We work with many clients that have high incomes. A common conversation we have is about what accounts to save into first. Here's our priority of savings accounts:
1) 401K
This can be a work 401(k) or if you're self-employed, you can do an Individual 401(k). (Really any work retirement plan is usually the first account we want to save into: SIMPLE IRA, SEP IRA, etc)
Work 401(k)s offer powerful tax deferral and high contribution limits giving you substantial opportunity to save for the future. (For 2024 this annual limit is $23,500).
A lot of employer sponsored 401(k)s also have a match. This is free money…who wouldn’t take free money?
2) HSA
The next account I like is the HSA or Health Savings Account. Not everyone is eligible, so be sure to check the rules on your eligibility.
If you can contribute, an HSA offers triple tax savings.
This means you get to deduct contributions into the HSA,saving you on taxes upfront.
Dividends and gains aren't taxed, so no increase to your annual tax bill.
Withdrawals are tax-free if you have qualified health expenses,so no tax on withdrawals. (The list of qualified health expenses is very broad.)
You can invest the money in a wide range of stocks, ETFs, or mutual funds so there is potential for growth as well.
The next is sort of a toss up between a Roth IRA and a brokerage account. But I give a slight edge to the brokerage account.
3) Brokerage account
Unlimited contribution amount and more accessibility/liquidity.
You can put as much as you want into a brokerage account, and if you withdraw money you only pay tax on the gains. This accessibility is attractive. Many clients want the ability to tap some money for investment opportunities, or random high expense items like AC units or a roof.
4) Roth IRA
I also consider a Roth IRA here. Roth IRA's offer tax-free growth on the earnings, some accessibility, just limited.
With a Roth IRA you can withdraw your contributions at any time without tax or penalty. But the contribution amount is limited - only $7,000 for 2024.
To withdraw gains tax-free you need to satisfy the rules:
Account opened at least 5 years
Reached age 59.5
5) 529
Not for everybody but I would put 529 accounts. Most clients we see with kids are going to help or pay for school costs somehow, so putting into a 529 saves them on state taxes and allows for tax free growth in the 529. If we're going to pay for it, why not get tax savings and tax free growth?
All of these I would call very common. A few more worth mentioning that we don’t rely on too much:
Cash Balance Plan
For our highest earners we can turn to a Cash Balance Plan. This is a form of pension plan through an employer. (Most often we see this with self-employed business owners.)
Cash balance plans allow a business owner to contribute money into the plan and write that off on taxes as a retirement plan contribution. The money gets taxed later when the individual/employee takes it out (ideally at a lower tax rate).
The downside is that as a pension plan, there are strict rules. Employers are required to keep it ‘funded’ via a set formula, which can lead to annual contributions. There are more recordkeeping requirements too.
Life Insurance or Annuity
I'm sure there are some advisors who could make an argument for an annuity or a life insurance policy here, but I'm personally not a huge fan of insurance products as a savings tool. In a future blog post I’ll dive into why I'm not a huge fan of these products as savings tools.
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