What Is the Tax Efficiency Ladder?

What it is

The Tax Efficiency Ladder is Financial Fellowship's funding order for a physician household's accounts, a sequence of rungs climbed in order rather than a menu chosen from.

The order changes the outcome more than the amount does, because each rung differs in how the money is taxed on the way in, while it grows, and on the way out.

This ladder orders the accounts only. The waterfall wraps around it: the match first, then one month of reserves, cards to zero, and coverage, before the rest of these rungs fill. Reserves reach three months after the workplace plans are maxed, and the reserve is finished, six months of expenses on W2 income or twelve months on 1099 income, after debt above 7 percent and before taxable investing.

The rungs

1. The workplace plan, up to the full employer match The match is compensation the household has already earned and has not claimed.
2. A backdoor Roth contribution for each spouse Most attending households are above the income threshold for a direct Roth contribution, which makes the backdoor route the standard path. The pro rata rule has to be cleared first. A household with existing pretax IRA balances can trigger an unexpected tax bill by executing this step out of order, and that single detail is the difference between a clean conversion and an expensive one.
3. The health savings account, if the household is on a qualifying high deductible plan It is the only account that can go in untaxed, grow untaxed, and come out untaxed for qualified expenses.
4. The workplace plan, to the annual limit The workplace plan, to the annual limit.
5. Additional employer plans the household has access to Some employers offer a second deferred plan, and a governmental 457(b) carries its own separate limit. Self employed or 1099 income opens a solo 401(k), but the employee deferral is one limit shared across every plan. Only the employer side is extra.
6. A taxable brokerage account, managed with attention to asset location Which holdings sit in which account type.
7. Education and other tax advantaged accounts, as capacity allows Education and other tax advantaged accounts, as capacity allows.

Where it shows on the show

It applies the moment a household has more to save than one account can hold, which for most physician households is the first attending year.

It applies whenever the household gains access to a new account type. A new employer, a second plan, a spouse starting work, or the first dollar of 1099 income all change which rungs exist.

It applies before a household adds a taxable account. Money placed in a taxable brokerage while a higher value rung is still unfilled is money that paid tax it did not have to pay. It applies at every year end, as a check on whether the rungs actually got filled in order. It applies with particular force to any household holding pretax balances in an IRA, because those balances interact with the backdoor Roth rung.

Financial Health Assessment episodes built on the Tax Efficiency Ladder are listed here as they publish. Physician households can submit their own finances at financialfellowship.com/submit.

What it is not