This guide will walk you through the best places to put your money. Following this can lead to massive tax savings and help protect you during down markets.
1. Emergency Fund
An emergency fund is money set aside for unexpected expenses. Some common examples include loss of income, expensive car repair, medical bills, or home repair.
How much cash should you stash? I recommend having 3-6 months of living expenses set aside in your bank account. For example, if your expenses are $5,000 a month, you would have $15,000- $30,000 set aside.
Be careful having too much in your emergency fund. Most banks pay next to nothing in interest and your money would be better invested elsewhere.
2. HSA (Health Savings Account) Match
Make sure to take advantage of your match if it is offered by your employer.
Health Savings Accounts are one of the best accounts to avoid taxes. They have the potential to be triple tax advantaged.
- Tax deduction when you put money in
- Tax deferred growth of your investments
- Tax-free withdrawals when used for medical expenses
Qualified medical expenses may include medical, dental, vision and more (full list here). To qualify for an HSA, you must be enrolled in a High Deductible Health Plan.
If you are fortunate enough to not use all of your HSA for medical expenses, once you’re 65, you can take penalty free distributions for any reason. However, to be tax-free and penalty-free the distribution must be for a qualified medical expense.
3. Defined Contribution Match
A defined contribution plan is typically a tax deferred account like a 401(k), 403(b), 457(b) or SIMPLE IRA.
Do you like free money? If so, some companies offer a match on contributions to their retirement plans.
For example, your employer offers a dollar for dollar match up to 5% of your salary. If you make $100,000 and contribute $5,000 into your company 401(k), your employer will add another $5,000.
Whatever match you get, contribute enough to get the full benefit.
4. Pay Down High Interest Debt
Next up, it’s a good idea to pay off your debt with interest greater than 5.75%. Common types of high interest debt could be student loans or credit cards.
Paying off your debt is a guaranteed investment return. Meaning when you put cash towards debt, your return is equal to the interest rate on the debt.
For example, let’s say you are carrying a credit card balance with 18% interest. If you use cash to pay down the debt, you are earning an 18% investment return.
You will never find a guaranteed 18% investment return in stocks, real estate, crypto, etc. That’s one of the reasons why it’s a smart choice to pay off high interest debt before investing further.
For more ideas on how to consolidate your debt, check out my previous post.
5. Additional HSA (Health Savings Account)
The max HSA contribution for 2021 is $3,600 for an individual and $7,200 for families. The catch-up contribution for those 55 older is an additional $1,000.
6. Additional Defined Contribution Savings
The current and future contribution limits are listed below.
7. Pay Down Lower Interest Loans
The remainder of the list is interchangeable. These decisions are more driven by personality and personal circumstances.
Some individuals prefer not to have any debt. And I have no problem with people paying off their mortgage early (or other debt with interest below 5.75%)
On the other hand, interest rates are extremely low. If you are comfortable holding debt, your money may be better invested elsewhere. Only do this if you believe your investments can return excess of your current interest rate.
8. IRA
Contributing to a Traditional IRA and Roth IRAs are another great option for retirement savings.
Generally, I recommend maxing out your Roth IRA first because of the tax-free withdrawals after 59 ½ and the ability to take out contributions at any time without a penalty.
Contribution limits for IRAs are listed in the chart above ($6,000 for 2021). For IRAs, you can make 2021 contributions up to the tax deadline (April 15th, 2022).
9. Taxable Account
This is a non-retirement account that is funded with after tax money.
It’s a general-purpose account with a wide degree of flexibility and no special restrictions or tax advantages. If you want to invest but know you may need money from the account short term, a taxable account is worth looking into.
George Maroudas
847-550-6100
george@pmgwealth.com
Twitter @ChicagoAdvisor
Disclaimers and Sources:
Qualified medical expense IRS Publication 502: Link here
Savings Order Chart: JP Morgan Guide to Retirement: Link here
This post assumes that a diversified portfolio may earn 5.75% over the long term, Actual returns may be higher or lower.
Income limits may apply for IRAs.
Stock investing includes risks, including fluctuating prices and loss or principal. This information is not intended to provide specific advice or recommendations about any stock nor is it intended to be a recommendation to buy, sell or hold any stock investment. We suggest speaking with your financial professional about your situation prior to investing.
Please consult your financial advisor regarding your specific situation. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual
