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Hey everyone, the SECURE Act took effect on January 1st and it is changing retirement. To help you understand the new tax law and learn how to use it to your advantage, my team is hosting a live webinar with attorney and retirement tax expert, Jamie Hopkins. To learn more and register, go to staywealthywebinar.com. That's www.staywealthywebinar.com.
Welcome to the Stay Wealthy Podcast. I'm your host, Taylor Schulte, and today I am sharing the order of operations for saving for retirement. Most people think the first stop for your hard-earned money should be your 401k or your IRA, but that's not always the case. And knowing exactly where to save your money first, second, third, and so on can make a really big difference in your long-term savings and your
and your tax bill in retirement. So if you've always wanted to know what accounts to contribute to first and the appropriate order, today's episode is for you. For all the links and resources mentioned today, head over to youstaywealthy.com forward slash 62.
Okay, with money coming in the door, it's important that we have a plan to save and invest it before we start to spend it. But as most of you know, not every savings and investment account is the same. There are different tax treatments, contribution limits, withdrawal rules, and so on.
If we want to maximize our wealth and reduce taxes, we want to make sure that our money is going into the right type of accounts, but also in the right order. So I've done all the hard work for you. I've narrowed it down to 10%.
options. You have 10 places that you can save and invest your money, and I've created this order of operations for you to follow. So let's just start with number one, and I promise you it's going to get better from here. You got to hang with me, but we have to start with the basics here. So number one, before you fund any investment or retirement account, and that includes your company 401k plan,
it's critical that you have an emergency fund in place and that should equal three to six months of living expenses. This is priority number one.
Since you're a listener of the show, you've likely heard me talk about this at length, so I'm going to spare you the lecture. But just a quick reminder that I highly recommend keeping your emergency account in an entirely different bank than your day-to-day checking or savings. We want to keep it out of sight, out of mind. We don't want to be tempted to borrow from it or spend it. I personally use an online bank called AdWords.
ally a LL why but there are a ton of other options out there and really the most important part is that it's a whole different bank so I'll link to a good resource in the show notes if you want to shop around a little bit and again you can find the show notes at you stay wealthy comm forward slash 62 so number one make sure you have that emergency fund in place and at a different bank
Okay. Number two, pay off debt. Paying off debt is a guaranteed investment return. If you have a credit card balance with an interest rate of say 15%, paying it off instantly gives you a guaranteed 15% rate of return. And you're not going to find that kind of certainty anywhere else. Now,
I've heard from a lot of our listeners over the show. You guys are super engaged. I love all the emails. And one thing that I know about you guys is that you're rockstar savers with really little to no debt except your home mortgage. And Paul, a recent listener, actually reached out and he asked me this question. He asked about, should I save additional dollars towards retirement versus working to pay down my mortgage?
I've covered this before, but let's revisit this again because it is really important. Here's the textbook answer to Paul's question about, should I save more for retirement or start to work on paying down my mortgage? So the textbook answer is, if your asset allocation for all of your investment and retirement accounts is 100% stocks, meaning you're taking the maximum amount of risk, then
then you should save additional dollars towards retirement and mortgage debt should not be the priority. That's assuming that your mortgage interest rate is a marketable rate.
If your asset allocation is not 100% stocks, meaning you own bonds in your portfolio, paying off your mortgage debt should be the priority. Yes, even if you have one of those 3%, 30-year fixed awesome home loans, if you own some bonds in your portfolio along with stocks, so if you have a mix of bonds and stocks,
your mortgage debt should be the priority. And this is really a question about risk. A lot of people look at this from a rate of return or a low interest rate, but it's really a question about risk. If you're not comfortable with owning 100% stocks and swinging for the fences and taking a lot of risk, then you really shouldn't be comfortable with taking out a loan on your house and
i.e. leverage to invest money. That's really risky. And if you own bonds in your investment accounts, that tells me that you're not really a super risky investor.
Michael Kitsis puts it best, and I'll link to his article in the show notes. He says, financial planners never tell clients to take out a loan to contribute to a retirement plan, yet they willingly tell clients to contribute to a 401k plan instead of paying down a mortgage, despite the fact that it's comparable when looking at the entire balance sheet.
So again, I'll link to his full article in the show notes. But in summary, unless you're 100% stocks in all of your investment and retirement accounts, mortgage debt really should be the priority. All right, number three.
