Your Savings Priority List: What to Fund First—and Why It Matters

We all know the goal is to save as much as possible for retirement. We’re told to save to our 401(k), save to a Roth IRA, save to an emergency fund—save, save, save.

However, what isn’t discussed as often is the order in which we should save to these accounts. Where you save matters. You could be in your early 50s with enough money to retire early, but if all of it is in tax-deferred accounts, any withdrawals before age 59½ will incur an early-withdrawal penalty.

While where you save depends on your goals, there is a general prioritization that works as a guide for most investors. You don’t need to max out any one account before considering the next. The goal is to diversify your savings vehicles because how you withdraw money in retirement is just as important as how you save it.

Before anything else, make sure you have an emergency fund. These should be assets you can access easily and without penalty, typically enough to cover three to six months of non-discretionary expenses. These are necessities—your mortgage or rent, utilities, food, insurance, and medical costs—things you cannot afford to miss. This fund keeps you afloat if you lose your job or experience a disruption in income.

Your next savings priority should be your 401(k) or other employer-sponsored retirement plan, especially if your employer offers a matching contribution. This is free money given to you for participating in the plan. Many employers match the first 4% to 5% of your salary that you contribute.

After establishing an emergency fund and contributing to your 401(k) up to the employer match, your next steps depend on your situation, goals, and income.

If you have a high-deductible health plan, you are eligible to contribute to a Health Savings Account (HSA). These accounts offer triple tax benefits: contributions are pre-tax, withdrawals for medical expenses are tax-free, and after age 65, withdrawals for any purpose are penalty-free—you only owe ordinary income tax on non-medical withdrawals.

The next investment option to consider is a Roth IRA. Contributions are made with after-tax dollars, so there is no immediate tax benefit. However, the money grows tax-free, and withdrawals during retirement are also tax-free. Roth IRA contributions are limited to investors below certain income thresholds, so high-income earners may not qualify. That said, if your 401(k) plan offers a Roth option, you can contribute regardless of income. While not encouraged, you can withdraw Roth IRA contributions (but not earnings) tax-free before retirement if necessary.

From there, consider returning to your 401(k) for additional savings. Contribution limits are significantly higher than those for IRAs, and contributions reduce your taxable income. You may also consider a taxable brokerage account. Contributions are after-tax, but the account has no withdrawal restrictions, and gains may qualify for favorable capital-gains tax treatment.

A general goal is to save around 15% of your annual income for retirement, but that can—and should—be spread among accounts with different tax treatments to give you flexibility later in life.

If you have questions on where you should be saving your funds for retirement, the experts at Henssler Financial will be glad to help: