You’ve heard the advice: “Save as much as you can into your 401(k).” This recommendation is mostly true, but before we write it down as absolute gospel, let’s dig a little deeper.
A 401(k) account (or traditional IRA) is your main savings for retirement, but it’s important to remember a nuance that many retirees don’t think about until it’s too late: You pay taxes when you withdraw funds from your 401(k) account. You also pay taxes when receiving Social Security — a double whammy. Trying to make ends meet during retirement and paying taxes at the same time is never fun.
To avoid taxes, it’s important to have some investments outside of your 401(k) — ones for which you have already paid taxes. Here are three alternative savings vehicles to consider for saving outside of your 401(k)/traditional IRA.
- The Roth IRA: This type of retirement savings account allows you to pay taxes upfront when you deposit money, but not pay taxes when you withdraw funds – meeting the need described above. Again, the ability to access money when you retire may be just what the doctor ordered. If your company’s 401(k) plan offers a Roth option, you can save there. Otherwise, you can open a Roth account on your own.
- The Health Savings Account (HSA): If you have a high-deductible healthcare plan, this account is the most tax-efficient of them all – with a triple tax advantage. Your dollars go in tax-free, grow tax-free, and can be withdrawn tax-free. Learn more about how HSAs can help you by checking out our previous blog post, “The Best Tax Deal in Town!”
- The After-Tax Regular Brokerage Account: You should know that with the above accounts, there are strings attached. For example, money in the Roth IRA cannot be withdrawn before age 59 ½ without paying a 10 percent penalty. But if you pay taxes upfront, and pay taxes when dividends are paid or when you sell for capital gains, a regular brokerage account offers no strings attached.
I’m not suggesting that you over-invest in after-tax investments because you should take advantage of pre-tax savings while working. However, I am encouraging you to strike a good balance and not save exclusively in your 401(k); you should also keep some investments outside of your 401(k).
In summary, the 401(k)/IRA pre-tax savings vehicles are important to your retirement portfolio, but remember to build assets outside of those accounts as well. When you retire and have to pay taxes, you’ll be glad you did. If you have any questions don’t hesitate to ask Tilly.