You’ve maxed your company 401(k) match. Now what? Where exactly should you direct your savings? Christine Benz has a short but useful Morningstar article called A Hierarchy for Retirement Savings. The structure reminds me a bit of the Personal Finance Flowchart from Reddit.
The best part of the article is that they explain the exceptions, or at least reasons for de-prioritization, in a clear and concise manner. These exceptions may be uncommon, but they are important to know. I recommend reading the entire article, but here are some quick notes.
- 401(k) up to the match. Exception: You may not have a match.
- IRA up to the limit (plus Spousal IRA). Exception: Your 401(k) may be so awesome it’s good enough. 401ks also have better asset protection.
- 401(k) up to the “normal” limit. Exception: In some limited cases near retirement, the benefits don’t outweigh the restrictions.
- Health Savings Account (HSA) up to the limit. Exception: You may not be eligible for an HSA.
- Additional after-tax 401(k) contributions to the “full” deductible limit, if allowed. (AKA “Mega Backdoor Roth”). Exception: Your plan may not offer additional after-tax contributions (only about 1/4 do), or your plan is otherwise extra bad.
- Taxable brokerage account. The default if nothing else is better.
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This isn’t bad, but it needs to be more specific in a few ways:
– To minimize the need for later Roth conversions, put all IRA money into a Roth account. The IRA cap is small so max out a Roth (after tax money). The entry (“Stop 2”) is not explicit enough about the future value of Roth accounts.
– One can sometimes withdraw the entire balance of a 401K if retiring at age 55 or later, and thereby get around the age 59.5 withdrawal rule (i.e., the “Rule of 55”). As such, there’s logic to building 401K to max after filling up the Roth IRA if you plan to retire early.
– Following from the prior item, put enough money in pre-tax accounts to cover the period between age 55 early retirement versus collecting social security (as late as age 70) and the start of Required Minimum Distributions (RMDs) at 75. Pre-tax money should be spent down upon retirement to avoid quirky (and higher) social security taxes too. There are often several good reasons to delay social security, if financially possible.
– I don’t think that there’s a compelling reason to make after-tax 401k contributions over building the balance of a taxable account (Stops #5 versus #6). If you don’t have a taxable account at all, build it to a reasonable size first. This is because a regular brokerage/taxable account is maximally flexible and it facilitates big life changes regardless of retirement status. No age lock ups; facilitates the use of (lower) capital gain taxation rules.
HSA should be priority #2, right after the 401k match (provided you are eligible, of course). Much better tax treatment than IRA and generally easier to withdraw if needed. That is a pretty big miss from the “expert” article.