When I first started on my path to FIRE, I had lots and lots of questions. One of them was where to put my money and in what order? I am not a teacher or government employee so what I have available to me are my 401k, IRAs, savings and brokerage accounts.
So how much money and into what bucket ? Lets take a look at the features of each type of account.
The order in which you fill these buckets is dependent on your own circumstances, but general wisdom is the following:
- 401k match
- Debt elimination
- 401k Maximum
- Savings and brokerage Accounts
Common wisdom dictates that one should at least get the entire company match (if a match is offered) as a minimum. That is free money and it is foolish to leave that on the table. Money put into this account is pre-tax, lowering your tax burden. Because of my salary, I needed this to reduce the size of the check I had to write the IRS on tax day.
Depending on the debt, sometimes this is step 1 but for Cat and I this was step 2. The debt we had once we sold our house was vehicle and student loans only, and we were able to clear the student loan debt with the proceeds from the house sale. If you are plagued with high interest debt, then a Dave Ramsey like debt snowball might be appropriate first. This of course does not include the mortgage.
If you are eligible for an HSA, you should have one. The HSA is the perfect savings account as it takes pre tax money, reducing your tax burden to the feds. It also grows tax free and you can withdraw from it tax free. The catch here, and of course there always is one, is that the amount you can put into an HSA is limited per year. Sadly I don’t qualify for one, but if I did, even at this late stage in the FIRE game, I would still contribute.
I actually did this at step 1 and went straight for the maximum, due to time, which probably slowed down my debt payments, but I wanted to get my taxes lowered. After getting the debts eliminated, pushing your 401k to the max is the next step. If you are over 50 as Cat and I am, don’t forget your top up amounts. I am preparing for 2020 and I believe including the top up, our max contributions are $25k each. That is $50k combined that Cat and I are not paying tax on and will grow tax free. We only pay tax on the money when we withdraw it and we have strategies for that.
Neither Cat nor I qualify for pre tax IRA contributions. However what we can do is a post tax contribution to a traditional IRA and roll that into a Roth IRA. The cap on this is $7k including the top up amount each. This is $14k/yr with tax free growth and no tax payable when we withdraw the money at retirement. I will add that due to our ages, we do not need a Roth IRA ladder as we both intend to be retired at about 60 and therefore incur none of the penalties that early retirees do.
Savings and Brokerage Accounts
This is where all the remaining post tax money will go. I had a brokerage account and a High Yield Savings Account (HYSA) but closed the HYSA as the interest (~2%) wasn’t worth it. I just run a brokerage account now. My emergency funds are now in bonds and all other savings go into low cost index funds. Usually total market or S&P500. This money is taxed when it goes in, taxed during its growth and taxed when withdrawn, however it is still an important part of the savings strategy. All the other accounts are capped and while they perform well, there is a strong argument for the use of a brokerage account to save a considerable sum especially for the early retirees who may need to rely on this money while still working their Roth ladders etc
Please note this is not a one size fits all approach to savings. I am not a financial adviser and your situation will be different than the situation Cat and I were in when we started this savings plan. However this is a general guideline that can be used as the basis for your own plan.