When it comes to saving for retirement, you should be taking advantage of all the help that's out there. This assistance can come in the form of employer matching contributions to your 401(k). It can also come from tax-advantaged accounts.
You should always contribute the necessary amount to your 401(k) to earn any employer matching funds. This should be your first priority when deciding where to invest for retirement. This free money from your employer can go a long way toward helping you build a secure future.
After you've earned the maximum match, though, you may not want to put more of your retirement money into your 401(k) -- at least not until you've maxed out an IRA first. Here are a few key reasons why it makes sense to divert your retirement savings dollars to an IRA after earning your employer match, rather than focusing on contributing as much to your 401(k) as possible.
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IRAs open up the door to many more investing options
With a 401(k), you have a limited pool of investments. You can only put your money into the assets available in the 401(k) plan your employer has chosen. Usually, this is just a few investments, like a handful of target date funds or index funds tracking specific sectors of the market. You may have about a dozen or fewer choices with most plans, none of which are individual stocks.
With an IRA, though, you can invest in almost any assets available from the financial institution where you opened your account. This could include stocks, cryptocurrencies, precious metals, or more, depending on where you decided to invest. The best brokers for IRAs typically offer tons of options for investments you can buy, so you have far more freedom in deciding how to best maximize your returns.
IRAs may offer more flexibility in the tax breaks available to you
If your employer offers only a traditional 401(k), you have only one option for when to claim retirement tax breaks. You won't pay taxes on the funds you contribute in the year you invest in your account, but withdrawals will be taxable.
When it comes to IRAs, though, things are different. You have a choice between a traditional IRA, which has the same tax savings structure as a traditional 401(k), or you can opt for a Roth IRA.
A Roth IRA provides tax breaks in retirement, with withdrawals made tax-free. You won't get to deduct contributions in the year you made them, though. So this is a better option for you if you think your tax rate will be higher in retirement.
Roth distributions also aren't counted as income when determining if Social Security checks will be taxed, so you can avoid the IRS taking a cut of your benefits. Unless your workplace offered a Roth 401(k), investing in a Roth IRA would be the only way to get these deferred tax benefits.
The best brokers for a Roth IRA also offer many assets you can choose from, just like those offering traditional IRAs. So you'd benefit both from more choices in investment options and greater flexibility in when you claim your tax break when you put money into an IRA.
IRAs may come with lower fees
Finally, it may be cheaper to invest in an IRA. If your 401(k) plan charges management fees or the investments within it have high expense ratios, it can make more sense to put as much of your retirement money as you can into an IRA where you can choose a broker that charges no fees and buy investments that charge very little.
For all of these reasons, you should seriously consider maxing out your 401(k) match and then immediately switching where you put your retirement funds to max out your IRA. If and when you've done that, you can always put more money in your 401(k) later -- but all the cash you put in the IRA could potentially work harder and more effectively for you to help you have the most secure retirement possible.