With an emergency savings account in place and an action plan for your debt, the next step is to go out and get the match on your company retirement account. And a company retirement account would be a 401k, 403b, 457, or even a simple IRA. And
These days, most employers offer some sort of match up to a certain percentage of your salary, which is essentially free money. So before you go fill up any other investment or retirement accounts, I just want you to go and get your free company match. You're not going to contribute any more than that. You're just going to contribute just enough to get your company match and
And then before adding additional dollars, we're going to go to step number four. So again, step number three, go get your company match. As soon as you have that emergency savings account in place, an action plan for your debt, you're going to go and get that company match. And then we're going to go to step number four, which is to max out your HSA. So number four is to go max out that health savings account. And don't get this confused with the FSA, which is a flexible spending account. So
The HSA, a health savings account, is what John in my office calls the magical unicorn. And he calls it this because it's the only account that's triple tax-free if you use it properly. And this is why we want to fund this account first before maxing out any other retirement buckets. You get a tax deduction when you put money in. Awesome. It grows tax-deferred just like an IRA or a 401k.
And then you get to take it out tax-free to pay for qualified medical expenses. Now, to qualify for an HSA, you must be enrolled in what's called a high-deductible health plan.
If you're in a high deductible plan, be sure to go and max out that HSA before going any further, before putting any more money in any type of retirement account. We want to take advantage of this magical unicorn. Now, if you're not enrolled in a high deductible plan, you might consider switching over to one when open enrollment is open later this year. But you
Using a high deductible plan does require you to be a good saver and in really good control of your cash flow. So not everybody is a good candidate for a high deductible plan. You need to understand all of the nuances before jumping in. Talk to your trusted advisors. This is my disclosure. Talk to your CPA. Talk to your financial advisor. Make sure you really understand what a high deductible plan is before doing it.
Lastly, remember that we want to contribute to the HSA and then invest that money and let it grow. A lot of people spend that money each year on qualified medical expenses, but we don't want to do that. We actually just want to contribute, invest, and let it grow and compound without taxes for as long as possible.
A little known trick, and I've mentioned it before, but you can save your qualified medical receipts along the way while you're a working professional. Let that HSA grow and compound and then apply those old medical expenses to your HSA dollars in the future. So again, contribute to the HSA, max it out, invest that money, and don't
Touch it, let it grow tax deferred for as long as possible. Save all of those receipts. You can just use a Dropbox folder or Google Drive, whatever you use, just have a dedicated place for all of those receipts along the way. Let that account grow over a long period of time and then you can apply those expenses in the future or in retirement, you're probably gonna have qualified medical expenses and you can use your HSA then. So really magical. If you're not taking advantage of it, I highly, highly recommend doing that.
Step number five, with the HSA maxed out, your next step before doing anything else is to take advantage of your company's ESPP or employer stock purchase plan. If you don't have one, you'll just ignore me for a couple minutes here and you're just going to skip straight to step number six.
But if you do have one, I want you to take advantage of this before doing anything else. And here's what you're going to do. You're going to buy your company stock at a discount and then you're going to immediately sell it. We all know that financial planning 101 says don't put all your eggs in one basket. When you buy company stock, both your paycheck
and your investments are now dependent on the same company. We don't like that, that's not good. So reduce your risk and profit from the ESPP by buying the stock at the discount that you get, immediately sell it, and then diversify the proceeds into a low cost portfolio of stocks and bonds.
Remember, anything can happen, even to reputable blue chip, large cap companies. Just remember what happened to General Electric back in 2017, 2018. The stock was down almost 80%. One of these companies we all know by name, blue chip company, could anything really happen? It was down 80% from top to bottom. There's a lot of employees who had
all their wealth tied up in GE stock, thinking that they were invincible. And they have to start over with their retirement savings. Not too long ago, Amazon stock was down 95% from top to bottom. So anything can happen. It's not worth the risk, but the ESPP is a good deal if you use it properly. Buy it at a discount, immediately sell it, reinvest the proceeds into a low-cost portfolio of stocks and bonds.
All right, step number six, with one through five out of the way, it's now time to circle back to your workplace retirement plan and contribute the maximum amount allowed. Remember, your workplace retirement plan is that 401k, 403b, 457, or even a simple IRA.
And in 2020, if you're under the age of 50, you can contribute $19,500 to your 401k, 403b. The simple IRA is different. So just push that aside for a minute. But in 2020, if you're under 50, remember the limits went up. You can contribute $19,500. If you're over 50 or if you're 50 or over, you can contribute $26,000. Okay.
There's one exception to contributing the maximum dollar amount to your workplace retirement plan, which is to do so only if you're sure the expenses on the investments in that account are reasonable. Remember, in these company 401K plans, they usually give you a menu of funds that you can choose from, and we want to make sure that those funds are low cost. If they're high cost funds, we actually may want to skip putting more money into our workplace retirement account.
To me, a low-cost investment means having underlying fees. These are also called the expense ratios. An expense ratio less than half of a percent or 50 basis points.
