There are a lot of ways you can save money for the future. Some of the most common include a traditional 401(k), Roth 401(k), traditional IRA (Individual Retirement Account), Roth IRA, HSA (Health Savings Account), and even “taxable” investment accounts. Whew!

So how should you prioritize your saving to be the most tax efficient? First, a few definitions:

Traditional 401(k) and traditional IRA: Both use pre-tax money (in most cases). This means you get a tax break now, but you have to pay ordinary income tax once you take the money out in retirement.

Roth 401(k) and Roth IRA: Both use after-tax money. This means you don’t get a tax break now, but assuming you follow all account rules correctly, earnings come out tax-free. 

Health Savings Account: You can only contribute to one of these if you have a “high-deductible” health care plan. A HSA offers triple-tax advantages: you get a tax break now since it uses pre-tax money; the money grows tax-free; and if you take the money out for qualified medical expenses, you don’t pay taxes. If you take the money out for non-qualified medical expenses after you’ve turned 65, the withdraw would be taxed as ordinary income (no additional 10% tax penalty).

Taxable investment accounts: These use after-tax money. But any long-term gains with these types of accounts are taxed at “capital gains” tax rates which are traditionally lower than ordinary income rates. There are no contribution limits or penalties for withdrawals. 

Ultimately, how you save really depends on what kind of traditional 401(k) you have:

If you get a company match with your traditional 401(k):

  • Save enough in your 401(k) to get your company match
  • Next, contribute to a Health Savings Account (if eligible)
  • If you have more to save, then divert money into a Roth 401(k) or Roth IRA (if eligible)
  • Then, save in a “taxable” investment account

If you don’t get a company match with your traditional 401(k):

  • First, contribute to a Health Savings Account (if eligible)
  • Next, divert money to a Roth 401(k) or Roth IRA (if eligible)
  • Contribute to your 401(k)
  • If you have more to save, put money in a “taxable” investment account

The Simply Money Point

Everyone’s situation is different, but these are Simply Money Advisors’ general guidelines. No matter what, you should try your best to spread out your tax burden among different types of accounts.

The best way to know how you should be saving is to get a financial plan from a trusted financial planner. We invite you to speak with our team about your specific situation.