Preparing for retirement is an essential part of financial planning. Employer-sponsored retirement plans, such as 401(k) plans, are a common tool for saving. While contributing to a 401(k) can be a great way to save for retirement, it’s important to consider other options as well.
First things first
Are you fortunate enough to work for a company that offers to match employer-sponsored retirement plan contributions? If so, you should put the required minimum into the account to get that free money. Doing less is basically like turning down a raise!
Once you’re doing that, there are reasons that you may want to save additional funds outside the 401(k). Of course, if you don’t have a match or a 401(k) available, you may also need another way to save. Besides not having a 401(k) option, the most common reason to invest outside a 401(k) is investment selection. So, here are some other common options:
For the self-employed, there are actually many different tax-advantaged retirement accounts you can contribute to. If you work for a company that doesn’t offer a retirement plan, you can still contribute to an IRA. If this is the case, you can contribute up to $6,500 (or $7,500 if 50+) to an IRA. Additionally, you can deduct traditional IRA contributions no matter your income. However, income limitations exist on deducting contributions when you already have a 401(k) or 403(b) available.
A popular choice these days is the Roth IRA. This is partially because of the tax benefits. However, there is also more flexibility in accessing Roth IRA money early versus traditional or even Roth 401(k)s. For example, you can withdraw your Roth IRA contributions without taxes or penalties. Another benefit is your ability to withdraw up to $10k in growth for a first-time home purchase. You don’t have that option with a 401(k), at least not without tax consequences.
If you have access to a high-deductible health insurance plan, you can contribute to a health savings account (HSA). Contributions are limited to $3,850 per person or $7,750 per family (plus an extra $1,000 if age 55+). The contributions are tax-deductible, and the money can be used tax-free for qualified health care expenses. If you use the money for non-medical expenses, it’s subject to taxes plus a 20% penalty. However, the penalty goes away once you reach age 65, turning it into a tax-deferred retirement account that’s still tax-free for health care expenses (including most Medicare and qualified long-term care insurance premiums). You may also consider avoiding using the HSA even for medical expenses and investing it to grow for retirement.
US Government Savings Bonds
Each person can purchase up to $10k per year in Series EE US Government Savings Bonds. For Series I Savings Bonds, that limit is $10k (plus another $5k from tax refunds). The federal government guarantees these tax-deferred bonds, which don’t fluctuate in value. As such, they can be good conservative options for retirement savings. However, you can’t cash them in the first 12 months, and you lose the last 3 months of interest if you cash them in the first 5 years. Interest rates may remain low, but the I Bonds are based on inflation, which is slowly creeping up.
If you’ve maxed out your other options, you can always invest for retirement in a regular taxable account. You can minimize taxes by investing according to your tax bracket. For example, invest in tax-free municipal bonds if you’re in a high tax bracket. Holding individual securities for at least a year will keep capital gains taxes low. You can also choose low-turnover funds like index funds and ETFs. Another strategy is to use losses to offset other taxes, including up to $3k per year from regular income taxes. The excess carries forward indefinitely. Just be aware that if you repurchase an identical investment within 30 days, you won’t be able to take the loss off your taxes.
Regardless of how you choose to save for retirement, the most important thing is that you save enough. Run a retirement calculator to see how much you need to save. Then, increase contributions through payroll or direct deposit. If you can’t save enough now, try gradually increasing your savings rate each year. Like it or not, your ability to retire depends on you.