Your employer is required to give you the expense ratio information on every single investment inside your 401k plan, 403b, 457, so on. But you can also take each ticker symbol and you can go and punch it into Morningstar.com and you can find it yourself. So no excuses here. We want to make sure that the funds that we're investing in are low cost. Again, which means half of a percent or less as the expense ratio.
If the expense ratios are higher than that, you may want to skip maxing out your company plan and go to step number seven. And maybe you'll work through this whole list of steps and you could circle back at that point. But we want to make sure that we're not getting sucked into these high cost investments.
Remember, you still want to get that free money that I talked about in step number three. You still want to get that company match, but if you have really high cost investments, a lot of 403B plans are riddled with annuities and really high cost stuff. You may just not want to add additional dollars above and beyond that match that you might be getting.
One common question I get around this is if I'm eligible for a Roth IRA, why wouldn't I go and max that out first? And there's really two reasons for this. And this is just personal opinion here, not a recommendation. There's some different schools of thought, but two reasons here. Number one, in an employer plan like a 401k, you can save a lot more money than you can in a traditional or a Roth IRA.
Number two, when you use your workplace company retirement plan to save money, you're taking advantage of automation. Money goes into the account directly from your paycheck and you never have a chance to spend it.
There's plenty of studies out there that have shown that automation actually helps people save more money. If you want to learn more about that, maybe the best place to go is Richard Thaler's book called Nudge. And I'll be sure to link to that in the show notes. But automation can be really powerful. The Roth IRA is great, but there's more work to do on your end. There's some manual stuff that you have to do. It's not as easy.
So those are the two reasons why I say, if you have low cost investments in that company plan, go max that out before doing anything else. But speaking of the Roth IRA, let's go to number seven, which is once your company plan is maxed out, you've taken advantage of the match. You've got that ESPP under your belt, that emergency savings account. You've got all that stuff done. Number seven is to go max out that Roth IRA in 2020. Okay.
You can contribute $6,000 to a Roth IRA if you're under the age of 50 and $7,000 if you're 50 or older. If you earn too much money to contribute to a Roth IRA, then you can just consider doing the backdoor Roth IRA technique. Now, the backdoor Roth IRA contributions only work when you don't have money in a traditional IRA, a SEP IRA, or simple IRA.
And there are a lot of nuances around the backdoor Roth IRA technique. So be sure that you understand exactly what it is, how it works for you. And I highly recommend checking with your CPA and trusted advisors to make sure that you don't make any mistakes with it. But just because you're a high earner and you're not eligible to go directly to a Roth IRA doesn't mean you're out of luck here. Again, you can consider the backdoor Roth IRA technique.
One common misconception that I've attempted to clear up before is you can still contribute to a Roth IRA or traditional IRA even if you participate in your company retirement plan. You may not get a tax deduction for the contribution, but your money still grows tax deferred, which I've talked about before, is really powerful.
So, don't let that trip you up. If you're contributing to your 401 , you can still contribute to an IRA, Roth IRA or traditional IRA. Again, you may not get the tax deduction, but it's still a great way to save money tax deferred. Also, if you're married, you will want to make sure that you have your spouse max out his or her Roth IRA as well. Even if they don't work and earn income, they can still take advantage of this if you're working and earning income.
Again, if income is too high, you're not eligible for the Roth IRA. You can again consider the backdoor Roth IRA for your spouse or at the very least make what's called non-deductible IRA contributions. Now that's a lot. I just want to just in summary, just say, we just want to max out those IRAs for you and your spouse. There's a way to do it. You got to figure out the right way for you and your tax situation and income and all that. Just know that step number seven is to go fully fund your spouse.
your IRAs, Roth or traditional, before moving to step number eight.
Be sure you and your spouse have maxed it out, whatever's going to work for you guys. And remember that's $6,000 or $7,000 per year, depending on your age, which means an additional 12,000 or $14,000 in savings per year if you're married. So not something just to gloss over. Again, tax deferred, that money compounding for 10, 20, 30 years, wherever you're at is really, really important.
All right. Number eight, number eight is to go and make after tax contributions to your workplace retirement account. So we're going back to that workplace retirement account. Again, a workplace retirement account is that 401k, 403b, a 457. Here's the thing, not
all employers allow for after tax contributions. So you're going to have to contact your HR department, benefits department to find out. You can ask them directly or I actually recommend asking for a copy of what's called your summary plan description. And it's usually a 30 page PDF and it'll contain all
all the information about your retirement plan, everything that you need to know. And you might find some other stuff in there as well. That's why I suggest going and getting that document because it'll not only answer this question, but it might answer a lot more and give you a glimpse into what your company actually offers.
