Here's Where Ramit Sethi Says You Should Be Putting Your Money
When the personal finance guru speaks, it pays to listen.
Investing your money is a great way to grow wealth over time. Does that mean you should rush to open a brokerage account? Maybe eventually. But if you ask personal finance expert and entrepreneur Ramit Sethi, he'll tell you there are other accounts worth saving and investing in before you open a brokerage account. Here's his saving and investing hierarchy that he thinks is smart to follow.
1. Contribute to a 401(k) plan to get your employer match
Not everyone has access to a 401(k) plan through their job. But if you have a 401(k), which is a dedicated retirement savings plan, and your employer matches contributions, it pays to put in enough money to claim that full match.
There's no such thing as a standard match; each company decides that individually. Right now, workers are able to contribute up to $19,500 a year to a 401(k) if they're under age 50, or up to $26,000 if they're 50 or older.
Companies generally won't match those limits -- not even close. But if your employer is willing to match contributions of up to $3,000, for example, then it's worthwhile to put in that much money so you can claim that free cash for your retirement.
2. Contribute to a Roth IRA
The great thing about Roth IRAs is that you never have to pay taxes on investment gains in your account, and withdrawals during retirement can be taken tax-free. This year, the annual contribution limit for a Roth IRA is $6,000 if you're under 50, and $7,000 if you're 50 or older. Because Roth IRAs are self-funded, you won't be eligible for a company match like you would with a 401(k).
3. Max out your 401(k)
Workers who earn an average salary generally can't max out a 401(k). But if you've already maxed out a Roth IRA and have more money to save and invest, then it pays to put your excess cash into a 401(k). Traditional 401(k) contributions get to go in tax-free, and the more money you put in, the less income the IRS will tax you on.
Roth IRAs don't happen to offer this benefit, so you won't lower your taxes immediately by funding one. But since they offer the advantage of tax-free investment gains and withdrawals during retirement, they make a lot of sense -- especially for people who think they'll be in a higher tax bracket during retirement than they're in today.
4. Max out your health savings account
Not everyone is eligible to contribute to a health savings account (HSA). To qualify, you must be enrolled in a high-deductible health insurance plan. This year, that's defined as a plan with a deductible of $1,400 or more for self-only coverage, or $2,800 or more for family coverage.
HSAs actually offer all of the benefits of both a traditional 401(k) and Roth IRA. HSA contributions go in tax-free, and then money that's not being used for immediate healthcare expenses can be invested for added growth. Investment gains in HSAs aren't taxed, and neither are withdrawals as long as they're used to cover the cost of qualified medical expenses.
HSA funds never expire so you can save money during your working years to pay for healthcare costs in retirement. And in doing so, you get a chance to invest your money in a tax-advantaged fashion.
This year, the annual contribution limit for HSAs is $3,600 for self-only coverage and $7,200 for family coverage if you're under age 55. If you're 55 or older, these limits rise to $4,600 and $8,200, respectively.
5. Invest in a traditional brokerage account
Once you've maxed out the above accounts, you should consider investing any additional money you have in a regular brokerage account. Traditional brokerage accounts don't offer tax breaks, which is why it pays to first max out those accounts that do come with tax benefits.
But brokerage accounts are also less restrictive. With a 401(k), you can't typically take a withdrawal before age 59½ without facing a penalty. Roth IRAs are a little more flexible, but there are rules you have to follow if you want your money before age 59½. HSAs penalize you for taking withdrawals for non-medical reasons. When you invest in a brokerage account, you can access your money whenever you want without a penalty.
Should you follow Sethi's plan?
Ramit Sethi knows a lot about saving and investing, and so it's not a bad idea to take his advice to heart. At the same time, it's okay to map out your own savings and investing plan based on your specific needs and goals. The key is to read up on the different places you can invest your money to make sure you're making choices that will benefit you in the long run.
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