Investors who are able to place their investments in several different kinds of accounts (such as taxable accounts, 401k, or IRA) need to decide which ones to prioritize. In order to maximize the tax efficiency of a portfolio, the general rule for investing priority is:
- Company plan (401k, 403b, etc.) up to the company match
- Health Savings Account, if eligible.[footnotes 1]
- Roth IRA or deductible traditional IRA up to maximum contribution limit, depending on personal circumstances and eligibility.
- Company plan up to maximum contribution limit
- Taxable investing
If the company plan offers good, low-cost funds, it may be preferable to contribute to the company plan before contributing to an IRA.
An investor's tax bracket may influence the decision as well: those in higher tax brackets should consider higher contributions to a tax-deferred plan (e.g. traditional 401k or IRA) rather than a post-tax plan (e.g. Roth 401k or IRA); see Traditional versus Roth for more guidance.
Many company plans contain high-cost funds which make them unattractive. If you have such a plan, look for one or two index funds or a bond fund that can be used. If your company offers matching funds up to a certain contribution level, it's always wise to use the company plan. If there is no match, the power of tax-deferred compounding and automatic contributions still favors using the plan with limited contributions. Also, if you leave your current employer you will most likely be able to rollover the assets in your poor-quality company plan to either a better company plan, or to an IRA.
Paying off debts
- Invest up to the match
- Pay off high interest debt
- Tax-deductible retirement accounts
- Roth IRA
- Taxable accounts
- Non-deductible IRAs and annuities
- Investor should determine if enrolling in a high deductible health plan and possibly gaining access to a HSA is appropriate for their personal circumstances and health care needs. If so, then using the HSA as an investment account can be advantageous and is therefore included in this list.
- Prioritizing investments- HSA goes where? in Bogleheads.org thread, 16 Feb 2014.