Before the year ends, contribute to tax-advantaged accounts.
The first six months of 2022 were not kind to the stock market. Since 1970, this has been the poorest first half on record.
As a result of record-high inflation and low consumer sentiment, stock values have plummeted. Everything — from blue-chip tech stocks like Facebook and Amazon to huge indices like the S&P 500 — has declined, leading many investors to pause down.
According to a survey conducted by BMO and released towards the end of May 2022, 21 percent of Americans had reduced their retirement contributions. Those who do so incur an opportunity cost, however, because tax-advantaged retirement funds have annual limits on contributions. And after the deadline has passed, there is no way to recover the investment opportunity.
Consider funding these three accounts before the end of the year if you have extra funds or want to prioritise saving for the future.
Health Insurance Savings Account (HSA)
Health Savings Account (HSA) contributions are an excellent method to begin saving for future healthcare expenses. This type of account can also be used as an investment vehicle for retirement.
To qualify for this sort of account, you must have a health plan with a high deductible, which is a suitable alternative for individuals who visit the doctor seldom. High deductible health plans typically have deductibles in excess of $1,400 for individuals and $2,800 for families.
As long as you have a qualified health plan, opening a Health Savings Account is simple. I am currently using Lively and am pretty satisfied with its HSA product.
Once you begin depositing funds into your HSA, you have the option of either keeping the funds in the HSA component of the account and saving them for qualified healthcare-related expenses or investing them in a self-directed brokerage account.
Specifically, the ability to convert your account into a triple-tax advantage account is crucial. Remember these three elements to make this strategy effective:
If your company offers an HSA, you can contribute pretax dollars from your salary.
If you choose to invest the funds in the brokerage section, the gains will be tax-free.
Once you reach age 65 or become disabled, you can take the funds tax-free so long as they are utilised for medical expenditures; if you opt to use the funds for other purposes, they will be taxed at ordinary income tax rates (similar to a 401(k) withdrawal).
A Health Savings Account is an excellent approach to prepare for future medical expenses, which are unavoidable throughout your lifetime.
In addition, the earlier you begin, the more time compound interest will have to work for you.
In 2022, the HSA contribution limits are $3,650 for individuals and $7,300 for families, with an additional $1,000 catch-up contribution for those 55 and older.
Once the calendar turns to the next year, it is no longer possible to contribute to these accounts retrospectively.
401(k) retirement plan
Contributing to a 401(k) retirement plan provides numerous advantages. As long as you work for an employer that offers a 401(k) plan, you can make pre-tax contributions that grow tax-free over time. These accounts will not be taxed until distributions commence in retirement.
Consider that there is a limit to the amount of money you can save each year. In 2022, you may contribute up to $20,500, excluding employer contributions. Over-50s can give an additional $6,500, for a total of $27,000. Once the calendar flips to the following year, this opportunity is lost.
Everyone with access to a 401(k) should contribute at least enough to qualify for their employer’s match. Sadly, according to Vanguard, nearly one-third of Americans aren’t saving enough to qualify for the match, meaning they’re essentially throwing away free money.
If you are unsure of the amount of your employer’s match or if you need more information regarding your employer’s retirement account programme, contact your human resources department.
The Roth IRA occupies a unique position in many investment portfolios as a tax shelter for a different reason than the first two. The previously three options offer tax advantages up front, however the Roth IRA is a goldmine at the end of your financial trip.
A Roth IRA is an individual retirement account that can be started in minutes with any major brokerage such as Vanguard, Charles Schwab, or Fidelity, or with a robo-advisor such as Betterment. In a Roth IRA, you can choose from a number of investments, and the contribution limit for 2022 is $6,000. If you are over the age of 50, you can also receive an additional $1,000 catch-up.
The finest aspect of this form of account is that, as long as you wait until you reach age 59 and a half, you can withdraw all the cash tax-free, meaning you won’t have to pay taxes on your gains throughout the years. In fact, a few individuals have been able to transform their tax-free Roth IRAs into billion-dollar behemoths.
Regarding investment deadlines, you have a bit more flexibility; you have until April 15 of the following year to maximise the account each year. For instance, you would have from January 1, 2022 until April 15, 2023 to fill your 2022 bucket. If you’ve already contributed to this year’s bucket, you’ll have to wait until January 1, 2023 to begin the following one.
These three accounts can yield substantial returns if optimised.
While these are the three primary investment buckets I employ in my own investing approach, it is prudent to visit a financial advisor for assistance in determining which ones would best serve your retirement objectives.
Consider my scenario as a single tax payer as an illustration. If I maximised my Roth IRA ($6,000), HSA ($3,650), and half of my 401(k) ($10,250, excluding company match), my annual retirement contributions would total $19,900. If I contributed this amount annually for 30 years, assuming an average annual return of 8 percent, my accounts would be worth a staggering $2,434,682 after investing only $597,000.
Despite the fact that there are other aspects to consider, like taxes and changes in the cost of living, among others, investing for the future can be highly rewarding.
Though there are a number of important statements to remember when it comes to investing, the most pertinent one is: Time in the market trumps market timing.
Simply put, the longer you let your money work, the better off you will be. You have a limited time to take advantage of these tax-advantaged investment accounts for these three types of investment accounts, so don’t delay.
Before you begin investing, you should ensure that your monthly costs are covered and that you have an adequate emergency reserve. Without an emergency fund, you may be forced to withdraw funds from your investments to cover unforeseen needs, which may incur taxes and other tax consequences.