The government allows you to put a ton of money into tax-advantaged accounts – you just wouldn’t know it at first glance. Technically, a traditional or Roth IRA is the only tax-advantaged account that every working person in the US has access to. As of 2021, the max contribution per person to those accounts is $6,000 per year. It’s a start, but someone saving only $6,000 per year will likely be saving for a long time.
Luckily, there are many other ways to save money in tax-advantaged accounts beyond the IRA or Roth IRA. You just need to think about what you need to do in order to gain access to the additional tax-advantaged space. Admittedly, it takes a lot of work and some unique working situations in order to put away a ridiculous sum of money in this manner. Still, most people with totally normal working situations should be able to save more than they probably think. This post will take a look at just how much someone could potentially save into tax-advantaged accounts.
Since we’re about reaching financial independence here, I’m going to assume for purposes of this article that everyone is under 50 years old. The government, being the nice folks that they are, lets you sock away a little bit more money when you get older. But if you’re reading this and you’re younger, hopefully, you’ll be in a position where you don’t even need to save money when you’re older. Thus, the over 50 catch-up contributions won’t even matter anyway.
The Standard Tax-Advantaged Accounts
Most people in traditional jobs assume that they have access to only two types of retirement accounts – a 401k and a traditional or Roth IRA. Let’s take a closer look at these two accounts.
401k or 403b = $19,500
The majority of you reading this are probably traditional employees with access to a 401k or 403b at work. The 401k is typically provided by your normal, private employer. The 403b is essentially the same thing and typically comes in the non-profit sector. Almost anyone working a professional job will have access to one of these two types of accounts.
As of 2021, the max you can contribute per year into a 401k or 403 is $19,500. Note that the maximum is $19,500 between all of your 401k and 403b accounts. In other words, if you leave your job and happen to have two 401ks during the year, your total yearly max contribution is still $19,500 between all of your accounts.
$19,500 in tax-advantaged savings is a decent start, but it’s not enough if you’re making a good salary and aiming for financial independence. Instead, we’re going to need to add a little bit more savings into our tax-advantaged pot.
Traditional or Roth IRA = $6,000
Every person reading this will have access to a traditional or Roth IRA unless, for some reason, you have no earned income for the year. Since basically all of us probably have to work a job, it’s safe to assume that you can throw some of your hard-earned income into a traditional or Roth IRA.
Some basic vocabulary might be handy here. You contribute to a traditional IRA with pre-tax dollars. You’ll pay ordinary income taxes when you withdraw it. In contrast, you contribute to a Roth IRA with post-tax dollars. In that situation, you’ll pay taxes on your contributions upfront and then you’ll never pay taxes on those dollars again.
I’d typically recommend contributing to the Roth IRA over the traditional if you expect your income to be pretty high in the future. If you’re already making a high income, you won’t be able to contribute to a traditional IRA anyway (or at least you won’t get a tax deduction for your contributions). And if you expect to make a high income later, you’ll want to make sure that all of your traditional IRA space remains empty in order to give yourself the ability to utilize a backdoor Roth IRA in the future.
If you take advantage of both of these standard accounts, you’ll be doing way better than most. With the $19,500 from your 401k or 403b, plus the $6,000 from your Roth IRA, you’re now sitting on $25,500 in tax-advantaged savings. Still good, but let’s see if we can get a little bit more.
Health Savings Accounts (HSA) = $3,600
I’ve written in the past about how the HSA is the perfect tax-advantaged account for millennials. If you want to contribute to an HSA, you’ll need to make sure that you’re signed up for a high-deductible health plan. It’s the only way to gain access to this tax-advantaged space. Most millennials aren’t going to the doctor very often anyway, so it doesn’t make much sense to pay higher premiums for something that we’re probably never going to use.
With the HSA in tow, we’re snagging ourselves another $3,600 of tax-advantaged savings. With the $19,500 from the 401k or 403b, plus $6,000 from the Roth IRA, plus $3,600 from the HSA, we’re now sitting at $29,100 per year of tax-advantaged savings.
The majority of people should be able to contribute to all three of these initial tax-advantaged accounts without having to do anything special beyond signing up for a high-deductible health plan. If you think about it, your typical married couple with both people working should be able to put away well over $50,000 per year in tax advantaged savings. That’s pretty incredible to think that almost everyone can potentially save the median household income in tax-advantaged accounts every single year.
But if you’re in a unique position, maybe you can save a little bit more.
457 Plan = $19,500
One of the pleasant surprises I discovered when I moved over to government work was that I gained access to a 457 plan. I’d never heard of this plan before I started my new gig.
The 457 is basically the same as a 401k or a 403b. It’s provided to you through your employer and any money you contribute to it is done on a pre-tax basis. Typically, only government employees have access to this type of account. There are two key things about this account that make it amazing.
