One of my favorite things about the new year is the resetting of contribution limits to tax-advantaged accounts. Very heartwarming, I know. Just like how my favorite part of turning 18 was opening a bank account in my own name, but that’s a story for another day.
As I was trying to figure out how I would fund these accounts over the course of the year, it got me thinking about if there’s a logical order in which to save, just like how we use PEMDAS, the order of operations in math.
So given these assumptions:
- Matching > No Matching
- Tax-Advantaged Accounts > Regular Accounts
- Time in the Market > Timing the Market or Dollar Cost Averaging
- Income – Expenses > Sum of All Account Contribution Limits
This is the rule of THUMB that I came up with:
- Traditional (pre-tax) accounts: 401k, 403b, 457
- Unless no retirement plan at you or your spouse’s work: Traditional IRA
- Mega Backdoor Roth IRA
- Backdoor Roth IRA
Of course, any additional savings can go towards other savings goals like an emergency fund, a downpayment on a house, or post-tax accounts for retirement.
So why traditional accounts first? Any employer matching means free money that can further grow in the markets. After reading the argument that the Mad Fientist makes in favor of front loading with pre-tax money, I’m convinced that the potential for growth on top of guaranteed returns (through employer matching) beats almost every other argument. Of course if you’re in a situation where your work offers a match on your HSA, but not your 401k, then by all means max out the HSA first with its triple-tax advantage.
What about the unfortunate people that don’t have a retirement plan through work? That U is for you, because income restrictions for pre-tax contributions to Traditional IRAs don’t apply if you or your spouse (if married) don’t have a retirement plan through work. You can also ignore the other two letters since they won’t apply either.
And why the Mega Backdoor Roth IRA before the regular Backdoor Roth IRA? That’s because if it’s available to you at all, it’s only available through your employer. There’s always the chance that your employment situation might change in the middle of the year and that you lose access to this rare account. In addition, a Mega Backdoor Roth IRA can only be funded with deductions from your paycheck so the effective deadline for contributions is the end of the year, whereas a regular Backdoor Roth IRA can be funded until tax day of the following year. So don’t be sad that you didn’t strike the iron while it was hot!
This is not to say that you should feel bad if you don’t have access to some of these accounts or can’t max out the ones that you do have access to. I know that planning for and writing about this means that I’m privileged with both access to these accounts and the means to fund them. I know because I’ve had jobs without any tax-advantaged accounts or health insurance. I hope, regardless, that this information is useful in the future should you ever find yourself in the position to take advantage of these accounts.
That said, I’m curious to hear your thoughts on my personal rule of THUMB. Leave a comment and let me know what you think!