A Proposed Rank Ordering of Wealth-Maximizing Actions
At the 2017, Financial Planning Association (FPA) meeting, Dr. Greg Geisler from the University of Missouri-St. Louis presented research on a hierarchy of steps to maximize wealth. In other words, if people have discretionary income to save or reduce debt, what should they do first?
According to Geisler, Step #1 is to contribute to a matched employer 401(k) retirement savings plan and/or a health savings account (HSA). Interestingly, the tax savings on many employees’ contributions to an HSA increases wealth by more than an employer match on the same employees’ 401(k) contributions. In such cases, the maximum allowable HSA contribution should be made prior to the employee contributing to a 401(k).
After deposits to a matched 401(k) and HSA, which were called Steps 1a and 1b, Geisler suggests the following order of wealth-maximizing actions:
¨ Step #2: Pay off high-interest debts in order of their after-tax interest rate. For example, various credit cards.
¨ Step #3: Put savings into a 529 higher education savings account if an individual is a resident of a state that offers tax savings for contributions.
¨ Step #4: Make unmatched contributions to an employer retirement saving account.
¨ Step #5: Pay off moderate after-tax interest rate debts in order of their after-tax interest rate. For example, low-interest rate credit cards and an auto loan, home equity loan, and student loans.
¨ Step #6: Make deposits to taxable (non-retirement) accounts.
This hierarchy is not “set in stone,” however. There may be excellent non-tax related reasons for not following these financial steps in exact order, such as saving for a house down payment and building an emergency fund.