What most people don't realize here is that the IRS limit for employer workplace retirement accounts is actually $57,000 this year. It's not that $19,500 or $26,000 that I mentioned earlier.
But to get to the $57,000, your company has to allow for after-tax contributions. And again, not all of them do. We're seeing it more and more. If your company doesn't offer it, maybe go and bring it up to them and see if it's something that they're willing to add. This strategy, you might have heard me talk about it before, is also referred to as the mega backdoor Roth. And I'll just go ahead and link to a great resource in the show notes if you want to learn more about
Don't forget, I still want you to keep an eye on those expense ratios. If your company plan is filled with just high cost, really bad investments, then you might just skip these after-tax contributions. Remember, we don't want to let the tax tail wag the investment dog. We don't want to invest in a bad investment just for a little bit of a tax break. That doesn't really make sense.
And again, you might also contact your benefits department here. If your plan is riddled with high cost investments, go to your benefits department, go to your HR director and see if they'd be willing to reshop your plan to find some lower cost investments. And if you have a good relationship with them, maybe just remind them of their fiduciary obligations as the employer here, because there are some really good plans out there, some really good low cost plans.
Number nine, my second to last recommendation here with all these other buckets full is to fund a 457F deferred compensation plan. Now, some of you might not have this, but if you do, you might be wondering why I put this so low on the list.
I put it at number nine because these plans do not offer creditor protection. This makes them way more risky than any of the other accounts we already addressed. Without creditor protection, any money in a deferred compensation plan could be lost if your company goes bankrupt. And again, we talked about some of these other companies a few minutes ago. Nobody's invincible.
So contributing to a 457F plan usually only makes sense when an investor already has enough retirement savings. They've already filled up all of those other buckets. They're highly paid executive and they want to continue to lower their tax bill. That's where the 457F comes in.
And I'll mention it one more time. Keep your eye on the expense ratios before just plowing your money into these plans. If they're high cost investments, you may consider just skipping it to step number 10, which is...
With everything else fully funded, you've done everything. The last thing that you can do if you have extra money above and beyond your current cash flow and you want to pile more money away for retirement or your long-term goals, I would recommend just using a standard program.
brokerage account. We refer to this as a taxable investment account. We call it a taxable investment account because every year you do pay taxes on interest and dividends earned. You also pay taxes if you realize capital gains in a given year. So it's a taxable account. It's not tax deferred like an IRA or a 401k.
But it is a good way to save money. And it's better than putting money into insurance products and other things with high fees. You can use this taxable investment account. I recommend, and most custodians, you can rename these accounts. And if it truly is a long-term bucket for retirement, I would rename this account taxable retirement savings and look at it like another retirement account.
In this account, you'll invest in low cost index funds. You can just use a simple kind of set it and forget it investment approach. This will help you to mitigate taxes and also maximize growth over a long period of time. If you build up a healthy amount of dollars in this taxable investment account and it's earmarked for retirement or some sort of long term goal 10 plus years away, you can also start to take advantage of asset location.
At the most basic level, asset location means holding your bonds in retirement accounts like your 401k and stocks in your taxable investment account or that brokerage account I just talked about.
You're going to likely need some software or some really good Excel skills here to make sure that your global asset allocation, your asset allocation across all accounts remains in line when you do this and take advantage of asset location. I'll link to just a really good resource in the show notes. If you do have a good amount of money in taxable investment accounts, I'll link to a resource and you might want to learn more about asset location. Not to be confused with asset allocation. This is asset location.
Lastly, before I let you go, I just want to warn you against getting sucked into these expensive tax advantage investment schemes like whole life insurance, permanent life, universal life, and a lot of the annuities that are out there.
There is a place for these products, but it's for a tiny fraction of the population. And I would just recommend tackling steps one through 10, unless you have a really unique situation that calls from one of these out of the gates. But I would, for most people, tackling steps one through 10 is going to be your priority before you go out and try to figure out if one of these expensive insurance products really does make sense for your situation.
And one more reminder, again, if you're interested in the Secure Act webinar that we're doing with attorney and retirement tax expert, Jamie Hopkins, head over to staywealthywebinar.com. That's staywealthywebinar.com. I hope to see you there. Thank you all for listening. And if I don't see you at the webinar, I'll see you back here in two weeks.
Hey, it's me again. I just wanted to say thank you one more time for listening and remind you to please, please, please leave a quick review. If you're on an iPhone, leave a quick review on iTunes. If you're enjoying the show, I'm getting great feedback from listeners just like you. And I really want to keep the momentum going. So if you have a chance on your iPhone, leave a quick review on the Apple podcast app. And thank you so much in advance for all of your help and support.
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