My Investing Hierarchy: A Breakdown of My Accounts

Recently I came across a statistic that stopped me dead in my tracks: 71% of women and 60% of men keep their money in cash. There are perfectly good reasons why someone might hoard cash, but I have a feeling that for many people, holding money in a savings account can give the illusion of a complete money strategy. As long as you’re not spending more than you earn, you’re all good, right?

Setting aside money in a savings account can only get you so far. If you want to get on the path to riches, you need to make the money you do save actually work for you. And for me, investing has been the key to growing my money exponentially.

I’m a natural minimalist, but when it comes to investing, I’ve been a greedy little squirrel hoarding all the acorns. Over the years, I’ve amassed five different investment accounts, and as of this post, those accounts make up 96% of my net worth.

I’m not saying those percentages are right or wrong, but it’s worth investigating why. There are a million articles on why investing is important, but many people don’t explain why they picked one account over another. So today I’m explaining which accounts I have and how those choices were affected by my real-life situation. If you haven’t already, you can start thinking about a hierarchy of an investing plan, and the pros and cons for each type of account.

PS: There are lots of rules to hold in your head, so I’ll try to be light and breezy so this doesn’t read like some kind of Wikipedia article.

Important reminder: I’m not a financial advisor, so please consider your own situation (because it’s probably a lot different from mine) and do your own research before making investment choices.

Was I Ready to Invest?

I probably should have done some math to decide whether or not to invest, but I’ll be honest with you: I jumped in without thinking much about it. Sometimes if you think about things too long, you never end up doing it. For me, there was one idea that compelled me to start investing: the idea of losing money didn’t scare me, but the possibility of not growing my money was absolutely terrifying. Investing was a no-brainer: I wanted to make money in my sleep. For a while, I was living paycheck to paycheck and barely scraping by. But once I started seeing money land in my checking account consistently, that was the green light to get started.

LEVEL 1: THE 401K MATCH

I started by investing through my 401k–student loans and credit card debt be damned–for one reason: that 401k match. My boss explained it as “free money”, and I didn’t want to miss out on an opportunity I might not get again. Getting an employer to match your contributions can be like a 100% return:

Let’s say I make $30,000 and my employer contributes 100% of up to 5% of my salary. So if I contributed 5%, or $1,500, then my employer would add in another $1,500. It’s like doubling your money without having to do anything.

Contributing to my 401k was also a lifestyle choice. I always contributed more than the match, at least 15%, because I wanted to make my paychecks smaller and get used to living on less. It helped that my credit card debt was only in the few thousands, and I imagine if I had more debt, I would have only contributed up to the match.

Once my high-interest credit card debt was cleared, and I had extra money laying around, I started getting curious about other places I could invest. Where else could I park my money so it would grow?

LEVEL 2: IRAS

As I’ve crossed socio-economic classes, here’s something I’ve noticed: Wealthy people think about how they can minimize their taxes. So, besides having money for when you’re old, another huge perk of investing is the tax breaks you can get.

One of those ways is by investing through tax-advantaged accounts, like these:

401K/403B/457
Roth IRA
Traditional IRA

I already contributed to my company’s 401k, so my next step was opening up a separate retirement account on my own, and choosing between a Roth IRA or Traditional IRA. This is where analysis paralysis can really set in, and thankfully, that didn’t happen to me.

In an IRA account I’d get to contribute up to $6,000 per year ($7,000 for people age 50 or older) for retirement and take advantage of some special perks that the 401k doesn’t offer.

In a nutshell, here’s how the two IRAs types differ:

Roth IRA = You pay taxes upfront, and the rest grows tax-free
Traditional IRA = You defer taxes now, and pay taxes when you withdraw the money (similar to a 401k)

Note that these are just two types of IRAs, and there are several more, depending on your situation.

I’ve been in the 15-25% tax bracket since I started investing. But I had no idea if my tax bill would be higher or lower when I retired 30+ years from now. But the Roth IRA sounded a lot like ripping off the bandaid of paying taxes now and reaping the benefits later. Where do I sign up?

First I had to see if I actually qualified, based on income. IRA eligibility rules are complex, so instead of reading a million websites I really wish this handy quiz existed, which would have helped me decide which IRA to choose.

Before figuring out when I wanted to pay taxes, my income could have been the ultimate deciding factor.

For a Roth IRA, here are the income limits for being eligible:

$139,000 for single filers and $206,000 for married couples filing jointly.

Sorry, some of you 22-year-old engineers making ballin’ salaries at Google are out of luck 🙂

If you have a retirement plan through your job, here are the income eligibility rules for a Traditional IRA:

Full deduction – Up to $123,999 for single filers and $195,999 for married couples filing jointly.
Partial deduction – Between $124,000 and $139,000 for single filers, and between $196,000 and $206,000 for married couples filing jointly.

Basically, if your taxable income is more than the amounts above, then you get no tax deduction, which means contributing to a Traditional IRA won’t do you much good. And ugh, the deduction you get also depends on whether or not you have access to a retirement plan at work.

At the time, I was making less than $40k per year and in the 15% tax bracket, so I qualified for both types of accounts. But like my decision to grab that 401k match, I thought, “I might never make this low of a salary ever again.” Better maximize this Roth IRA while I have the chance and pay the lower taxes now. I mean, as most people get older, they tend to make more money, and that’s definitely how it’s played out for me.

Another big plus for the Roth IRA was flexibility. I liked that withdrawal rules were fairly generous: I could withdraw contributions early if I desperately needed it (because I wouldn’t touch the money, otherwise). And the fact that you can withdraw up to $10,000 for a down payment on a house was super appealing. I had no plans for buying a house at the time, but I might change my mind later. With the traditional IRA, the withdrawal rules are strict: I can’t take out the money until I’m 59 ½ without getting charged a 10% penalty.

