Side Lesson 11: Retirement Accounts — 401(k), IRA, Roth, HSA, and the Optimal Contribution Stack

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1. Why This Is Important

The US tax code hands every working household a stack of tax-advantaged wrappers — a 401(k), an IRA in two flavours, a Roth, an HSA, and (for some plans) a mega-backdoor channel — and the dollar limits go up nearly every year. In 2026 the headline numbers are: $23,500 in a 401(k) ($31,000 if you're 50+), $7,000 in an IRA ($8,000 if 50+), $4,300 in an HSA single ($8,550 family), and a total 401(k) cap of $70,000 when you stack employee deferral, employer match, and after-tax mega-backdoor contributions. Used in the right order, these wrappers shelter roughly six figures per year of pre-tax income for a high-earner household.

Four reasons this lesson matters more than any equivalent hour of fund selection:

The match is a 50-100% guaranteed return. A 401(k) employer

match of 50¢ on the dollar up to 6% of salary is a 50% instant return on the marginal dollar. No equity strategy on Earth pays that. Skipping the match is the single most expensive mistake in retail finance, and roughly one in five eligible workers does it anyway.

The HSA is the only triple-tax-advantaged wrapper. Deductible

going in, growth tax-free, withdrawals tax-free for qualifying medical expenses. Save the receipts and reimburse yourself decades later and the HSA functions as a stealth Roth IRA with a deduction on top.

The Roth-vs-Traditional choice compounds for 30+ years. Pick

wrong and the cost is 10-20% of your terminal wealth. The decision reduces to one comparison: **your current bracket vs. your expected retirement bracket.** Get that comparison right and the rest is bookkeeping.

The order matters more than the level. Two identical earners

contributing the same total dollars get different terminal wealth if they fund the wrappers in a different order. The interactive on the website ranks the stack and tells you the marginal dollar's home.

Horace's deeper view — "tax via options and margin" — sits beneath this entire lesson: every dollar that lands inside the right wrapper is a dollar the IRS cannot tax, ever, at the right endpoint. The stack is the cheapest alpha you will ever find — written into the code, public, mechanical.

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2. What You Need to Know

2.1 The 2026 Contribution Limits — One Page

Every wrapper has a separate annual limit. Filling all of them is not double-counting; it is the optimal stack.

Wrapper	2026 limit	50+ catch-up	Income limit?
401(k) employee deferral	$23,500	+$7,500 = $31,000	none
401(k) total (incl. match + after-tax)	$70,000	+$7,500 = $77,500	none
IRA (Traditional or Roth)	$7,000	+$1,000 = $8,000	Roth phases out $165-180k single / $246-256k MFJ
HSA, single coverage	$4,300	+$1,000 at 55+	HDHP required
HSA, family coverage	$8,550	+$1,000 at 55+	HDHP required
457(b) (govt / non-profit)	$23,500	+$7,500	sometimes stackable with 401(k)

Two operational notes. First, the catch-up (age 50+) is allowed only if your plan permits it; almost all do for the 401(k), the IRA catch-up is statutory. Second, the HSA requires you to be enrolled in a High-Deductible Health Plan (HDHP). If your employer offers a PPO and an HDHP, the HDHP usually pairs with an HSA — and most years, for healthy savers under 50, the HDHP plus maxed HSA is the mathematically dominant choice.

The total 401(k) cap of $70,000 — sometimes called the §415 limit — is the most under-used dollar in the code. It includes your $23,500 employee deferral, your employer match, and any after-tax non-Roth contributions your plan permits. The space between (deferral + match) and $70,000 is the mega-backdoor Roth lane: contribute after-tax dollars into the gap, immediately convert to Roth via in-service rollover, and another $30,000-$45,000 per year flows into the tax-free wrapper that is otherwise capped at $7,000.

2.2 Traditional vs. Roth — The Single Decision That Matters

Every wrapper in the stack is one of two flavours.

Traditional (tax-deferred). Pre-tax going in (deduction today), tax-deferred growth, taxed as ordinary income on withdrawal. Think: "tax break now, pay later."

