Optimize Your 2021 Tax Strategy

Have more cash at the end of the year. Plus 2021 IRS contribution limits for your 401K, IRA and HSA.

If you’re planning on saving some money in 2021 for retirement you might as well do it in the most tax efficient way. For the very simple reason that you actually increase the amount of cash you get to keep at the end of the year.

I don’t think most people can really conceptualize this when deciding between their traditional and roth 401K.

But it’s quite true.

FYI, this article is focused on the U.S. as that is where I’m based and that’s what I know.

The three primary retirement tax accounts you should be using

First up is the good old 401K

  • 2021 contribution limit is $19,500 ($26,000 if you are over 50).

There are three levels you should think about here in terms of contributions levels.

1) You should without doubt get up to your employer match level. So, if your employer matches 3, 4 or 5% you should contribute 3, 4 or 5%. Be careful, that your employer plan doesn’t do something like match 50% of each percentage you contribute up to say 3%. This would mean you have to contribute 6% to get the full 3% employer match.


Unless you are 100% sure you will be at your employer in less than a year and the match will never vest. It’s free money!

2) The Second Level to consider is the annual limit that you are allowed to contribute to your 401K. The limit for 2021 again is $19,500. If you contribute this as traditional contributions it dollar for dollar directly reduces your AGI (Adjusted Gross Income) on your taxes. i.e. you will have more total cash at the end of the year by maximizing this deduction.

Note, if you are over 50 the catch up contribution limit is $6,500 in 2021. So you can contribute up to $26,000.

3) Most people will stop at level 2 because the advantages of level 3 are not as great but I want to highlight because I had a specific reason to contribute more than the deductible limit in a previous job. Ok, so first you’re asking you can contribute more than the deductible limit?

Yep, for 2021 the total limit for what can be contributed to your 401K is $58,000. Most people won’t need to do this but you can read more about why you may want to do that here if you are really aggressive with your retirement savings.

The Traditional vs Roth question

Let’s keep it simple. 99% of you should just go traditional.

Whether you put in traditional or Roth or some mix, they both will count towards the $19,500 cap. But only the traditional will get you the tax deduction this year and allow you to maximize your cash savings right now.

If you are truly sophisticated in your plan and you are in a very low tax bracket today and plan to be in a higher bracket in retirement then sure do the math on Roth vs traditional.

But for most people that aren’t quite sure, just go traditional.

Note, the $19,500 limit does not include the employer match. But the $58,000 limit does.


The IRA is similar to your 401K except that it’s outside of your employer.

  • 2021 contribution limit is $6,000 ($7,000 if you’re over 50).

If you are hitting level 2 on the 401K and can contribute more to retirement this is the next place you should be doing it.

The IRA has the same rules as the 401K, it is deductible from your AGI reducing the total amount of taxes you are paying. As well as you can contribute either before (traditional) or after (Roth) tax.

Again, unless you are a sophisticated investor with your entire future mapped out go traditional and max that cash out this year.

One quirk to note on the IRA, is that unlike the 401K you have until April 15th of the following year to make your current year contribution. i.e. you have until April 15, 2021 to make your contribution for 2020 so can still receive a deduction and increase your tax refund this coming spring.

Another point in the favor of an IRA is that you can buy a wider variety of investments with your IRA. 401K’s are limited to what your 401K provider determines (mostly mutual funds and index funds) but with an IRA you could buy say Apple, Amazon, Tesla, GBT etc. Be very careful with this though, as most of your money should probably be in index funds so if all you contribute to is an IRA this could lead you down a bad path.

HSA (Health Savings Account)

Ok, this is by far my favorite tax retirement account.

Yep, that’s right retirement account, not healthcare account. Because if you don’t use it you can save it, invest it and use it for retirement when you turn 65.

And the best part is that for most of these retirement vehicles you make the choice to either get taxed now (Roth) or in the future (Traditional). But the HSA if you use it for health expenses either now or in the future it is never taxed.

How to set up your HSA

So, first your employer needs to offer the HSA and not all employers do. But a lot more seem to be adopting these than have had them in the past, so double check with your employer even if you didn’t see that option in the past.

The HSA is quite different than an FSA by the way. The FSA you lose every year.

But a HSA works like a retirement account. You keep the balance you don’t spend at the end of the year and it just keeps adding up year after year. There are people out there with over a $100,000 in their HSA accounts.

And the best part of course is if you do not ever use those funds on health care you can still withdraw it like a 401K or IRA after you are 65 with no penalty and simply pay taxes on it like you would with a roth 401K or IRA.

The reason I love this one is that if you are going to spend 2, 3, 4K a year on your healthcare match whether you have a HSA, FSA or other health care plan. Why not get to keep that money at the end of the year and let it build like a retirement account.

We’ll get into high deductible etc. in another post. And if you are a family with significant healthcare needs maybe this is not the answer for you.

But for you young, healthy people, who don’t have very much healthcare expenses. HSA all the way baby!

  • Limit is $3,600 for 2021 for individuals and $7,200 for families.

Make sure once you pass the $1K limit in your HSA that most plans require you to keep in a cash account that you set up an automatic investment for all contributions over that $1K. I have mine set up to all go into an S&P index fund.

So, by the way how exactly do all of these retirement accounts maximize the amount of cash you are bringing home at the end of the year?

Ok, so simple example. If your income after your personal and standard deduction is $100K a year and don’t use any of these retirement accounts and have an effective rate of 15% you’ll pay $15K in taxes and take home $85K at the end of the year.

If you max out your 401K, IRA and HSA for 2021 in the amounts of $19.5K, $6K, and $3.6K reducing your AGI from $100K to $70,900 you will push down your AGI used to calculate your taxes and your effective rate will actually be 12.4%** and your taxes will be $8,778 for the year. So, you will be taking home $100K minus $8,778 or $91,222.

i.e. you have maximized the cash you are taking home $6,222 ($91,222 vs $85K) by using these strategies.

** The effective rate is lower as the $29,100 you are no longer paying taxes on is in the highest bracket.

This article is for informational purposes only, and it should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions

Finance professional with a passion for reading, writing, history, economics and the world.

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