The 401(k) is arguably the most popular retirement savings vehicle because employers usually match their workers' contributions. Unfortunately, not everyone has the opportunity to contribute to a workplace plan, but that doesn't mean you can't save for retirement at all.
There are several alternative accounts that can help you build up a sizable nest egg for retirement. I discuss three options -- Individual Retirement Accounts (IRAs), Health Savings Accounts (HSAs), and taxable brokerage accounts -- in detail below.
IRAs are available in two types: traditional and Roth. Traditional IRAs work like a 401(k) in that the amount you contribute reduces your taxable income in the same year. But then you must pay taxes on your distributions in retirement. Roth IRAs work the opposite way: You don't get a tax break for the contributions you make the year you make it, but after that, your money grows tax-free and it's not taxed at all when you make qualified withdrawals in retirement.
Contribution limits for IRAs are lower than for 401(k)s. You can only contribute up to $6,000 to an IRA in 2019 or $7,000 if you're 50 or older, compared to $19,000 for a 401(k) and $25,000 for adults 50 or older. However, this shouldn't be an issue unless you plan to make a large contribution.
It's worth noting IRA fees tend to be lower. Some 401(k)s can charge as much as 2% of your assets in fees each year. The cost you pay for an IRA will depend on which company you're working with and which investments you choose, but it isn't difficult to find IRAs that charge less than 1% of your assets per year. It may not sound like much, but a 1% annual fee on $1 million is $10,000 per year. This seemingly small cut can seriously dampen your retirement savings over time.
Another benefit of IRAs is that you usually have more investment choices. 401(k)s often limit you to a few mutual funds chosen by your employer, but these may be more expensive than you'd like or ill-suited to your retirement goals. With an IRA, you have the flexibility to choose from mutual funds, stocks, bonds, and other investment products, to build a portfolio that suits your needs.
You may not think of a Health Savings Account (HSA) as a retirement savings vehicle, but it's actually well-suited to the task. In order to open an HSA, your insurance policy must be a high-deductible health plan (HDHP). This is one that charges a deductible of at least $1,350 for an individual or $2,700 for a family. Once you open the account, you can contribute up to $3,500 in 2019 if you're an individual or $7,000 for families. Adults who are 55 and older may contribute an additional $1,000. Many HSAs enable you to invest these funds once you reach a certain sum, to grow your savings more quickly.
The money you contribute reduces your taxable income for the year, and if you use the money for a qualified medical expense, you won't pay any taxes on it at all. Unlike flexible spending accounts (FSAs), the money can sit in your HSA indefinitely and you won't lose it.
You can use your HSA for nonmedical expenses, but then you must pay income tax on the distributions, plus a 20% penalty. However, that penalty goes away when you turn 65, making your HSA more like a 401(k) or traditional IRA. You can use the money for anything you want, and spending on qualified medical expenses is still tax-free.
3. Taxable brokerage accounts
Retirement accounts have useful tax advantages, but the downside is that you can't touch the money without penalty until you turn 59 1/2. If you'd like the ability to access your money at any time, a taxable brokerage account may be the way to go. This is also a good option if you've maxed out your IRA, and you're looking for a place to store your extra savings.
There's no limit to how much you can contribute to a taxable brokerage account, but you won't get the same tax breaks you get for your retirement accounts. However, you could still save on taxes if you hold the money in your account for a year or more. Then, your earnings become subject to long-term capital gains tax instead of income tax. You'll pay either 0%, 15%, or 20% tax on your capital gains, depending on your income.
Most people in the 10% and 12% income tax brackets won't pay any taxes on their long-term capital gains, but as your income rises, so does your capital gains tax rate. Single filers earning more than $39,375 and married couples filing jointly earning more than $78,750 in 2019 will fall into the 15% long-term capital gains tax bracket. You won't have to worry about paying a 20% capital gains tax unless you make over $434,550 as a single adult or $488,850 as a married couple.
With few exceptions, your long-term capital gains rate will be lower than your income tax rate, so you'll lose less of your money back to the government. Just remember, you need to hold your investments for at least a year for them to qualify as a long-term capital gain. If you hold them for less than a year, you'll pay regular income tax on any capital gains. CC: How will that be the case in ever case if your tax rate is 10% or 12%?
The other nice thing about taxable brokerage accounts is there are no limits on what you can invest in. This gives you greater control over the fees you're paying and more freedom to adjust your portfolio as your needs change.
You can use a combination of these accounts in your retirement planning. Think about which ones suit you the best, and consult with a financial advisor if you're unsure about which investments and retirement savings vehicles are right for you.