Roth (tax-free at the back end). Post-tax going in (no deduction today), tax-free growth, tax-free withdrawals after 59½ and a five-year holding window. Think: "pay now, never again."

The fundamental decision is bracket arbitrage. Hold today's $1 of contribution constant; the after-tax wealth at retirement is:

$$ W_{\text{Roth}} = (1 - t_{\text{now}}) \cdot (1 + r)^{N} $$

$$ W_{\text{Trad}} = (1 + r)^{N} \cdot (1 - t_{\text{ret}}) $$

The two are **algebraically identical when $t_{\text{now}} = t_{\text{ret}}$**. Roth wins when your retirement bracket is higher; Traditional wins when your retirement bracket is lower. The image below makes the parity visible.

Three working rules.

• High earner, expecting to spend down hard in retirement → Trad.

A 37% bracket today and a 22% bracket at 70 (after Social Security, no wages) is a 15-percentage-point arbitrage. Take the deduction now, pay the lower rate later.

• Young, modest income, expecting to be richer later → Roth. A

22% bracket at 28 with a 32% expected bracket at 50 is the inverse arbitrage. Pay now while the rate is low, lock in tax-free growth forever.

• Don't know? Split. A 50/50 Roth/Traditional 401(k) hedges the

uncertainty. The split also gives you "tax diversification" — in retirement you choose which bucket to draw from based on each year's bracket.

The often-overlooked bonus for Roth: **no Required Minimum Distributions during the original owner's lifetime**. A 75-year-old with $2M in Traditional IRAs is forced to withdraw roughly $80,000 each year (taxed at ordinary rates), regardless of need. The same $2M in a Roth IRA can sit untouched, compounding tax-free, and pass to heirs. For high-net-worth households, the no-RMD feature alone tilts the math toward Roth even at parity brackets.

2.3 The Optimal Contribution Stack — Six Tiers

The image at the top of this lesson is the cheat sheet. The logic under each tier is what makes it stick.

Tier 1 — Capture the employer 401(k) match in full. The most expensive mistake in retail finance is leaving match dollars on the table. A typical formula is "50% match on the first 6% of salary" (a 3% gift if you contribute 6%) or "100% match on the first 4%." Whatever your formula, the marginal return on the dollar that captures the last bit of match is 50-100% guaranteed. No investment beats that. Even if you have credit-card debt, even if your plan's fund menu is mediocre, capture the match first.

Tier 2 — Max the HSA if you have an HDHP. Triple-tax-advantaged. $4,300 single / $8,550 family in 2026. Pay for current medical out of cash flow when possible, save the receipts, and let the HSA compound. After 65 the HSA can be withdrawn for any purpose at ordinary rate (like a Traditional IRA), with the medical-tax-free option preserved indefinitely. There is no other wrapper in the code with this profile.

Tier 3 — Max the Roth IRA (or backdoor it). $7,000 a year. If your income is above the phaseout ($165,000-$180,000 single in 2026), the backdoor Roth route still works: contribute non-deductible to a Traditional IRA, immediately convert to Roth, pay zero tax on the (zero) gain. The catch is the pro-rata rule — if you have existing pre-tax balances in any Traditional IRA, the IRS treats every conversion as a proportional mix of pre-tax and after-tax across all your IRAs. The fix is to roll any pre-tax IRA balances into your current 401(k) first, leaving the Traditional IRA empty for the backdoor operation.

Tier 4 — Max the 401(k) employee deferral up to $23,500. Whether you contribute to the Traditional or Roth bucket within the 401(k) follows §2.2's bracket logic. The employer match always lands in the Traditional bucket regardless of your election.

Tier 5 — Mega-backdoor Roth, if your plan permits. Verify two plan features: (a) after-tax (non-Roth) employee contributions are allowed above the $23,500 deferral, and (b) **in-service Roth rollover** is allowed (sometimes called "in-plan Roth conversion"). If both are present, contribute up to (Total Cap − Deferral − Match) in after-tax dollars and immediately convert. Math example: $70,000 total cap − $23,500 deferral − $11,500 match = **$35,000 mega-backdoor lane**. That is $35,000 a year flowing into a Roth wrapper that the IRA's $7,000 limit would otherwise cap.

