3 better ways to save for retirement than a 401 (k)
Using only a 401 (k) for retirement could be a costly mistake. The 401 (k) is popular for good reasons: tax deferrals, automatic savings, employer matches, low fees, and advice from the plan administrator are all great features.
However, any type of financial account has some drawbacks, and a balanced approach can have some advantages. You may want to consider alternatives to improve the flexibility and control of your retirement fund.
1. Traditional IRA
Traditional IRAs are similar to 401 (k) accounts. Both allow people to deduct earned income from their taxes and defer income tax payable on that income until retirement.
The IRA differs from your 401 (k) in several ways. The main drawback of the IRA over a 401 (k) is the contribution limits. Many employers offer matching contributions in their benefit programs, which means they’ll put a little extra money into your 401 (k) based on your savings. Annual tax deferrals in these accounts can reach $ 19,500. IRAs are individual accounts and therefore are not eligible to receive correspondence from employers. They also have much lower deferral limits – you can only deduct $ 6,000 in contributions each year (up to $ 7,000 if you’re 50 or older).
IRAs offer more control over your retirement investment. 401 (k) accounts are limited to the investment options offered by the plan provider. Most plans offer a wide variety of mutual funds and ETFs that can be tailored to suit any retirement goal. However, you are subject to fees charged by the provider, thousands of mutual funds and ETFs are not offered in the plan, and you generally cannot purchase individual stocks.
You are free to choose any custodian for your IRA, and the account can contain any security available on this brokerage platform. There are even self-directed IRAs designed for assets outside of the normal realm of stocks, bonds, mutual funds, and ETFs. This provides more control over fees and portfolio allocation compared to a 401 (k), which is important for many retirees.
2. Roth IRA
The Roth IRA has many of the same features as the traditional IRA, but with a completely different approach to taxation. Roth contributions are not tax-deferred, so they won’t reduce what you owe the IRS. However, the proceeds of your investments are not taxed if you make qualifying withdrawals after age 59 1/2. Distributions from a 401 (k) or traditional IRA are subject to income tax in retirement. This makes the Roth ideal for high growth investments that would otherwise be subject to high income tax or capital gains tax in other accounts.
Roth IRAs also provide better access to the money you put into the account. Contributions to your 401 (k) and traditional IRA are functionally locked on these accounts. There are early withdrawal exemptions for financial hardship and first-time home buying, but you usually have to pay income taxes and a 10% penalty on any withdrawals made from these accounts. The Roths are different. You can withdraw up to the amount you contributed without incurring taxes or penalties.
Unfortunately, not everyone can take advantage of Roth IRAs. The amount you can contribute is being phased out for unattached individuals with incomes between $ 125,000 and $ 140,000.
For joint filers, this range is $ 198,000 to $ 208,000. If you win above these upper limits, you can’t put anything in a Roth.
3. Health savings account
Health savings accounts are valuable tools that combine certain qualities of the 401 (k) and Roths plans. HSA contributions are tax deductible, just like a 401 (k) or traditional IRA. However, withdrawals to cover eligible medical expenses can be made tax-free. To be eligible to use an HSA, you must have a qualifying high deductible plan.
You can use HSA funds at any time. Contributions can be carried over indefinitely and you can invest these funds for growth. While the average person incurs over $ 400,000 in medical costs in retirement, an accessible, tax-free pool of money can transform your retirement plan.
Many employers offer HSAs, but they can also be opened privately by individuals. Singles can contribute up to $ 3,600 per year, and families can double that amount. People over 55 can contribute an additional $ 1,000. Funds withdrawn for ineligible expenses are available, but will carry a penalty of 20% plus tax. Plan accordingly.
Ultimately, the best account for you depends on your personal circumstances. For most people, it is beneficial to use different types of accounts to unlock the benefits of each. Consider these other options before you put all of your eggs in the 401 (k) basket.