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AS SOON AS THE BALL dropped, ushering in the new year, I got my ball rolling, making contributions to three tax-favored accounts. Why did I do this in January? I like my investments to have all year to grow.
I go through the same routine every year, and it’s always a chore. I invariably forget what to do and, in any case, the steps involved often change.
The first account I contributed to was my Roth IRA. Since my income is too high to contribute directly to a Roth IRA, I do so via the “backdoor.” For that, you need two accounts: a traditional IRA and a Roth IRA conversion account. Here are the steps I took earlier this month:
It’s easier if you set up the ACH link in advance. Otherwise, it might take several days to activate. Make sure you select the correct IRA contribution year and make sure your checking account balance is adequate before making the transfer.
Next, I moved on to my solo 401(k), which is at TD Ameritrade. This is a 401(k) plan covering a business owner with no employees or the owner plus his or her spouse. It has the same rules and requirements as any other 401(k) plan. The business owner wears two hats with a solo 401(k)—employee and employer—and contributions can be made to the plan in both capacities.
The 2021 employee contribution limits are the same as with other 401(k) plans: $19,500, plus an additional $6,500 for those age 50 and over. You can also make an employer contribution, but it’ll be based on your income and you might not know what that number is until the end of the year. The employee account can be of the tax-deductible or Roth variety and is separate from the employer account, which is non-Roth only. Note: Your contribution can’t exceed your earned income. I made the full employee contribution in January as follows:
Finally, I contributed to my health savings account (HSA). If you have a qualifying high-deductible health insurance plan, you can make tax-deductible contributions to an HSA. The money can be invested in mutual funds and other securities, and then left to grow tax-free. Alternatively, you can withdraw the money tax-free to pay for qualified medical expenses.
If you opt to use non-HSA money to pay those medical expenses, the money in the HSA can grow for years. Keep your medical receipts and you can reimburse yourself with tax-free HSA withdrawals in the future. When used in this way, an HSA is referred to as a “stealth IRA.” Most health insurance providers will let you choose your HSA provider. Mine doesn’t. The process for Connect Your Care, where I have my HSA, is as follows:
I can understand how all this can feel overwhelming, especially the first time around. You can, however, simplify the work in January by completing the following steps in advance:
One last piece of advice: Keep step-by-step notes. Your future self will thank you.
Jannette Collins, MD, MEd, FACR is a radiologist and former chair of a university radiology department. Her previous article was Screening Choices. Janni’s passions are finance and education. She is Director of Medical Content for MRI Online, an educational platform for radiologists, and blogs about radiology jobs, finance and education for The Reading Room. Follow Janni on Twitter @JanniMD.
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Agree with you 100% on the value of HSA’s as an investment vehicle. But I would be careful about front-loading contributions – the IRS says that contributions must be prorated by the number of months that you’re eligible. If you contribute the maximum in January, but then lose your job and HSA plan in June, you’ll need to backout the excess contribution.
Yes, you need to be confident that you will have a HDHP throughout the year. When front-loading the IRA and 401k you need to be confident that you will bring in enough earned income during the year.
A very good plan. I’ve gone through a similar process for years. Fund IRA’s and do backdoor conversions the first week of the year. I also fund my state tax deductible granddaughters 529’s the first week of the year. I plan all this out in December. I can’t do my SEP as my income fluctuates.
Very proactive! 2 or 3 comments: 1) While your insurer may require you to use one particular HSA custodian, you can transfer that money to another custodian without leaving the plan, unlike the situation with 401k’s and 403b’s, where participants are stuck with the custodian until your employer changes it or you leave the job. You could do this every January or every time you accumulate a certain amount. 2) Sometimes, for tax planning purposes, waiting to contribute to an IRA allows the taxpayer to adjust taxable income by choosing either a traditional or Roth IRA or a combination. This isn’t true for you because your income is too high to make a direct Roth IRA contribution. 3) While one can technically save receipts and leave money in an HSA, the IRS has three years to audit in normal situations, and saving all these receipts may increase one’s risk. For this reason, I make it a habit to take the withdrawals for any medical expenses once a year, so that they are rolling off the horizon rather than accumulating until they are far in the past. Like deductible non-cash charitable contributions, such expenses might be an attractive target to an aggressive auditor.
Point 1 can’t be stressed enough: your HSA is your own, and you’re not obligated to stay with the provider that your employer has chosen. A few years ago I setup my own HSA with a provider that had terrific investment choices and didn’t require $1000 or more to remain in a deposit account earning negligible interest. Then I would periodically transfer recent contributions in my employer-chosen HSA over to the Vanguard funds in my own HSA. The financial benefit was well-worth the small bit of hassle entailed by the transfer paperwork.
Good point about being able to have more than one HSA. The insurer-required HSA account I have does not charge any fees (although it would if I changed my insurer) and has reasonable investment options. I find it is a hassle to move $ from one HSA account to another (I’ve had to do it twice) and I don’t like having my money out of the market during the transfer.
I wasn’t aware that there was much risk of an HSA audit. But I will probably spend a lot of my HSA dollars once I’m on Medicare, to pay for Part B and D premiums for my husband and I.
(Stating the obvious,) long term, since HSA dollars are only tax-free until they are inherited, you would want to have used the maximum possible for medical expenses within your lifetimes. I agree HSA’s are unlikely to be audited in their own right, as the IRS doesn’t have enough auditors, but in a general audit deductions requiring documentation are an easy target “along the way” and could also be viewed as an indicator that this return might be more worth auditing. Obviously lower amounts year by year are less interesting to any auditor than large deductions, while expenses being deducted that go back a long time can be harder to substantiate when questioned. My point is that a sure thing now (or a sure thing three years from now) may be worth more than a future possibility. In fact, while perhaps unlikely, the laws could even change at a later point. I point this out to my millennial children who sometimes think it is all a game, or at least their friends do. If it’s a game, it’s one where some of the players can change the rules and others can’t. (And if we’re that good at playing the game, we probably don’t need to max out every advantage! With all this in mind, I’m just saying deferring medical expenses for later reimbursement is a small advantage I choose to skip.)