Tier 6 — Taxable brokerage. The wrappers are full. Now asset-location and tax via options become the levers. Side Lesson 4 covers this layer.

The stack is strict priority: empty Tier 1 before opening Tier 2, empty Tier 2 before Tier 3, etc. The interactive on the website allocates a user-supplied annual cash-flow figure across all six tiers in this order and reports the projected after-tax wealth at 65.

2.4 The Backdoor and Mega-Backdoor in Detail

Backdoor Roth IRA (high-income earners). Required when your income exceeds the Roth IRA direct-contribution phaseout.

Contribute $7,000 (or $8,000 if 50+) non-deductible to a

Traditional IRA. There is no income limit on non-deductible Traditional contributions.

Convert the entire balance to a Roth IRA, ideally within days of

the contribution and before any gains accrue.

File Form 8606 with your tax return to document the

non-deductible basis.

The conversion is taxable on any pre-tax basis or accrued earnings; zero in the clean case. The pro-rata rule (§2.3) makes this messy if you have other pre-tax IRA balances — clean those out first by rolling into a 401(k) that accepts incoming rollovers.

Mega-backdoor Roth (plan-dependent). A separate operation that uses the §415 total cap.

Verify your 401(k) plan supports after-tax non-Roth

contributions and in-service rollovers (look at the SPD or call HR).

After hitting the $23,500 employee deferral, instruct payroll to

contribute additional after-tax dollars up to the gap between (deferral + match) and $70,000.

Configure an automatic in-plan Roth conversion so each

after-tax contribution flips to Roth on the next pay cycle. If automatic isn't available, do quarterly manual conversions to minimise pre-conversion gains.

A plan that allows the mega-backdoor has effectively raised your annual Roth contribution ceiling from $7,000 to $30,000-$45,000. For high earners, this is the largest single-wrapper opportunity in the code.

2.5 The 5-Year Rules (Plural) and Roth Conversion Ladders

There are two distinct five-year rules for Roth IRAs, and they trip up almost everyone.

Rule A — the five-year holding period for earnings. Before age 59½, your Roth contributions can be withdrawn anytime tax- and penalty-free. The earnings on those contributions are a different story: to withdraw earnings tax-free, the Roth IRA must be at least five years old (measured from the first Roth contribution to any Roth IRA you own — once the clock starts, it never resets). Otherwise earnings withdrawals before 59½ are taxable plus 10% penalty.

Rule B — the five-year holding period for converted amounts. Each Roth conversion starts its own five-year clock. Withdrawing a converted amount before five years have passed (and before 59½) triggers the 10% early-withdrawal penalty on the conversion principal.

Roth conversion ladder. A retirement-distribution strategy that exploits Rule B. Steps:

Retire early, say at age 50. Begin annual Roth conversions of

~$50,000 from your Traditional IRA, paying ordinary income tax on each conversion (in the low income-window of early retirement).

Wait five years for each conversion to "ripen." A conversion done

at 50 is withdrawable penalty-free at 55. A conversion done at 51 is withdrawable at 56. And so on.

Starting at age 55, withdraw the converted principal annually,

tax- and penalty-free. (You already paid tax at conversion; it's Roth dollars now.)

By 59½ all rules collapse — everything in the Roth is fully

accessible tax- and penalty-free regardless of conversion date.

This is the standard FIRE-movement bridge between early retirement (50-59) and traditional retirement-account access (59½+). The 5-year ladder transforms a "locked until 59½" Traditional IRA into spendable cash starting at 55.

2.6 Required Minimum Distributions (RMDs) — The Back-End Tax

For Traditional 401(k)s and Traditional IRAs, the IRS eventually collects. SECURE Act 2.0 (passed 2022) raised the RMD age:

• Born 1951-1959: RMDs begin at age 73.
• Born 1960 or later: RMDs begin at age 75.

The annual required amount is your prior-year-end balance divided by the IRS Uniform Lifetime Table life-expectancy factor. At 75 the factor is ~24.6, so the RMD is roughly 4.1% of the balance that year, rising to about 6.1% at 85 and 10% at 92. RMDs are taxed at ordinary rates.

