How to Make the Most of Your Retirement Accounts

Key Takeaways

• How to establish a hierarchy of accounts that can be used to save for retirement.
• Using a health savings account for retirement savings, although that isn’t technically its intended purpose.
• Suggestions on what to do after investing in available retirement vehicles and matched employer contributions.

Susan Dziubinski: Hi, I’m Susan Dziubinski for Morningstar. Many of us have several vehicles at our disposal to use for saving for retirement, including 401(k)s and IRAs to name just two. How do we know which accounts to fund and in what order? Joining me to share some guidance on the issue with Christine Benz. She is Morningstar’s director of personal finance and retirement planning.

Nice to see you, Christine. Thanks for being here.

Christine Benz: Susan, it’s great to see you.

Establishing a Hierarchy of Retirement Accounts

Dziubinski: So, let’s start out with some stage setting. Most people, when they are working, have multiple accounts that they have at their disposal that they could be using to save for retirement. Let’s walk through some of the most common ones that most people or many people have.

Benz: Right. And I’ll just say I love that you’re tackling this topic because I think this topic of household capital allocation is so underdiscussed. People just kind of wing it. We spend a lot of time talking about investment allocation. But how do we allocate our household capital? The key things in the toolkit would be a couple that you mentioned: your company retirement plan, assuming you have one available to you; IRAs would be another option; and you might also look at a taxable brokerage account, where you wouldn’t earn the same tax incentives to make those contributions, but there’s still some tax benefits, which we can touch on. And then there are sort of ancillary vehicles that someone could use. The big one in my mind is a health savings account, which is not a retirement account per se, but it’s something that you can bring into the mix as you’re thinking about retirement funding.

Dziubinski: Is there a hierarchy among those accounts that people should be using to decide which to fund first? Where should you start?

Benz: Right. I think a good spot to look at would be to take a look at your company retirement plan and find out if you’re earning any matching contributions from your employer. Because, as people have probably heard a million times, that’s free money. But seriously, you want to put in at least enough to earn those matching contributions. Households that are just getting started, I would say focus on your emergency fund and focus on making sure you’re earning the matching contribution. Start there.

Using a HSA for Retirement Savings

Dziubinski: Next, you actually think a health savings account is a great second place to be looking at for retirement savings. And as you pointed out, that’s not technically a retirement savings vehicle. Tell us about why it ranked so highly, what you like about it, and who can use it.

Benz: Right. It’s important to discuss who can use it first. You need to be covered by a high-deductible healthcare plan. It needs to be a qualified high-deductible healthcare plan. And so, if you are covered by such a plan, if that’s your type of healthcare coverage, you can also use what is called a health savings account, and the tax benefits are better than anything else. You’re putting in pretax contribution, so you’re not getting taxed on the funds going in. You are earning tax-free compounding on your money, so no taxes due as long as the money stays inside the confines of that account. And then, assuming that you are pulling the funds out for qualified healthcare expenses, you can avoid taxes on those distributions as well. So, tax benefit at every step of the way.

And then, another thing I would say is that there’s actually some flexibility around the distribution. Once you hit age 65, you can pull the funds out as you would with a traditional tax-deferred IRA. So, it’s, I think, a valuable account, especially if you’re covered by a high-deductible plan, you want to set aside those funds to cover your healthcare expenses as you would incur them, but it’s also something valuable to carry into retirement.

Advantages of Investing in a Roth IRA

Dziubinski: Step number three, once you’ve looked at that HSA if you can contribute to that and you’ve matched your employer contributions on your retirement plan, what’s next?

Benz: Look at a Roth IRA. And there are a couple of key advantages. One is that even though you’ll put in aftertax dollars, you’ll be able to enjoy tax-free withdrawals in retirement. The other key advantage, and the reason I really like to talk about Roth IRAs for people who are getting their plans off the ground, is that you have a lot of flexibility in terms of those contributions. So, you’re able to pull the contributions out, not the investment earnings, but the contributions out without any taxes or penalties for any reason. And so, it’s a nice backup emergency fund, even though you might have the best of intentions to leave the funds in there and to get them growing for retirement, you do have a fair amount of flexibility to pull the funds out earlier.

Dziubinski: And then, after the Roth IRA, let’s say, you still are fortunate enough to have assets that you want to be investing for retirement. Where do you look next?

Benz: Definitely do your due diligence on that company retirement plan. Go get the matching contributions regardless, it can be a really crummy plan, still contribute to it enough to earn the match. But if you want to put additional funds into the plan and you have them to invest, do your homework on the quality of the plan. So, you’re looking at investment options. That’s really the most transparent part of most plans. Do your homework on how much you’re paying in fees on those investment options. Then do a little bit of sleuthing on any administrative expenses that you’re on the hook for. If you work for a very large employer, chances are those will be nice and low. Smaller employers unfortunately tend to field higher-cost plans. Try to get your arms around what those administrative costs are. It’s hard to give a ballpark figure that is sort of a red flag, but I would say if you’re seeing administrative expenses over 0.5%, that’s a signal that you’ve got a high-cost plan. And unfortunately, you oftentimes see high-cost investment options to go along with that high administrative fee. So, in that case, you may want to use your funds, invest your funds elsewhere. But for many folks, especially folks with bigger plans, it’s a really good option to invest in that low-cost 401(k) plan.

Avoiding High Costs for Retirement Savings

Dziubinski: Let’s say you are in that boat where you’ve investigated the plan and either your options in that plan are high-cost and subpar or the whole plan itself is high cost, what do you suggest then?

Benz: Here, you would look to a taxable brokerage account. And so, the advantage of the taxable brokerage account, even though you’re putting aftertax dollars in, is just flexibility that you can decide whatever you want to put the money into. I guess that can be a double-edged sword. You could pick something crazy, but you have that flexibility in what to invest in. You can invest at any amount. There are no income limits on how much you can put into a taxable brokerage account, no contribution limits. So, just a ton of flexibility. And then, even though you’re putting aftertax dollars into the plan, so you’re not earning a tax break on your contributions, you have the potential to earn capital gains treatment when you pull the funds out for whatever your plan is for those dollars. Capital gains taxes are typically lower than the ordinary income taxes that would apply to, say, withdrawals from a traditional IRA or a traditional 401(k).

Dziubinski: And then, lastly, let’s talk a little bit to this group that you call super savers. Who qualifies as a super saver to start, and then what do you suggest for this cohort?

Benz: Right. So, for people who have maxed out, say, their IRA contributions, maybe their HSA, they’ve also maxed out their 401(k), their company retirement plan up to the limits, they want to be aware of what are called aftertax 401(k) contributions. Not all plans offer them. Bigger plans are increasingly offering this feature. But the idea is that you are making aftertax contributions. You’re contributing aftertax funds. And many plans offer what’s called an in-plan conversion feature. So, it’s a way to make that contribution of aftertax dollars and then almost immediately thereafter convert those dollars to a Roth 401(k). So, it’s a really nice option. If you are a heavy saver and you work for a large employer, check this out. See if it’s an option. If it’s not an option, lean on your administrator to investigate whether your plan could potentially include this option because it’s a really nice way for higher-income folks to save additional funds and earn tax-free withdrawals in retirement.

Dziubinski: Christine, thank you for your time today and for providing this framework for retirement savings. We really appreciate your time.

Benz: Thank you so much, Susan.

Dziubinski: I’m Susan Dziubinski with Morningstar. Thanks for tuning in.

Watch “6 IRA Mistakes to Avoid in 2023″ for more from Susan Dziubinski and Christine Benz.