Saving For Retirement: Savings Waterfall

By Jon Scott

Abstract: This article details the order of savings for retirement. This article is helpful for those who wish to save beyond their 401K and want to know additional methods to store and grow their retirement fund.

We’re going to tackle the most difficult part of saving for retirement: where to start. The following lists out the priorities, in order, you should address when saving for retirement.

401K Match

The first priority should be your employer's 401K match, which is the amount your employer will contribute to your 401K based on your contribution. The 401K match is usually capped at a certain percentage of your annual salary with an average of 5.4% across US employers. At minimum, you will want to contribute up to your employee match. For example, if you are making $60,000 and your employer matches 6% of your salary, you can contribute $3600 and your employer will also contribute $3600.

High Interest Debt

The definition of high interest debt varies widely but generally you will want to prioritize paying down debt with an interest rate of 9% or above. Generally these will include personal loans and credit cards.

Max out your Roth IRA

The next step would be to max out your Roth IRA contribution, which is $6,000 for individuals younger than 50 years old and $7,000 for those 50 and older. It is important to note that Roth IRA has an income limit meaning in order to contribute a Roth IRA you must make less than $129,000 and $204,000 for those married filing jointly. If you exceed these limits you will want to consider a Backdoor Roth IRA.

Max out your HSA

An HSA is a health savings account provided through your health insurance if you picked a plan that offers a HSA account. You can use your HSA for health expenses like doctors appointments or even health related items. The money contributed to your HSA is tax free up to $3,650 for individuals and $7,300 for families. Typically you can select your HSA contribution through your employer’s healthcare portal.

Max out your 401K

For those that are able, you will want to maxout your contribution to your 401K. For individuals in 2022 this amount will be $20,500 for those under age 50 and $27,000 for those 50 and older (along with a catch-up 4 contribution of an extra $6,500).

Taxable or Alternative Investments

There are other tax free savings options for individuals with additional savings after funding the waterfall items above. Annuities and whole life insurance are ways to allow your money to grow tax-free after you have maxed out a 401k, IRA, HSA, and other saving vehicles.

Annuities

Annuities are two-stage products, one half is where you pay money into the annuity (accumulation phase) and then the other half is where the annuity pays you periodic income (annuitization phase). If you run out of ways to save tax-deferred, this is a good option.

Whole Life Insurance

Whole life insurance allows you to pay for a life insurance death benefit while also accumulating a cash value within the policy. Because you can't easily withdraw the cash value, it grows tax free. Rather than taking out the cash value, you can take a loan against it much like you would take an equity loan against your house. This is another way to have tax-free growth on assets while still having access to liquidity, but it is probably the least optimal way to do it and becomes completely useless if you don't need life insurance (therefore it is not actually an investment vehicle).

How much to save by age

The next burning question is how much you should save based on your age. The chart below demonstrates one theory about how much you should save.

Savings Calculator

Saving calculators are another good method to decide how much you should save based upon your age.

Action Items

Here are the action items you should take for planning out your retirement

  1. Find out your employer's 401K match (if applicable). Ideally you will be maxing out your 401K but if this is not financially viable you will want to at least contribute enough to receive the full employer match

  2. Pay off high interest debt. You will want to contribute as much money as possible to paying off high interest debt. Remember, this is debt with an interest rate of 9% or above.

  3. Set up and max out your Roth IRA. There are many Roth IRA providers, some examples include Fidelity, Vanguard, Interactive Brokers, and Merril.

  4. Check your health insurance. If you have a HSA as part of your health insurance, make sure you contribute the full tax free amount per year

  5. If you have additional money you are looking to save for retirement, do some research into annuities and whole life insurance policies.

  • This is the waterfall I recommend to clients but feel free to change it to match your own priority!

    • 401k match

    • High interest debt

    • Max Roth IRA (or backdoor)

    • Max HSA (if available)

    • Max 401k

    • Taxable or alternative investment accounts (ie whole life policies, annuities, etc)

  • How to calculate how much you should be saving per year (link out to calculator)

  • Rule of thumb for how much you should have saved for retirement by age:

Abstract: This article details the order of savings for retirement. This article is helpful for those who wish to save beyond their 401K and want to know additional methods to store and grow their retirement fund.

We’re going to tackle the most difficult part of saving for retirement: where to start. The following lists out the priorities, in order, you should address when saving for retirement.

401K Match

The first priority should be your employer's 401K match, which is the amount your employer will contribute to your 401K based on your contribution. The 401K match is usually capped at a certain percentage of your annual salary with an average of 5.4% across US employers. At minimum, you will want to contribute up to your employee match. For example, if you are making $60,000 and your employer matches 6% of your salary, you can contribute $3600 and your employer will also contribute $3600.

High Interest Debt

The definition of high interest debt varies widely but generally you will want to prioritize paying down debt with an interest rate of 9% or above. Generally these will include personal loans and credit cards.

Max out your Roth IRA

The next step would be to max out your Roth IRA contribution, which is $6,000 for individuals younger than 50 years old and $7,000 for those 50 and older. It is important to note that Roth IRA has an income limit meaning in order to contribute a Roth IRA you must make less than $129,000 and $204,000 for those married filing jointly. If you exceed these limits you will want to consider a Backdoor Roth IRA.

Max out your HSA

An HSA is a health savings account provided through your health insurance if you picked a plan that offers a HSA account. You can use your HSA for health expenses like doctors appointments or even health related items. The money contributed to your HSA is tax free up to $3,650 for individuals and $7,300 for families. Typically you can select your HSA contribution through your employer’s healthcare portal.

Max out your 401K

For those that are able, you will want to maxout your contribution to your 401K. For individuals in 2022 this amount will be $20,500 for those under age 50 and $27,000 for those 50 and older (along with a catch-up 4 contribution of an extra $6,500).

Taxable or Alternative Investments

There are other tax free savings options for individuals with additional savings after funding the waterfall items above. Annuities and whole life insurance are ways to allow your money to grow tax-free after you have maxed out a 401k, IRA, HSA, and other saving vehicles.

Annuities

Annuities are two-stage products, one half is where you pay money into the annuity (accumulation phase) and then the other half is where the annuity pays you periodic income (annuitization phase). If you run out of ways to save tax-deferred, this is a good option.

Whole Life Insurance

Whole life insurance allows you to pay for a life insurance death benefit while also accumulating a cash value within the policy. Because you can't easily withdraw the cash value, it grows tax free. Rather than taking out the cash value, you can take a loan against it much like you would take an equity loan against your house. This is another way to have tax-free growth on assets while still having access to liquidity, but it is probably the least optimal way to do it and becomes completely useless if you don't need life insurance (therefore it is not actually an investment vehicle).

How much to save by age

The next burning question is how much you should save based on your age. The chart below demonstrates one theory about how much you should save.

Savings Calculator

Saving calculators are another good method to decide how much you should save based upon your age.

Action Items

Here are the action items you should take for planning out your retirement

  1. Find out your employer's 401K match (if applicable). Ideally you will be maxing out your 401K but if this is not financially viable you will want to at least contribute enough to receive the full employer match

  2. Pay off high interest debt. You will want to contribute as much money as possible to paying off high interest debt. Remember, this is debt with an interest rate of 9% or above.

  3. Set up and max out your Roth IRA. There are many Roth IRA providers, some examples include Fidelity, Vanguard, Interactive Brokers, and Merril.

  4. Check your health insurance. If you have a HSA as part of your health insurance, make sure you contribute the full tax free amount per year

  5. If you have additional money you are looking to save for retirement, do some research into annuities and whole life insurance policies.