Roth IRAs have no RMDs during the owner's lifetime. Roth 401(k)s also no longer have RMDs as of 2024 (a SECURE 2.0 change). Inherited Roth IRAs do have a 10-year payout rule for non-spouse beneficiaries, but the distributions are still tax-free.

Penalty for missing an RMD. SECURE 2.0 lowered the penalty from 50% (savage) to 25% (still savage), reducible to 10% if corrected within two years. Set a calendar reminder on December 1st of every RMD year.

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3. Common Misconceptions

**Misconception 1: "The 401(k) and IRA limits are combined; I can only contribute one or the other."**

False. They are separate limits. A 50-year-old in 2026 can contribute $31,000 to a 401(k) and $8,000 to an IRA in the same year, totalling $39,000 across the two wrappers — plus HSA, plus mega-backdoor.

**Misconception 2: "Roth always wins because tax-free growth is better than tax-deferred."**

It is the same number when current bracket = retirement bracket. The algebra in §2.2 is exact. Roth wins only when retirement bracket is higher than current bracket.

Misconception 3: "I make too much for a Roth IRA."

The income phaseout blocks direct Roth contributions. The backdoor Roth (§2.4) is fully legal and has been blessed by Congress (the 2018 TCJA technical-corrections language explicitly acknowledged it). Most high earners are using it.

**Misconception 4: "The 401(k) match goes into my Roth bucket if I elect Roth."**

No. The employer match always lands in the Traditional (pre-tax) bucket regardless of your contribution election. You will pay ordinary tax on the match dollars at withdrawal.

**Misconception 5: "I should max my 401(k) before capturing the match — I'll get to the match anyway."**

No. The match is per-paycheck in most plans, with no annual true-up. If you front-load contributions and hit the $23,500 cap by July, you forfeit the match for the rest of the year. Spread contributions across the full 12 paychecks to capture every match dollar.

**Misconception 6: "The HSA is just for medical expenses; I should use it as a checking account for prescriptions."**

The HSA is an investment account with optional medical-expense withdrawal. Pay current medical out of pocket if your cash flow allows, save the receipts, let the HSA compound for 30 years, and reimburse yourself the receipt amount at any time tax-free. The optimal use of the HSA is to not spend it.

Misconception 7: "Mega-backdoor is only for tech bros at FAANGs."

It depends on whether your plan supports after-tax contributions and in-service rollovers. Many plans do (read the SPD or call HR), and the share is rising as more plans adopt the feature. Public-sector and small-business plans tend to lack it; mid-large corporate plans often have it.

Misconception 8: "I'll convert everything to Roth in retirement."

Each conversion is taxable as ordinary income in the year of conversion. Converting $500,000 of Traditional IRA in a single year will push almost all of it into the 32-37% bracket, plus IRMAA Medicare surcharges, plus possibly state tax. The mechanical rule is convert only enough to fill the next bracket edge each year — spread over a decade if needed.

Misconception 9: "If I leave my employer I lose the 401(k) money."

Your own contributions are 100% vested (yours forever). The employer match may be on a vesting schedule (typically 3-6 years graded or cliff). On separation you can leave the 401(k) where it is, roll it to your new 401(k), or roll it to an IRA. Don't cash it out — that triggers ordinary tax + 10% penalty + the loss of decades of compounding.

**Misconception 10: "Roth conversions in retirement are pointless; I'll never spend the converted amount."**

The point is to **drain the Traditional balance into the Roth wrapper before RMDs hit at 75**. Each conversion in your low-bracket years 60-74 reduces the future RMD denominator. A $100,000 conversion at 65 in the 22% bracket costs $22,000 in tax and removes ~$4,100/year of mandatory ordinary-rate withdrawals starting at 75.

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4. Q&A

**Q1: My 401(k) has a $23,500 employee limit and a $70,000 total cap. What happens between those numbers?**

That gap is the after-tax non-Roth contribution lane. If your plan permits it, you can contribute additional after-tax dollars up to the total cap, then immediately convert each contribution to Roth via in-service rollover (the mega-backdoor). If the plan doesn't permit it, the gap is filled only by employer contributions.

