If you work for a larger employer, you’ve likely been offered the option to participate in a 401(k) plan. Between the available tax advantages and the contributions that your employer likely would make on your behalf, a 401(k) plan is a great way to build up your nest egg.
But there are additional retirement plan options that you might consider in addition to your 401(k), particularly if you are maxing out your contributions there. Here are some retirement plans to consider that go beyond your 401(k).
One of the benefits a traditional IRA has over a 401(k) plan is complete investment flexibility. While your 401(k) plan likely limits you to a choice of various mutual funds and/or ETFs, in a traditional IRA you can generally purchase any type of security you want, from individual stocks to bonds to preferred stocks and so on.
The main drawback — particularly if you’re in the position to max out your 401(k) plan — is that IRA contributions for 2023 are limited to $6,500 per year, or $7,500 if you are 50 or older. Also, since you’re covered by a 401(k) plan at work, your ability to deduct your IRA contributions may be restricted or eliminated.
A Roth IRA functions like a traditional IRA but with significant differences in taxation. While you can often deduct your contributions to a traditional IRA, you can’t with a Roth IRA.
In exchange, your qualified distributions will be tax free, unlike with a traditional IRA where all withdrawals are fully taxable as ordinary income.
Of course, if you’re already covered by a 401(k) plan at work, you may not be able to deduct your traditional IRA contributions anyway, in which case a Roth IRA can make a lot more sense. The same contribution limits apply to both traditional and Roth IRAs.
Health Savings Account
A health savings account isn’t a “retirement” plan in the strictest sense of the word, but it’s nonetheless being used as such by many investors. HSAs are popular because when used as designed, they are triple tax free. Investors get a tax deduction on any contributions they make, and their account balance grows tax free.
When money is withdrawn for qualifying medical expenses, distributions are also tax free. So, how is an HSA used as a retirement account? After you reach age 65, you can withdraw your HSA money for any purpose at all without paying any penalties. However, distributions will be fully taxable, as with a traditional IRA.
A SEP-IRA can be a retirement plan option if you run your own business in addition to working for an employer. As long as you’re making contributions for different businesses, you’re allowed to use both types of accounts. Even if you contribute the maximum of $22,500 to your 401(k) plan, for example, you can also put in up to 25% of your compensation, with a limit of $66,000 for 2023, to your SEP-IRA plan.
Once the money is in your SEP, it functions essentially as a traditional IRA. But it’s important to note that the money you put into your SEP has to come from your business income — not the money you earn as an employee. There are also other important things to know about SEP-IRAs, including your requirement to contribute the same percentage for your employees as you do for yourself. For that reason, a SEP is best used by self-employed individuals rather than those who have workers.
Tax-deferred annuities are another way to sock away money for retirement. Although they have their drawbacks, you can use an annuity as a form of alternate retirement plan. Contributions are made on an after-tax basis, and only your earnings are taxable upon withdrawal.
While funds remain in the annuity, they are tax deferred. Annuities share the same early withdrawal penalties as IRAs and 401(k) plans, meaning if you take money out before age 59 ½ you’ll face a 10% early withdrawal penalty. This is on top of any surrender fees that annuity companies typically charge for the first eight or 10 years after purchase.
The Bottom Line
Your 401(k) plan is likely your best option for a retirement account. But if you’re already maxed out in that account or if you don’t like your investment options, there are a number of other tax-advantaged plans that you can use, often in conjunction with your 401(k). Which one is the best for you will depend on your personal financial situation, so you might consider consulting with a financial and/or tax advisor.
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