Keeping your retirement savings in a 401(k) or IRA can save you money on taxes and make the task of saving a little easier. But in a few rare instances, these accounts could actually make life more difficult for you. Below, we'll look at three scenarios where you're better off keeping your money out of tax-advantaged retirement accounts and consider where you might want to put it instead.
1. You plan to retire earlier than 59 1/2
Retirement accounts usually charge a 10% early withdrawal penalty if you attempt to withdraw funds before age 59 1/2, though there are exceptions. You can withdraw your Roth IRA contributions at any age without penalty, though not your earnings. You might also be able to access your 401(k) funds early through substantially equal periodic payments (SEPPs) or the rule of 55.
But if none of those options work for you, you may prefer to keep some of your savings in a taxable brokerage account instead. These accounts don't offer the same tax breaks as retirement accounts, though you could save a little if you hold onto your investments for at least one year before selling. Then, they become subject to long-term capital gains tax. These tax brackets are lower than income or short-term capital gains tax brackets, and depending on your income, you may not owe taxes on your investment earnings at all.
If you plan to retire early, consider keeping only what you need to get you to 59 1/2 in your taxable brokerage account. Keep the rest in one or more retirement accounts so you can take advantage of the tax savings they offer.
2. You don't want any limitations on your investments
One of the biggest drawbacks to a 401(k) is the fact you're usually limited to the menu of investment options your employer selects for you. These aren't always the best or most affordable choices. You can ask your employer to offer some new investments if you don't like what it already has, but it doesn't have to comply with your request.
IRAs offer fewer restrictions on investments, but there are still a couple to be aware of. For example, you can't invest in life insurance, antiques, most coins, or real estate that you personally profit from. There are other things, like options trading, that are possible only through some IRA brokers, but they are more difficult to find.
While most people should be satisfied with what their retirement accounts offer, you may prefer a taxable brokerage account if you want to invest in some of these more unique options. There are no limitations on what you can invest in with a taxable brokerage account, though again, you won't enjoy the same tax benefits you'd get with a retirement account. That's something to weigh when deciding which investments and accounts are best for your savings.
3. You feel stifled by the annual contribution limits
Workers are only allowed to contribute up to $19,500 to a 401(k) and $6,000 to an IRA in 2021. Adults 50 and older are allowed to make an extra $6,500 and $1,000, respectively, in catch-up contributions. If you have access to both accounts, these limits may not pose a problem, but if you're only saving in an IRA, the low annual limit could become an issue.
Rather than stopping once you've hit the annual maximum, you can invest your extra money elsewhere. Again, a taxable brokerage account is an option and there are no limitations on how much you can contribute. If you're self-employed, you might also consider a self-employed retirement account too.
Those who have a high-deductible health insurance plan — one with a deductible of $1,400 or more for an individual or $2,800 or more for a family — can also contribute to a health savings account (HSA). Though these accounts aren't technically considered retirement accounts, they serve the purpose quite well.
You can contribute up to $3,600 in 2021 if you have an individual health insurance plan or $7,200 if you have a family plan. Your contributions to this account reduce your taxable income for the year just like contributions to 401(k)s or traditional IRAs. But unlike other retirement accounts, you can make tax-free medical withdrawals to HSAs at any age. Once you turn 65, you can also make non-medical withdrawals without paying the 20% early withdrawal penalty adults under 65 face.
If you plan to use your HSA for retirement expenses, look for one that enables you to invest your savings. This will help your savings grow more quickly like they would with the other options.
Think about what makes sense for you this year, but be flexible. You can always change which accounts you contribute to next year if your job or retirement plans change. But don't just limit yourself to traditional retirement accounts. Think outside the box, especially if one or more of the above scenarios applies to you.
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