The Waterfall of Retirement Savings by Account, Episode #20
In this episode, we talk about retirement accounts and how to prioritize which ones to save to and in what order. Each physician has certain retirement accounts they’re eligible to contribute to. However, since different accounts have different features and tax treatment, it can be hard to determine how to order them when allocating your retirement savings. In this episode, we provide a blueprint for the typical employed physician, explaining the key features of the various accounts and the rationale behind how we rank them. Our goal is to help you leverage your available retirement accounts in an optimal way, to make the dollars you save for retirement go as far as possible.
Outline of this episode
- Level one is the 403b or 401k [2:20]
- Level two is the Health Savings Account [6:34]
- Level three is the 457b [9:19]
- Level four is the backdoor Roth IRA [13:21]
- Level five is a taxable investment account [18:19]
- Summary of the levels of the waterfall of retirement savings accounts [20:48]
Understanding the waterfall analogy and how you can benefit from it
We all have a certain amount of money, or cash flow, that we're able to save for retirement each month or year. The question is how do you optimize it across the different accounts? We use the waterfall analogy because, for each physician, there's a certain optimal order of accounts. When you’re looking at your available cash flow, you want to first fill up the most attractive account, then the next most attractive, and so on.
Understanding the order of where to save first is especially important because not everyone has enough cash flow to fill up all the available accounts. Different accounts have different tax treatments, and being smart about which accounts you save to in which order allows you to maximize the tax advantages of the money you're saving. In other words, by saving the same amount of money, but using the right accounts, in the long run you'll end up with more money after taxes. Using the right accounts in the right order maximizes how far the money you save will go for you in retirement.
Why the 403b or 401k retirement account tops the list
The reason we put the 403b or 401k first in the order of retirement savings accounts is because of the employer match. The way the match works is that you contribute a certain percent of your salary to the account and your employer then "matches," or makes a contribution on your behalf up to a certain amount. The amount of the match varies by employer. The employer match is free money and by not taking advantage of it you are effectively leaving part of your compensation on the table. This makes maximizing your employers match the most important first step in saving for retirement. For this reason, make sure you are contributing at least up to the percentage of your salary required to receive the full matching contribution.
All five levels of the retirement account savings waterfall
Here is a quick summary of the order of priority when it comes to retirement savings accounts. Number one is a 403b or 401k. Make sure you're taking advantage of your employer’s match which is essentially free money by contributing to your four 403b or 401k. Number two is a Health Savings Account. If you're enrolled in an eligible health insurance plan and have access to an HSA, use it to take advantage of the triple tax benefit and have an account to tap into for healthcare costs or other costs after age 65. Number three is a 457b (if available) to take advantage of additional tax deductions and early withdrawal potential for early financial independence. Number four is a backdoor Roth IRA - assuming you don't have any money in a pre-tax IRA, consider making backdoor Roth IRA contributions to fill out your tax advantage savings space. And lastly, number five is a taxable account. For any money left over after maxing out all other tax-advantaged accounts, consider a taxable account for the flexibility it provides.
Resources & People Mentioned
- Download our guide: The Toolkit for Optimizing Your Finances as an Employed Physician
- Download our guide: The Financial Checkup
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