You can save up to $83,900 in retirement accounts each year.
| 401k | HSA | IRA | Total |
|---|---|---|---|
| $72,000 | $4,400 | $7,500 | $83,900 |
Most people should use tax-advantaged accounts before putting long-term retirement money in a taxable brokerage account. A 401k, HSA, and IRA each reduce taxes in different ways: some lower taxable income now, some shield investment growth from yearly taxes, and some can allow tax-free qualified withdrawals later. The result is that more of your money stays invested and compounds for you.
Most people earn more and pay a higher marginal tax rate in their working years than in retirement. By deferring income tax during high-earning years and instead paying it during retirement at a lower tax rate, you can save more money.
In taxable investment accounts, you pay capital gains taxes when you sell stocks, and you pay income tax rates on most dividends. Most retirement accounts don't incur taxes on sales or dividends of investments.
There are some situations in which you don't have to pay tax at all on income used to pay for certain health expenses. We'll take a look at some of these cases in the HSA section.
A 401k is a tax-advantaged retirement account managed by your employer. Many people are familiar with the popular pre-tax 401k, but not many people know about the mega backdoor Roth process, which allows you to save up to $72,000 a year total across Roth and Traditional 401k.
In a regular pre-tax 401k, you can contribute up to $24,500each year. With your employer's contribution of $0, you'll be able to contribute an additional $47,500 via the mega backdoor Roth process.
Two savers earn the same salary and end up with the same spendable cash after saving. One contributes to a traditional 401k. The other invests only the after-tax equivalent in a taxable brokerage account. The 401k investor starts with more money invested because the contribution goes in before income tax. That structure also avoids annual income tax on gains inside the account until distribution. Over long periods, those two advantages can outweigh the taxes owed later.
HSAs are tax-advantaged retirement accounts that help people save for medical expenses that high-deductible healthcare plans (HDHP) don't cover. You have to be covered under an HDHP to contribute to a HSA, but it is one of the most tax advantaged accounts available. Unfortunately, the benefits of HSAs don't apply to state taxes in California and New Jersey, but they still retain their benefits for federal taxes in those states.
HSAs are commonly used to pay for qualified health expenses in the year they occur. The hack is that there is no time limit on when expenses occur and when you can withdraw that money tax free.
That means you can pay for your health expense with after-tax money, leave the money in the HSA to continue to grow tax-free, keep the receipt, and then in retirement, you can use those receipts to withdraw from your HSA tax-free. This strategy maximizes the amount of your money you keep in tax-advantaged accounts.
IRAs are tax-advantaged retirement accounts managed by individuals. There are two types of IRAs: Traditional and Roth. You can contribute up to $7,500 a year to an IRA and an additional $1,100 if you are 50 or older. If you are married, you can generally contribute up to $15,000 between both of you before catch-up contributions.
An advantage of a Traditional IRA is that contributions may be tax-deductible, but there is an income limit to who can take advantage. Similarly, there are income limits to who can directly contribute to Roth IRAs.
If your income is greater than the Roth limit, you can still use a Backdoor Roth process. The Backdoor roth is a process that allows anybody to contribute to a Roth IRA regardless of income.