For many high-income earners, contributing the maximum amount to a 401(k) is an important milestone. If you have reached this point, give yourself a pat on the back, as this is not something the average person has the capacity to do. It means you are taking full advantage of one of the most valuable retirement savings tools available, and in many cases, capturing the full benefit of your employer’s matching contribution. But once you have reached that limit, you might find yourself at a crossroads asking yourself a new question: What should I do with the next dollar I save?
There is no single right answer. The next step depends on your income, tax situation, cash flow needs, employer benefits, debt, goals, and how much flexibility you want your investments to provide. For some people, the answer may be an HSA or Roth IRA. For others, it may be additional 401(k) contributions through a mega-backdoor Roth strategy. Some may need more diligent planning if part of their income is derived from employee-benefit company stock plans. For most, building up a more liquid taxable brokerage account may be in the investor’s best interest. It might also be time to purchase a home, a new car, or plan for a new member of the family. Maxing out your 401(k) is not the end of the wealth-building process. For many high earners, it is where financial planning becomes the most important.
Before deciding what comes next, make sure you understand where you are now. Have you taken the time to look through the investment options available within your 401(k)? Is the account properly diversified and in line with your portfolio’s target asset allocation? Have you been saving on a pre-tax basis, Roth basis, or a blend of both? Does this make sense given your marginal tax rate now versus what it might be in the future? Next, take some time to think about your short-term, medium-term, and long-term goals. This will primarily drive the decision-making process as to which other set of tools you want to take advantage of in order to meet these goals. Finally, let’s understand the various types of tools that might be available to you and decide how you can best leverage them in order to achieve financial independence.
One type of account you can leverage that might be available through your employer is a Health Savings Account (HSA). HSAs provide a unique combination of tax benefits in which they are the only account type that offers a triple tax advantage. Contributions to your HSA are tax deductible, invested funds grow tax free, and withdrawals used for qualified medical expenses are also tax free. If the account is left to grow over time, it may provide a great way to pay for medical expenses in retirement. Medical expenses typically increase with age and often become a key trouble point for many retirees. HSAs can be leveraged into another source of retirement assets that provides a great benefit. The tradeoff is that you must be on a high-deductible health plan (HDHP) in order to do so. The important point is that an HSA can be considered as part of the broader retirement strategy rather than simply another account to contribute to.
What about a Roth IRA? If you are eligible to make a direct Roth IRA contribution, that may be another logical destination for additional retirement savings. Roth IRAs provide tax-free qualified withdrawals in retirement and do not have required minimum distributions during the account owner’s lifetime. Not everyone can contribute directly to a Roth IRA, and some might need to explore a backdoor Roth IRA strategy. A Roth IRA is not simply another account that makes sense for everyone to contribute to. It is primarily driven by what your marginal tax rate is now and what it might be in the future. It might also be goals-based, and the distinction between whether you accelerate tax-free savings over pre-tax savings is something that must be analyzed within the context of an investor’s entire retirement account structure rather than treated as an automatic next step.
For many high-income earners, the next logical destination is a taxable brokerage account. Unlike a 401(k) or IRA, a taxable brokerage account does not provide the same tax benefits or tax-deferred growth. However, it offers something that retirement accounts generally cannot: flexibility and liquidity.
There are no annual contribution limits and money can generally be accessed at any time without the early withdrawal rules that can apply to retirement accounts. Additionally, certain investments can be eligible for more favorable long-term capital gains treatment when sold, making withdrawals potentially more tax efficient than other retirement accounts. This makes implementing a taxable bucket within your overall portfolio particularly valuable for most investors. Whether you are using your brokerage account for shorter-term goals, long-term wealth building, or a combination of both, many investors will find it advantageous to direct available cash flow towards this section of their portfolio.
Investing is not automatically the best use of every additional dollar. You may still have a mortgage, student loans, or other forms of debt. The decision to invest additional savings or accelerate debt repayment depends on factors such as interest rate, tax treatment, liquidity needs, expected investment returns, and personal preferences. For example, someone with high-interest debt may benefit from prioritizing repayment before making additional savings towards other investment accounts. Someone with a relatively low-interest-rate mortgage and a long investment horizon may reasonably choose to invest instead of paying down debt. There is no cookie-cutter rule, and decisions should be evaluated within the context of the entire financial plan.
Maxing out retirement savings can sometimes create the impression that every remaining dollar should immediately be directed towards your investments. However, this is not true, and everyone’s goals will look different. You may be saving for a home, funding a child’s future education, buying a car, building a business, preparing for a career transition, or planning a major purchase. The best financial plan is not necessarily the one that maximizes retirement savings. It is the one that balances long-term wealth building with the flexibility to accomplish the things that matter to you along the way.
In conclusion, one of the biggest mistakes a high-income earner can make is assuming that financial planning is simply a process of finding another account to contribute to. If you are not taking into account your current situation, outlining your goals, setting up a plan to achieve these goals, protecting your wealth along the way, and projecting your future financial position, you will miss an important component of your financial picture. All of these considerations, among others, are areas where your CERTIFIED FINANCIAL PLANNER® professional can help assess whether these strategies are suitable for you. Finally, without guidance from a financial planner and tax professional, it may be easy to overlook important implementation and reporting requirements associated with these strategies.
Treat this excellent financial milestone not as the finish line, but as an opportunity to build a strategic wealth plan. This may be the start of your journey toward achieving financial independence.
Tags:
Reach out today. This could be the start of a great relationship.
Contact Us
