In a recent article, we discussed “tax-aware investing,” focusing on how to minimize taxes while saving for retirement. We described various ways to save that (legally) minimize taxes, including whether certain types of investments should be held in taxable, tax-deferred, or non-taxable (Roth) accounts, tax-loss harvesting, and other things to consider when looking at how the tax code might affect how you invest.
In this “Part 2” of that article, we address another essential aspect of tax-aware investing for retirement – the order in which your savings are allocated to different types of accounts. Many people focus on saving and investing a targeted amount, or simply “as much as possible” (not a flawed approach, unless it interferes with your ability to enjoy at least some of your discretionary income before you retire). However, they often overlook that there is a logical progression to follow when putting aside money for retirement.
The order in which you fill up the various retirement savings “buckets” available can make a significant difference in what you ultimately keep of the money you put aside and invest it for the long term. It comes down to how much you keep for yourself versus what you pay to the IRS, either before money goes into a retirement savings account or when it comes out to pay your expenses after you retire.
This can be thought of as optimally diversifying where you save for retirement. We’re not talking about the mix of stocks and bonds to hold—that’s an important topic, but it’s not the type of diversification we’re addressing here. This article focuses on tax diversity in retirement savings.
Types of Retirement Accounts
You are probably at least somewhat familiar with many of the types of accounts available for retirement savings, including 401(k) and equivalents (such as 403(b) accounts), traditional IRAs, or SEP IRAs for those who do not have access to an employer-sponsored retirement plan, Roth 401(k)’s, Roth IRAs, and taxable brokerage accounts. We encourage you to read Part 1 of this article if you are unfamiliar with them.
We’ll add another to this list: Health Savings Accounts (HSAs). These are often overlooked because the name doesn’t scream “long-term investing,” but HSAs can be a powerful, under-the-radar retirement savings option.
The question we address here is: Which options should we use to save for retirement, and in what order of priority? Not all are available to everyone, and many have annual contribution limits. We can think of them as buckets that can be used to store retirement savings – when the most advantageous one is filled, we move on to the next, and so on, until we have directed each available dollar of retirement savings to its optimal location.
HSAs: A Retirement Account in Disguise
First in line in terms of where to direct your retirement savings each year (the first “bucket” to fill up) is, if you are eligible, an HSA. Sometimes referred to as a “stealth IRA,” you qualify for an HSA if you are enrolled in a high-deductible health plan. An HSA helps you to set aside pre-tax money, which reduces your taxable income in the current year, in a tax-free account. This account allows you to save for the out-of-pocket medical expenses you will likely incur by accepting a higher deductible health plan. No income restrictions limit who can contribute to an HSA; in other words, you can contribute the maximum even if you are a high earner.
Unlike a Flexible Savings Account that requires you to use or forfeit the funds in the account each year, the money you deposit into an HSA is yours, permanently. Even if you switch out of your high-deductible insurance coverage, you keep what you have in the HSA. The money in your HSA can be used for a qualified medical expense at any time – even many years later – even after you retire. While your savings sit in an HSA, you can invest them in mutual funds, ETFs, and individual stocks and bonds.
There are more benefits: You pay no federal income tax on the investment returns earned in your HSA while the money is in the account (which could be many years), and withdrawals are not subject to federal income tax when used to pay qualified medical expenses. If you are healthy and do not need all of the money in your HSA, after you turn 65, you can withdraw the money with no penalty. Non-qualified HSA withdrawals are treated as payouts from a traditional IRA and are taxed as ordinary income. If you use the money for qualified medical expenses after you retire, you never pay taxes on that money or the investment returns you earned.
When the HSA account holder dies, the funds left in the HSA are transferred to a beneficiary. This move is tax-free if the beneficiary is the account owner’s spouse, and the money can be used under the same rules that apply to the original account owner. If the beneficiary is not a spouse, the account is no longer treated as an HSA and becomes taxable to the beneficiary the year the HSA owner dies. That argument favors spending your HSA rather than leaving it to your heirs. Any qualified medical expenses for the decedent within one year after the date of death reduce the taxable balance for the beneficiary.
Given these “triple tax benefits,” your HSA should be the first bucket you fill when directing money toward retirement savings if you are eligible for one. The maximum you can contribute to an HSA changes each year – for 2025, the limits are $4,300 for individuals and $8,550 for families, with an additional “catch-up contribution” of $1,000 if you are over 55.
The Many Advantages of 401(k) / Roth 401(k) Accounts
Next are your 401(k) – or equivalent employer-sponsored retirement plan – and Roth 401(k). Contributions to a regular 401(k) account reduce your taxable income for the current year, and then you pay taxes on the withdrawals after you retire. Contributions to a Roth (401(k) are taxable as ordinary income the year they are made, and then grow tax-free forever after.
As an added incentive, your employer may match some of your 401(k) contributions, and that’s free money – don’t pass it up. Employer contributions to a regular 401(k) do not impact your taxable income the year they are made, while employer contributions to your Roth 401(k) are added to your taxable income that year, but the after-tax amount grows tax-free. Investment returns generated in your regular (non-Roth) 401(k) are not taxed until you withdraw the money – no earlier than age 59 ½ without penalty, and you must begin withdrawals by age 73 (the start date varies according to your age, so check with your advisor).
