If you created a financial planning checklist of to-do activities, I am sure it will be a long list. Many experts recommend taking a “personal day” to take care of all those things. Make a list of things to do, take a day off from work and knock off that to-do list. Easier said than done, right! Let me give you some motivation to do that. In this week’s article, as you are getting ready for the tax day approaching in April, here is a list of six things that you can start with. Let me mention from my personal experience that the financial returns generated from this invested time will be far greater than most of the things that you do on your day-off. Here we go
- 401K Contribution: Are you contributing enough to your 401K to get the full employer match? This is free money. If your employer matches up to 5% of your salary to your 401K plan and you are contributing only 4% then you are leaving that 1% employer contribution on the table.
- 401K Investments: If you have a 401K Plan and you are contributing part of every paycheck to that plan, check to see where that money is being invested. Usually, most of the 401K plans investments default to target date mutual funds and most of target date funds will have some sort of bond investments thrown in there. Are you okay with that? Usually, if you have a long-term horizon, you should be okay with no bonds and just stock index funds. Some 401K plans have a healthy mix of investments to choose from and some of them will have pretty bad choices so it just depends on your employer. Most of the time, you will be okay with choosing an index fund like a S&P 500 index or a total stock market index fund if you don’t have many choices. You should stay away from annuities or active mutual funds that have expense ratios above 1% as those could eat into your returns. I recommend checking on your investments at least once a year to make sure your 401K plan money is invested into things that you want to invest because sometimes those plans default into some of the choices that are benefitting someone else. Look at the investment returns generated by your choices over 3 years, 5 years or 10 years. Are you at least earning market returns? If not, maybe it’s time to make a change.
- HSA Contribution: As I describe in this article, a Health Savings Account (HSA) is the best retirement account as this is the only account where you never pay taxes if you meet certain conditions. The yearly contribution for this account is $3,600 for single and $7,200 for married filing jointly. Are you maxing out this plan? If not, then maybe this is the time to increase your contribution by just a little to see if you can get close to contributing the maximum. Good news! You have until tax filing deadline (usually April 15) to contribute to this account so if you didn’t max out this account for the year 2020, you can still do it until April 15, 2021.
- Roth IRA: I believe Roth IRA is the second best retirement account after the HSA as you only pay taxes on the money that you contribute to your Roth. That money grows tax-free and stays tax-free if you meet certain conditions. If you are a high-income earner, you can use a strategy known as backdoor Roth IRA. Not only that, Roth IRA is exempt from Required Minimum Distribution (RMD) which are required for 401K plans and traditional IRAs. Good news! If you haven’t contributed for the year 2020, you still have until Apr 15, 2021 to make your contribution for the year 2020.
- College Savings: Do you want to save for your kids to go to private school and/or college in a tax-efficient way. Check out this and this article that I wrote about 529 plans and the Coverdell accounts. Unfortunately, to take advantage of the state tax deduction for these plans, you have until December 31 to contribute. So, if you haven’t done so for 2020, you can’t contribute now but you can plan ahead for the year 2021. Remember that usually, it is a good idea to over-save but not a good strategy to over-save in your 529 plan because you might end up paying more in taxes if you do that.
- Roth 401Ks: About 40% of employers in the U.S. offer a Roth 401K plan to their employees. Does your employer offer that? If so, it might be a good idea to check those out in addition to a regular 401K. A Roth 401K works very similar to a Roth IRA. There are three differences – you can contribute more in a Roth 401K than a Roth IRA, your investing choices are usually limited in a Roth 401K by your employer and finally Roth 401K are subject to RMDs. However, you can easily rollover your Roth 401K funds to a Roth IRA to escape from the RMD provision. The advantage of doing a Roth 401K over a regular 401K is that you are contributing post-tax money and you will likely never pay taxes on the gains of this account.
Let me re-emphasize the importance of following up on this financial checklist at least once per year. Many of us spend so much time on trivial decisions such as deciding what stock to buy next, what to sell and some other financial decisions and far less time on the things that I mention in this article. In my opinion, optimizing your decisions about these six things will save you far more money over your working life than you realize.