A 401(k) is a great tool to help you save for your later years. It can be easy to open since you may be auto-enrolled at work or just have to fill out a little paperwork. You’ll be able to contribute with pre-tax dollars, and your employer may even match some of the money you put in, helping your money grow even faster.
But while 401(k)s have big benefits, they’re often not the only type of tax-advantaged plan you should be contributing to. In fact, once you’ve invested in your 401(k) enough to earn the maximum matching funds, you may want to put some of the remaining money into two other account types that offer benefits 401(k)s can’t provide. Here’s what they are.
1. An IRA
An IRA, or individual retirement arrangement, is similar to a 401(k). You can invest in an IRA with pre-tax dollars but will need to pay taxes on withdrawals when you take out the money as a senior. While IRAs have lower contribution limits than 401(k) accounts, and contributions are deductible only if your income doesn’t exceed a certain threshold, they can still be a great supplement to a workplace retirement plan.
The biggest benefit of an IRA is that you can choose to open this type of account with any brokerage firm or financial institution that offers it. And that means you can gain access to a much broader choice of investments than your 401(k) offers. While most 401(k) accounts offer a choice of a few preselected funds, you can invest in any assets your financial institution offers if you choose to put money into an IRA. That means you have the option to invest in stock shares of individual companies, ETFs that charge low fees, or even alternative investments such as cryptocurrencies.
You also have the option of selecting a Roth IRA as an additional account to save for retirement. This type of account works differently from a traditional workplace 401(k) as there’s no upfront tax break in the year you make contributions. Instead, you can withdraw money tax-free as a senior. If you suspect your tax bracket will be higher later in life, this could be a better choice.
While some workplaces offer a Roth 401(k) to give you this opportunity to defer your tax savings, many don’t. If your employer doesn’t provide a Roth option, a Roth IRA may be the only way you can save your tax breaks until later in life.
2. An HSA
An HSA is a health savings account. The eligibility rules for an HSA are much stricter than for a 401(k), as you can contribute to this type of account only if you have a qualifying high-deductible health plan. The contribution limits are also lower.
The big benefit of HSAs is that you can make contributions with pre-tax dollars and withdraw the money tax-free to cover qualifying medical expenses. Since many retirees end up spending a good portion of their income on medical care, an HSA could give you a double tax break that no other investment account offers.
Of course, you may not need to spend your HSA funds on healthcare services. If you don’t, you’re allowed to take out money penalty-free for any reason after age 65, but you will be taxed at your ordinary income-tax rate on withdrawals — just as you are with a 401(k). So, even in this scenario, you’re getting the same tax break as your workplace plan provides. But this account at least offers the chance to end up with more tax savings.
Ultimately, you should consider contributing to both an IRA and an HSA as a supplement to your 401(k) after you’ve earned your employer match. Both accounts offer benefits a 401(k) simply can’t, and there’s little downside to spreading your retirement funds around to take advantage of them.
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