First, unlike a 401k or 403b, the 457 has no early withdrawal penalty. You read that right. You can’t withdraw the money while you’re working for your employer, but once you leave your job, you’re allowed to pull money out of your 457 accounts as if it were any other taxable investment account. This is an amazing benefit for anyone pursuing early retirement.
Second – and a huge benefit for super savers out there – the 457 has a completely separate contribution limit from a 401k or 403b. This basically means that if you have access to a 401k and a 457 plan, you can max out both accounts.
Most people who might have access to a 457 have no idea that they can do this or that they even have access to a 457. I know two physician assistants who both work for public hospitals and both of them only recently discovered that they could contribute to a 457. They’d previously only been maxing out their 403b but had not been taking advantage of the extra tax-advantaged space they had available in the 457 plan.
If you happen to have access to a 457, that’s another $19,500 in tax-advantaged savings you can put away. Doing the math, that’s $19,500 from your 401k or 403b, plus $6,000 from the Roth IRA, plus $3,600 from the HSA, plus another $19,500 for the 457 plan. If you have all of these accounts, you’re now sitting on $48,600 in tax-advantaged savings. A household with access to all of these accounts is looking at putting away an astonishing $97,200 – almost double the median income in the United States.
But we’re not done yet.
Self Employed Retirement Accounts = Up To $57,000
One of the lesser-known benefits of starting up a side hustle is that, by doing so, you gain access to bonus tax-advantaged accounts that other people don’t get to have. There are basically two types of self-employed retirement accounts that matter for our purposes – the SEP-IRA and the Solo 401k.
A person maxing out their 401(k) at work could theoretically save an additional $57,000 into a Solo 401k or SEP-IRA. I knew that you could do this with a SEP-IRA but I didn’t realize that it was possible to save that much into a Solo 401k even if you’re maxing out your employer’s 401k already. However, the IRS provides an example that shows that this is indeed possible:
Source: IRS Retirement Topics – 401(k) and Profit-Sharing Plan Contribution Limits
I’d recommend the Solo 401k simply because it avoids any potential issues with backdoor Roth conversions. Any money in your SEP-IRA counts towards the pro-rata rule and will make backdoor Roth conversions much more complicated or impossible
Obviously, very few people are going to be able to put away $57,000 into their SEP-IRA or Solo 401k. You’d have to make well over $200,000 per year of side hustle income in order to achieve that feat. But, considering how easy it is to side hustle these days, most people should be able to make a few thousand dollars over the course of the year. Even a lowly Uber driver or bike courier like myself can shelter much of that income into this bonus tax-advantaged account.
Someone making use of all of these accounts is looking at putting away a staggering $105,600 in tax-advantaged savings. Obviously way easier said than done. But it’s theoretically possible.
This family could save a ridiculous $197,750.
Additional Tax-Advantaged Accounts
You’ll notice that throughout this exercise, we haven’t even discussed employer matching. If we take that into consideration, many people should be able to add another $5,000 or so to their tax-advantaged accounts.
If you’re a government employee, you might also have access to a pension. My government job required me to contribute 5.5% of our salary into a defined contribution pension plan. My employer put in 6% as a match. This was additional tax-advantaged savings that didn’t count towards any of my other contribution limits.
You could also consider a 529 plan as an additional tax-advantaged account. If you happen to live in a state that offers a tax deduction for 529 contributions, all the better. I personally think of 529 contributions as separate from the tax-advantaged accounts talked about here.
How Much Can You Realistically Save In Tax-Advantaged Accounts?
Realistically, very few people are going to be in a situation where they’re able to fully maximize all of these accounts. However, I think many people can save way more than they think. We already saw that most people can utilize their 401k, Roth IRA, and HSA without much additional work. Combined, that’s over $50,000 in tax-advantaged savings for a normal household. It wouldn’t be that hard to add an additional $1,000 or so in tax-advantaged savings through strategic side hustling.
The following scenario, for example, wouldn’t be crazy:
This household is putting away $55,000 per year in tax-advantaged accounts without having to do anything particularly extraordinary.
Imagine what a two-person household could pull off if both people worked in the public sector and had access to a 457 as well. It would look something like this:
I know a physician assistant couple that could definitely pull this off if they tried. Any couple able to do this would easily be millionaires in just a few years.
Takeaways
It’s pretty shocking to think that it’s possible to save nearly $200,000 in tax-advantaged accounts. Obviously, very few households are going to be in that position, but it’s interesting to see what is possible.
What’s more interesting, though, is the fact that most professional households should be able to put away over $50,000 in tax-advantaged accounts without having to do anything particularly out of the ordinary. If you’ve got a little bit more drive, you can throw in some side hustle income and save even more money each year.
With a median household income of around $50,000 per year, most professional households can essentially save the equivalent of one family’s yearly income every single year.
It seems like the government wants you to save money, especially since they give you so many ways to do it. You just need to do the work and figure out how to take advantage of those opportunities.
