Your 401(k) may very well provide the easiest way for you to invest for your retirement. After all, you can invest money directly out of your paycheck and have it compound for your retirement in a tax-advantaged way. In fact, if you get a match for contributing to it, investing in your 401(k) until you maximize that match is beyond a doubt the first investment you should make.
The problem with many 401(k) plans, though, is that limited investment choices and high fees often make them difficult to invest in after you’ve reached that max. Fortunately, you can invest your money elsewhere. These three better ways to save for retirement can help you build a decent nest egg for your retirement even if you never go above that match inside your 401(k) itself.
1. An ordinary brokerage account
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Although ordinary brokerage accounts do not shelter dividends and realized capital gains from immediate taxes, they can still be a great place to invest for retirement. After all, there are no limits on how much money you can invest in an ordinary account, and the money can come from any legal source.
In addition, unlike with most retirement accounts, you are never required to withdraw money from an ordinary brokerage account simply because of your age. Plus, while capital gains are taxed, they are taxed only once you close out a position. Unless there is something like a corporate acquisition involved, you might never be required to close one out.
When it comes to spending money in retirement, an ordinary brokerage account also brings with it more flexibility than most retirement accounts. You can start withdrawing at any age without penalty and limit your withdrawals to exactly as much as you need.
All that, along with the fact that your heirs get a step up in basis on the account value when you pass, make ordinary brokerage accounts worth considering instead of a 401(k) for retirement savings.
2. A health savings account
If you have a qualifying high-deductible health insurance plan, you can sock away money in a health savings account (HSA) to help you cover your out-of-pocket healthcare costs. HSAs are generally triple tax advantaged:
- You get a tax deduction for contributing.
- Your money can compound in the account tax deferred.
- Money you spend from the account for qualifying healthcare costs can come out of the account tax-free.
In addition, once you reach age 65, you can spend money from an HSA however you like and pay only ordinary income tax on it. That makes an HSA’s tax treatment similar to that of a traditional IRA for folks age 65 and up, only without the hassle and mandatory costs of required minimum distributions.
When you also consider the fact that people’s healthcare costs tend to rise as they age, the benefits become clear. After you retire, you can use your HSA to pay for them.
3. A Roth IRA
When it comes to tax-advantaged retirement-focused accounts, Roth IRAs offer great features. Once your money is in a Roth IRA, it can grow tax-free for the rest of your life. Unlike with other qualified retirement accounts, there are no required minimum distributions for the original owner of a Roth IRA. As a result, if you don’t need the money, it can continue to compound in that account.
Plus, most brokerages allow a very wide variety of investments inside a Roth IRA, making them more flexible than most 401(k) plans. In addition, most brokerages offer fee-free Roth IRAs and many even have $0 commission trading. That along with the tax-free compounding lets you eliminate most of the friction costs associated with investing. Plus, money you directly contribute to one can be removed and spent at any time, for any reason, with no taxes or fees attached.
If there’s a downside to Roth IRAs, it’s that it can be challenging to get sufficient money into one for it to be a cornerstone of your retirement plan. Contributions are limited to $6,000 per year ($7,000 if you’re age 50 or up) and must be made from taxable compensation (money from working). Also, if your income — from all sources, not just work — is too high, you can be prohibited from directly contributing to one.
There is an approach — known as a backdoor Roth IRA — that lets you get money into a Roth IRA even if your income is too high to directly contribute to one. To use it you first contribute to a traditional IRA, then quickly convert it to a Roth IRA.
If you have no money in any traditional IRAs, making a backdoor Roth IRA contribution lets your money compound for your retirement much as if you had directly contributed it. If you already have other money in a traditional IRA, the rules get more complex, and the immediate taxes can be higher. Also note that money that gets to a Roth IRA via that back door may have to age in place for five years before you spend it, or else you could be subject to an early-withdrawal penalty.
Still, despite the challenges of getting money into a Roth IRA, if you can do so, its flexibility, longevity, and long-term tax benefits can’t be beat.
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No matter what combination of 401(k), ordinary brokerage account, HSA, Roth IRA, and other accounts you use, time is your most valuable asset when it comes to saving for retirement. The longer you have before you call it quits, the more compounding can work for you, and the more paychecks you’ll be able to use to fund your plan. So make today the day you take advantage of the tools you have available to you to get your retirement plan underway.
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