I'm someone who doesn't like paying the IRS a penny more than necessary. For this reason, I'm a big fan of retirement accounts such as individual retirement accounts (IRAs) and 401(k)s.
With a traditional IRA or 401(k) plan, your contributions go in on a pre-tax basis, shielding some of your income from the IRS. You also don't have to pay taxes on gains in your IRA or 401(k) year after year. Rather, those taxes are deferred and come into play only when you start taking withdrawals.
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But as awesome as IRAs and 401(k)s are, you should also be looking outside of these accounts in the course of saving for retirement. Here's why.
You need flexibility
In exchange for the tax break IRAs and 401(k)s offer, the IRS gets to impose certain restrictions. When you're older, for example, the IRS can require you to take mandatory withdrawals from your savings each year, known as required minimum distributions.
Another problem with IRAs and 401(k)s is that withdrawals taken before age 59 1/2 are usually penalized to the tune of 10% unless you qualify for an exception. But you never know when you might need to tap your savings before age 59 1/2.
You might think you'll stay in the workforce until age 62 at least, since that's the earliest age to sign up for Social Security. But what happens if you get laid off at age 57 and can't find another job?
At that point, you may want to tap your retirement account. And you may even be eligible to raid your most recent employer's 401(k) in that scenario, since there's an exception to the early withdrawal penalty if you separate from your employer in the year you turn 55 or later.
However, what if you're laid off at age 57 from a job you've been at only for a few months? At that point, you may be able to access that employer's 401(k) without a penalty. But if you have only a few thousand dollars in that workplace plan and the bulk of your retirement savings is in an IRA, you won't be able to access most of your money without a penalty.
That's why it's crucial to keep at least a small portion of your retirement savings in a taxable brokerage account. That way, you can access your money at whatever age you need.
Max out your IRA or 401(k) first if possible
As important as it is to have some retirement savings in an unrestricted account, since IRAs and 401(k)s offer a pretty sweet tax break, you should try to max out contributions to those accounts before funding a taxable brokerage account.
That said, 401(k) plans come with very high contribution limits. It may not be feasible to max one out and still have money left over for a brokerage account.
In that case, contribute enough to your 401(k) to claim your employer match in full. Then, see how much you're able to contribute toward retirement savings for the year and allocate your money between other accounts accordingly.
Say you can contribute $12,000 this year to retirement savings and you have a $5,000 match in your 401(k). You should absolutely contribute that $5,000. With the remaining $7,000, you have choices. You may decide to put half that amount into your 401(k) while putting the remaining $3,500 into a taxable brokerage account.
There's no right or wrong percentage to go by. The key is to have some money in an unrestricted account in case your retirement date ends up being earlier than planned.
