Order of Contributions

By Corinne Hannah, CFP®

 

Whether you are an employee deciding about your annual benefits at election time or an employer deciding which benefits to offer, make your workplace benefits work for you. Your benefits can maximize your savings for retirement and lower your tax bill.  Assuming you already have an emergency fund, consider the following questions to determine in what order to fund your benefit buckets:

Does your retirement plan offer a match? 

Your employer may match dollar-for-dollar contributions up to a certain percentage, which means your return on your contribution is immediately 100%.

a) If an employee will only be with the company for a short time (1-2 years), consider whether the matching contributions are subject to vesting. A shorter matching schedule allows even short-term employees to earn the match. With a longer vesting schedule, a short-term employee should consider contributing to an HSA or FSA first. (Skip to the next section.)

b) If you are an employee who will stay with the company long-term (at least 3 years), contribute enough to earn the whole match.  Example: Some companies match 100% on the first 3% of salary and 50% on the next 2% (up to 5%) of salary.  Contribute 5% of your salary to receive the whole match.

c) If you are under 45 or if you already have a sizeable 401(k) or IRA account, consider reading this article to decide whether Roth 401(k) contributions would be better than regular 401(k) contributions to maximize your after-tax savings.

What type of health insurance plan do you have?

High deductible (HSA eligible plan): 

Funding your HSA is the most tax-advantaged way to save for retirement and medical expenses.  You receive a tax deduction on contributions, the growth of funds in the account is tax-free or tax-deferred, and your withdrawals for qualified medical expenses (current or previous) are tax-free.  See this handout for more information.  Your high-deductible insurance plan may also give you the option to fund a limited purpose Flexible Spending Account for your vision and dental expenses.

Standard deductible plan with Flexible Spending Account option:

If you know that you will have medical expenses in the next year, are you willing to maintain complete records of the receipts for those expenses?  See below for answers:

Yes: Fund your flexible spending account (FSA).  Remember: FSAs are subject to “use it or lose it” restrictions at the end of each year; any money above $500 remaining in the account at the end of the year is lost.  Estimate your medical expenses (within $500) before funding the FSA.  Also, because of the tax advantage (using pre-tax dollars to pay medical costs), FSAs are highly regulated.  Your FSA provider will require you to submit documentation for expenses, and you must keep that documentation for five years.

No: Put any savings in your retirement plan.  You are not responsible for record keeping, and you will not run the risk of being audited and charged taxes and a penalty for not having sufficient records.

The following examples of selecting workplace savings buckets may help you make your decisions.

Example 1

James earns $50,000 per year and plans to stay with Gizmo Company for the long-term.  Gizmo Company offers a 3% match, and James is on a high deductible health plan.  James decides he can save 15%, which is $7,500.  He has deferred $4,150 to his 401(k) and $3,350 to his HSA.

Total savings ($9,000):

$4,150 employee contributions to 401(k)

$1,500 employer matching to 401(k) contributions

$3,350 HSA contribution.

Example 2

Lauren also earns $50,000 per year at Gizmo Company, but Lauren just started working at Gizmo and will likely move in a year.  Lauren is also on a high deductible health plan, and she has $4,500 to save through work benefits after funding her emergency fund.  Lauren has deferred $3,350 to her HSA and $1,150 to her 401(k).

Total savings ($4,500 portable, $5,650 with vesting)

$1,150 employee contribution to 401(k)

$1,150 employer matching to 401(k) contributions (subject to vesting)

$3,350 HSA contribution

Example 3

Javid earns $40,000 per year at Widget Company, and he plans to stay with Widget for at least 3 years.  Javid has a standard deductible health plan, and Widget matches contributions up to 5% with the match vesting after 2 years of employment.  Javid wants to save $4,000 through his work benefits, and he estimates that he will have $150 per month of eligible health care expenses.  Javid defers $2,200 to his 401(k) and $1,800 to his FSA.

Total savings ($6,000)

$2,200 employee contributions to 401(k)

$2,000 employer matching to 401(k) contributions

$1,800 flexible spending account contributions

The amount you’re able to save may be large or small, but let your work benefits work for you.  Always seek the advice of a professional financial planner and a CPA when considering the tax ramifications of your savings.

 

Corinne S. Hanna, CFP® is a 2006 graduate of the Honors College at the University of South Carolina with a BS in Mathematics. In 2009, Corinne received her MS in Mathematics from Cornell University.  She joined Abacus in 2011 and received her CFP® designation in 2013.  Corinne is a Level II candidate of the Chartered Financial Analyst program.

Abacus is a financial advisory and investment counsel firm known for its passion in creating success for clients and family businesses through skillful listening and smart financial decision-making. Managing over $830 million on behalf of its 190 clients, Abacus consists of a team of multi-disciplinary experts who work collaboratively to serve its clients.