3 Retirement Accounts That Run Circles Around a 401(k)

There are a lot of advantages to saving for retirement in a 401(k), but that doesn’t necessarily mean it’s the best choice for you.

After you get your company match, if your employer offers one, the 401(k) often isn’t the best place to put your savings to work. There are many better options you should consider on your path toward retirement. Here are three accounts that run circles around the typical 401(k).

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1. A regular old brokerage account

Among the biggest drawbacks of a 401(k) are the limited investment options.

An employer-sponsored plan will require you to keep your money with whichever financial institution your employer selects. On top of that, the funds you can invest in are limited to whatever option that institution decides. The end result can be some very high fees and suboptimal investments.

A standard brokerage account will do away with any restrictions. You can invest however you want in whatever you want.

That said, you’re giving up on the tax advantages of investing in a 401(k). But if you’re paying high fees just to save on taxes, you might not be saving very much, if anything at all.

Using a standard brokerage account with no maintenance fees and investing in low-cost investments like index funds or individual stocks can result in a much larger portfolio by the time you reach retirement than if you saved the same amount in a 401(k).

The added advantage of a standard brokerage account is the ability to access your funds at any time without penalty. While there are ways to access your 401(k) funds early, you might end up having to pay a penalty to permanently withdraw funds before age 59 1/2.

2. An IRA

The IRA provides almost the exact same benefits as investing in a 401(k) (sans matching contributions), and without the added fees and limitations.

You can choose a traditional tax-deferred IRA or the Roth version of an IRA, where you pay taxes up front. The benefits of an IRA are that you have a lot more freedom to choose the financial institution where you invest and the investments you make. That means you can save a lot on fees.

The IRA still restricts your ability to access funds, but it’s more generous in some cases. For example, you can withdraw contributions to a Roth IRA at any point, and you can withdraw any amount you convert to a Roth IRA after five years.

That’s not quite possible with a Roth 401(k) because all withdrawals are prorated between contributions and earnings. You’ll have to pay income taxes and a 10% tax penalty on the earnings portion of the withdrawal. With an IRA, you don’t have to prorate.

The downside of an IRA is the relatively low contribution limit. You can only contribute $6,000 to an IRA in 2022 versus $20,500 to a 401(k). But you might as well max out the IRA before looking at your other options.

3. An HSA

Not everyone has access to a health savings account (HSA), but if you do, it’s a fantastic option instead of your 401(k). In order to use an HSA, you must have a qualifying high-deductible health insurance plan.

The big advantage of the HSA over a 401(k) — or any other retirement account — is the tax savings. Not only can you take a tax deduction for your contributions, you could also be able to withdraw funds tax-free. If you use the funds to pay for qualified medical expenses, you won’t pay any taxes on the distribution. What’s more, if you contribute directly through your payroll, you won’t pay FICA taxes, either.

Importantly, you don’t have to reimburse your medical expenses right away. You can archive your receipts, invest your funds, and wait to reimburse yourself until retirement.

And you’re not stuck with whatever HSA provider your company selects. Once the funds are in the HSA, they’re yours. You’re free to move them to any financial institution you please — perhaps one with lots of low-cost investment options.

Once you turn 65, the HSA can work just like a traditional IRA. You can withdraw funds without penalty, but if they’re not reimbursing a qualified medical expense, you’ll have to pay income tax on the distribution.

The only downside of the HSA is the low contribution limit: $3,650 for individuals and $7,300 for families for 2022.

Don’t 401(k) and call it a day

There are a lot more options out there for saving for retirement than simply enrolling in your 401(k).

Some workers are fortunate to have a 401(k) that works out great, with low fees and great investment options. More often, though, 401(k) plans get bogged down with high administrative expenses and poor mutual fund choices with high expense ratios. That said, if your employer offers a match on 401(k) contributions, it can be worth putting up with a subpar plan to get what’s essentially free money from the match.

If you find yourself stuck with a financial institution you don’t like and paying much more in fees than you would with an IRA or other brokerage account, you may want to try adding an additional account to your retirement portfolio. Taking a more active role in your financial planning and looking at the fees you’re paying in your retirement accounts can help ensure you reach retirement with as much money as possible.

Don’t settle for a mediocre 401(k) when you could do much better.

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