So, if you put money into a 401(k) plan starting at age 35 and postpone withdrawals until you are at least 59 ½ and possibly until you reach 73 (after which you have minimum distribution requirements), you’ll have decades of accumulating investment returns without paying any taxes on them. When you do pay taxes on withdrawals from a non-Roth 401(k), you may be in a lower tax bracket than when you were working. However, it is not unusual to discover that your RMDs, Social Security, and investment returns generate higher taxable income than you expected.
Withdrawals from a Roth 401(k) are not taxed, as you paid ordinary income taxes on the money you put into the account the year you made those contributions. In 2025, you can sock away as much as $23,500 in a 401(k)/Roth 401(k) or equivalent plan. While prioritizing non-Roth 401(k) contributions makes sense for many people, if you have additional savings capacity or your retirement accounts have grown to the point where your required minimum distributions are likely to push you into a higher tax bracket after you retire, you may want to consider a Mega Backdoor Roth Contribution.
This strategy allows you to convert 401(k) savings to a Roth account. If your 401(k) plan permits, you can contribute after-tax funds, above and beyond the maximum pre-tax contribution (up to the IRS limit, which is $66,000 in 2024 and includes whatever your employer contributes), and then convert those contributions to either a Roth 401(k) (thus remaining in the employer-sponsored plan) or a Roth IRA. While these “extra” after-tax contributions are not taxed again when you shift them into a Roth, the earnings on any pre-tax contributions that are moved/converted to the Roth account are taxable. This strategy, which is entirely legal despite the “backdoor” name, maximizes tax-advantaged savings, bypassing Roth IRA income limits to provide significant long-term tax benefits."
What if you don’t have a 401(k) plan?
Suppose you do not have access to an employer-sponsored retirement plan. In that case, you can make pre-tax contributions to a traditional IRA, after-tax contributions to a Roth IRA, or a combination of the two. However, the total amount you are allowed to contribute to these accounts is far below what you can put into a 401(k)-type plan and people who earn over a certain amount cannot contribute to a Roth IRA (it doesn’t seem fair, but those are the rules).
To address this, high earners can use strategies such as a (perfectly legal) Mega Backdoor Roth IRA contributions or make substantial Roth conversions that move money from a traditional IRA to a Roth IRA by paying taxes today – with no limit on how much you can convert. Taking advantage of these strategies can make a tremendous difference in the savings you will eventually draw upon in retirement. Consult with your financial advisor to ensure you don’t run afoul of the rules that dictate these backdoor contributions or Roth conversions.
Last but Not Least – Taxable Savings
Finally, we come to taxable brokerage accounts. These come last because they do not offer tax advantages. They have disadvantages relative to HSAs, 401(k)s, IRAs, and Roths as you pay ordinary income taxes on the money you funnel into a taxable brokerage account at your marginal federal rate and pay taxes each year on dividends, interest, and realized capital gains.
So, why save in taxable brokerage accounts at all? First, you may max out your contributions to an HSA and 401(k) or an IRA. Second, you may want to save for things you want to do before retirement – maybe traveling, a significant home remodel, or a career change. The money you save in a taxable brokerage account can bring tremendous value to your life in many ways. Finally, life is full of surprises, some of which require money. Taxable brokerage accounts are entirely flexible – you can withdraw from them at any time with no penalty because you’ve been paying taxes on the investment returns all along. To reiterate, the order to follow in allocating your retirement savings dollars is as follows: HSA, 401(k)/Roth 401(k), or a traditional and/or Roth IRA if you cannot fund a 401(k), and finally, a taxable brokerage account. Improving your “tax diversity” with respect to your retirement savings accounts can tremendously impact the wealth you accumulate over time. The importance of filling up these retirement “buckets” properly can rival the value you obtain by choosing which types of assets (stocks versus bonds, for example) to hold in each type of account.
Not only is this a lot to absorb, but it can also take several years to implement tax diversification optimally. That is precisely why we urge people not to wait until they are a couple of years away from retirement to discuss these things with an advisor. Tax diversity should begin early, in what we call the accumulation phase. The longer you wait, the more you are likely to leave a significant amount on the table (for the IRS) as your options become more limited. The impact of making optimal choices grows exponentially over time, so it is critically important to start this planning process earlier than you think is necessary. Contact us if you have questions or need help sorting through it all.
At Gold Medal Waters, we believe truly serving our clients means going beyond the traditional advice about investment choices and how to reduce your taxes. Our focus is solely on helping you to reach your financial goals based on your life’s priorities – and that’s not just a slogan; it’s our purpose.\
Disclosure: Advisory Services are offered through Gold Medal Waters, a Registered Investment Advisor. This post and material presented are for informational and illustrative purposes only, and do not constitute investment advice and is not intended as an endorsement of any specific investment. As such, this material is not client-specific, we make adjustments in individual portfolios based on each client's financial plan, income needs, risk tolerance and total asset allocation. Interactive checklists are made available to you as self-help tools for your independent use and are not intended to provide investment advice. While Gold Medal Waters believes information derived from third-party sources to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability in regard to your individual circumstances. Investors should carefully consider the investment objectives, risks, charges, and expenses associated with any investment. The information discussed is not intended to render tax or legal advice. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Investing involves risk including the potential loss of principal, and unless otherwise stated, are not guaranteed. Past performance does not guarantee future results. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Consult your financial professional before making any investment decision.