Q2: I'm 28 and in the 22% bracket. Roth or Traditional 401(k)?

Almost certainly Roth. At 28 your wage trajectory probably points up, and 22% is near the bottom of the schedule. Lock in tax-free growth now while the rate is cheap. Reconsider when your bracket crosses 32%.

**Q3: I'm 52, in the 32% bracket, with $1.5M in a Traditional 401(k) and $250k in cash. Anything I should be doing?**

Three things. (a) Continue maxing the 401(k) at 32% — Trad probably right given your bracket. (b) Add $8,000/year to a backdoor Roth IRA. (c) Investigate whether your plan permits the mega-backdoor — $35,000+ a year of after-tax-to-Roth at your stage materially changes the retirement tax picture.

**Q4: I have an old 401(k) from a previous employer and a Traditional IRA. How do I do a clean backdoor Roth?**

Roll the Traditional IRA (and any pre-tax balances) into your current 401(k) first. Most plans accept incoming rollovers from both other 401(k)s and IRAs. Once your Traditional IRA balance is zero, the backdoor (non-deductible Traditional contribution + immediate conversion) is clean: pro-rata applies to a $7,000 base of $7,000 = 0% taxable.

Q5: My wife stays home with the kids; can she contribute to an IRA?

Yes. The Spousal IRA rule lets a non-working spouse contribute up to the IRA limit ($7,000, or $8,000 if 50+) using the working spouse's earned income, as long as the couple files jointly and the working spouse has at least that much earned income. The spousal IRA can be Traditional or Roth, subject to the same income phaseouts.

Q6: Can I use a Roth IRA to buy a house?

You can withdraw your contributions (not earnings) at any time, tax- and penalty-free. Additionally, $10,000 of earnings can be withdrawn for a "first-time" home purchase (defined liberally — no home in the prior 2 years counts) tax- and penalty-free, provided the Roth has been open at least 5 years. Above that, the early- withdrawal rules apply.

Q7: I'm self-employed. What's my retirement-account stack?

The two main wrappers are the Solo 401(k) (employee deferral $23,500 + employer profit-sharing up to 25% of net SE income, total cap $70,000 — same as a regular 401(k)) and the SEP-IRA (up to 25% of net SE income, capped at $70,000, no separate employee deferral). Self-employed individuals often pair a Solo 401(k) with a backdoor Roth IRA. The HSA still applies if you have an HDHP.

**Q8: I'm in a high-tax state (CA, NY, NJ). Does that change the math?**

Slightly. State income tax adds 5-13% to the ordinary rate, amplifying the gap between current and retirement brackets if you plan to retire in a no-tax state (FL, TX, NV, WA, TN, NH, SD, WY, AK). A Californian at the 32% federal + 9.3% state bracket retiring to Florida arbitrages 9.3 percentage points of state tax by choosing Trad over Roth and also by deferring conversions until after the move. Tax-domicile planning is a real lever.

**Q9: At age 75 I'm forced to take RMDs from my Traditional IRA but I don't need the cash. What do I do?**

Two clean options. (a) Take the RMD as a **Qualified Charitable Distribution (QCD)** — direct from the IRA to a qualified charity, counts toward the RMD, and is excluded from your AGI. The 2026 QCD limit is roughly $108,000. (b) Take the RMD as cash, pay the tax, and reinvest in a taxable brokerage account using Side Lesson 4's asset-location playbook.

**Q10: What's the actual after-tax benefit of contributing to a 401(k) match instead of just a taxable account?**

For a 32% bracket worker contributing $5,000 with a 100% match, here are the dollar paths over 30 years at 7% growth, after-tax at 32% ordinary withdrawal:

• Match'd Trad 401(k): $10,000 contributed → $76,123 future

value × (1−0.32) = $51,764

• Taxable instead: $5,000 (after-tax already) → contributing

$5,000 in taxable, growing at ~5.5% net of tax drag → $24,800

The match alone doubles the lifetime after-tax outcome. Capture it.