming your plan permits Roth contributions).
9. Consider After-Tax Contributions
Your employer plan may also offer the ability to make after-tax contributions. Generally, after-tax contributions are a consideration after maxing out your pre-tax and/or Roth contributions for the year.
With money in an after-tax account, your plan may also permit you to take advantage of a mega backdoor Roth strategy.
A mega backdoor Roth strategy is when, after making after-tax contributions, you convert the contributions immediately to a Roth 401(k) or Roth IRA. This way, both the after-tax contributions and the earnings would be tax-free in retirement.
10. Max Your Savings Outside of Your Employer
Not all of your retirement savings have to be through your employer plans. Along with an employer retirement plan or HSA, you may also have an IRA or taxable brokerage account that can play a significant role in your annual savings plan.
Traditional IRA: When you make a contribution to a traditional IRA, you have the potential to receive a tax deduction on your contribution, your money grows tax-deferred, and distributions from the account will be hit with ordinary income tax.
Roth IRA: When you make a contribution to a Roth IRA, you are putting money into the account after paying income tax on it, and then those dollars grow tax-free and can be withdrawn tax-free.
11. Consider a Backdoor Roth IRA Strategy
If you earn too much to contribute directly to a Roth IRA, given the income limits, you may consider a backdoor Roth IRA strategy.
This involves making a non-deductible Traditional IRA contribution and then making a subsequent conversion to a Roth IRA account.
However, before considering this strategy, you’ll want to be aware of the IRS’ pro-rata rule. This rule requires you to consider all of your IRAs as the same account.
Therefore, if you have a Traditional IRA, SIMPLE IRA or SEP IRA, those balances are considered when it comes to determining your tax owed on the conversion.
12. Build and Maintain a Holistic Financial Plan
It is likely that you try to eat well, exercise regularly, socialize with friends, and work, read books, or engage in other activities that keep your brain working well. These are all activities related to wellness.
But, do you also have habits and a practice around your financial life? Personal finance is a critical component of your overall wellbeing. Building and maintaining a personal financial plan for all aspects of your money is a great first step to taking control of your financial life.
Use the Boldin Retirement Planner to take control and build the habits you need for better financial decisions, confidence, security, and peace of mind.
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