I also wanted to diversify when I would pay the taxes. With the 401K, I was already going to defer paying taxes until I retire. So why not try the opposite option (paying taxes now) with a Roth IRA? I have no idea what taxes will be like when I retire so putting some money in an account where I pay taxes now seemed like a nice hedge.

Looking back, I’m really glad I prioritized contributing the max to my Roth IRA every year until I no longer could (more about that later).

So my three main deciding factors for which IRA to choose were:

How much money I was making
When I thought I might need the money
When I wanted to pay taxes

A few years later I picked up a Traditional IRA account. Yes, you can contribute to both accounts, as long as the combined amount doesn’t exceed the maximum allowed (in my case, it was $5,500 per year). I didn’t know about this little fact at first and over contributed one year–oops. Anyway, the Traditional IRA acts a lot like a 401k, as they both defer taxes, so when I found myself working at company with no 401k, that was the year I contributed to my Traditional IRA.

Then I quit my job. I had to decide what to do with my old 401k, and since I didn’t have a new job and 401k to roll it into, I moved the money into my Traditional IRA account via direct rollover.

And that’s how I ended up with both Roth IRA AND Traditional IRA accounts.

LEVEL 3: TAXABLE ACCOUNTS

My income rose as I job-hopped and negotiated, and I steadily added more to my 401k plan until I eventually hit the limit. Even though I maxed out all my tax-advantaged accounts, I still had money left over to invest.

My next step was opening a taxable account. This means the money comes from my paycheck post-tax. Then if I sell my investment shares, I have to pay a tax on the earnings. Instead of paying taxes one time, like with the IRAs, I get to pay twice. Let’s look at a real scenario that happened a few months ago:

I bought $5,000 worth of shares in an individual stock. A few months later, that investment grew to be worth $10,282. I decided to sell, because oh my god, investing in individual stocks is emotional turmoil.

It looks like I made $5,282 off the deal, which seems pretty awesome, right? Basically doubled my money. But in this specific case, I have to pay my regular tax rates on that $5,282. Remember that I live in NYC and for that privilege, I pay federal taxes, state taxes, AND city taxes. This means my real net ends up being about $3,500. How much you get taxed on the earnings also depends on when you sell.

This is why taxable accounts are at the bottom of the totem pole in terms of tax-efficient investment accounts.

So why would I put money in an account that doesn’t seem to help me?

There are also some sweet advantages that IRAs don’t have. For example, way fewer rules to navigate:

You can take the money out whenever you want
No income limits

No rules, except you have to pay taxes on the money you contribute and then again on the earnings. Even more flexibility than the Roth IRA. And even when I have to pay tax on the earnings, I still come out ahead versus leaving the money in a savings account, barely beating inflation.

LEVEL ‘WHENEVER AVAILABLE’: HEALTH SAVINGS ACCOUNT

Did you know that you can contribute money to a special account, invest the money and let it grow, then use the money to pay for healthcare expenses? That’s the Health Savings Account (HSA)–an account that you can only get if your employer offers it to you as part of a health insurance package. I’ve only been able to get it at my current job, and I saw something-something about taxes, so obviously I jumped on it right away. Here are the details:

The money you contribute is pre-tax, the earnings are tax-free (if you invest it), and you don’t pay taxes when you withdraw the money for qualified medical expenses.

That’s right. You pay ZERO taxes on any of it. Contributions or withdrawals. To sweeten the deal, my company also kicked in a couple hundred dollars per year into my account.

The downside is that when you sign up for this account you also have to sign up for a high-deductible health insurance plan. At the time, my deductible was $1,650 versus $700 with a normal insurance plan. I was responsible for paying $1,650 out of pocket before insurance kicked in. Guess how fun it was when I broke my finger playing catch in the park and had to pony up over $1,000 in medical bills? However, I’m generally healthy, so I still felt like the HSA was worth it for me. Especially as I’ve watched the money grow over time.

My husband used to run a lot and the other day he was lamenting how he’d have to get both knees replaced at some point. And I was like, “Don’t worry, honey, I have set aside money to buy you the nicest knees on the market–the equivalent of 18k gold grills.” As medical expenses no doubt increase, it’s nice to have an option to grow the money I set aside instead of leaving it in a savings account.

Next Steps: A Lucky Problem to Have

Remember the income eligibility limits I listed above in the IRA section? Well, now that my husband and I are married, we no longer qualify to contribute to a Roth IRA or get a tax deduction with the Traditional IRA. So I’m looking at advanced strategies for high earners, like the Backdoor Roth IRA. The fact that I have an existing (and hefty) traditional IRA complicates things, so I’m looking into rolling that my existing traditional IRA money into my 401k. After a year of “looking into this,” I’ve finally found a form on my company’s website that explains how to transfer IRA money into my 401k. Baby steps. Once I have everything set up, my husband and I can contribute $6,000 each into new Traditional IRA accounts, and then convert those to Roth IRAs.

I really, really miss my Roth IRA. It was the first investment account I opened by myself, and as nerdy as it sounds, when I couldn’t contribute to it anymore, it felt kind of bittersweet. Welcome to my world, where I get upset that I can’t invest in an account.

Summary

There’s no right or wrong way to invest, but here’s the order of how I’ve decided to invest:

15% or more into my employer-sponsored retirement plan
Roth IRA, if under income limits
Go back and contribute the max in employer-sponsored retirement plan
Taxable account once the above three are complete
Bonus: Health Savings Account, if available and I’m young/healthy
Bonus: Traditional IRA, if no employer-sponsored plan

For me, a driving factor behind the accounts I chose is diversification. I don’t want to lock up all my money for when I’m 59 ½, but I also want to make sure I’m being smart with taxes for both now and the future.