User:LadyGeek/Prioritizing investments

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Investors have many choices where to invest their money. Knowing which accounts to invest in first (such as taxable accounts, a 401(k), or an IRA) will maximize return with a minimum of taxes (maximize tax efficiency). Prioritizing investments guides investors on the appropriate order of placing their investments into these accounts.

Investors should take care that any investment priority decision is aligned with their Investment Policy Statement.

Funding priority
Here is a general account funding priority that often works well for many people (not all points will apply to everyone). Refer to Figure 1.


 * 1) Establish an emergency fund to your satisfaction. If you have many other high financial priorities (like paying off high-interest debt), start with a smaller emergency fund, and grow it later over time, as those other priorities are satisfied.
 * 2) Contribute to an employer retirement plan (eg. 401(k) or 403b) enough to get the full employer match (the match is like free money, your best possible investment).
 * 3) Pay off high-interest debt (a guaranteed high return, the next best thing to free money).
 * 4) Contribute to a Health Savings Account (HSA) if available (unlike many other tax deductions, there are no income restrictions to contribute to an HSA).
 * 5) Contribute the maximum to an IRA, traditional or Roth (or  backdoor Roth technique ), depending on eligibility and personal circumstances. (See  below for situations where you may prefer to swap steps 5 and 6.)
 * 6) Contribute the remainder of the maximum employee contribution to the work-based plan.
 * 7) If your plan supports it, employ the mega-backdoor Roth strategy.
 * 8) Pay off medium-interest debt (eg. student loans, car loans, personal loans), especially if the interest is not tax-deductible.
 * 9) Invest inside a taxable investing account. In certain circumstances, a Non-deductible traditional IRA may be better than a taxable account.
 * 10) Pay off low-interest debt (eg. most mortgages, some car loans).

It is important to realize that these steps are not cast in stone. The above list should be considered with some flexibility for an investor's needs and personal preferences.

For example, if the company plan offers good, low-cost funds, it may be preferable to contribute to the company plan before contributing to an IRA; see: Comparison between IRAs and employer plans.

Also, 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 401(k) or IRA) rather than a post-tax plan (e.g. Roth 401(k) or IRA); see Traditional versus Roth for more guidance.

The choice to pay off debt or invest is based mostly on the expected after-tax rate of return (what's left after taxes are taken out). When the returns are similar, secondary factors sway the decision; see: Paying down loans versus investing.

Health savings accounts: Use of an HSA requires participation in an IRS qualified high deductible health plan (HDHP) at work. Look at your particular health care needs to decide if you may be better off with a traditional health care plan or an HDHP plus HSA. If the latter, then using the HSA as an investment account can be advantageous.

Choosing between an employer retirement plan and an IRA
If one of the following applies to you, it may be preferable to swap steps 5 and 6 (i.e., contribute to the company plan before contributing to an IRA ): See: Comparison between IRAs and employer plans.
 * If you earn too much for a full IRA tax deduction (above the IRA Deduction Limits) and you prefer traditional to Roth. In this case, you should contribute to a traditional employer plan, and then to a Roth IRA (or backdoor Roth technique). Note that a non-deductible traditional IRA is not recommended until step 9.
 * If your earnings are partially IRA tax deductible (the partial deduction limits in the charts linked from IRA Deduction Limits) and you prefer to deduct a traditional IRA instead of using a Roth IRA. If you go over the limit, you could bring the deductions back into range by contributing to the traditional employer plan. Contributions to the plan will reduce your MAGI for traditional IRA purposes (Modified Adjusted Gross Income).
 * If the company plan offers lower-cost funds than the 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 401(k) or IRA) rather than a post-tax plan (e.g. Roth 401(k) or IRA); see Traditional versus Roth for more guidance.

Rationale for funding priority
Table 1 describes the rationale for investing in the order previously described.

401(k) plans with high cost funds
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.