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Beyond 401(k) and IRA


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You’re contributing as much as you’re allowed to a 401(k) or other employer-sponsored retirement plan. If your income allows it, you’re also contributing the maximum annual amount to your Roth or traditional IRA. But you still want to set aside more money beyond 401(k) and IRA, to make sure your retirement is everything you hoped for. What options do you have? Here are some things to consider…

Before moving beyond – are you really maxing our your 401(k) and IRA?

IRAs and employer-sponsored retirement plans like 401(k)s have some real advantages when it comes to saving for your retirement. So, before you go any further, make sure you’re really contributing all you can.

In 2020, most individuals can contribute up to $19,500 to a 401(k) plan, and up to $6,000 to a traditional or Roth IRA (subject to income limitations). If you’re age 50 or better, though, you can make up to an additional $6,500 in “catch-up” contributions to your 401(k) in 2020, and an additional $1,000 to your traditional or Roth IRA. What’s more, if you file a joint tax return with your spouse, your spouse may be able to make a full IRA contribution, even if he or she has little or no taxable compensation. (See Spousal IRAs for Stay at Home Parents for more details.)

Above and beyond the deductible limit described above, most 401(k) plans also allow for non-deductible contributions. The limit for all contributions to your 401(k) plan, including deductible and non-deductible contributions and the over-50 catch-up, is $63,500 for 2020. The great benefit to the non-deductible contributions is that you can be eligible to rollover these non-deducted contributions directly to a Roth IRA (subject to plan restrictions). This is known as the mega-backdoor Roth IRA contribution, and it can really be a big deal.

Taxable investment accounts

Your other primary option is to invest through a taxable investment account. The lower federal income tax rates that apply to long-term capital gains and qualifying dividends go a long way toward taking the bite out of holding investments outside of a tax-advantaged retirement account like a 401(k) or IRA. And, a taxable investment account offers one enormous advantage: You have a tremendous amount of flexibility. You can choose from a virtually unlimited selection of investments, and there’s no federal penalty for withdrawing funds before age 59½.

Investment options worth mentioning:

  • Mutual funds or separately managed accounts (SMAs) managed for tax efficiency intentionally minimize current taxable distributions
  • Indexed mutual funds and exchange-traded funds (ETFs) trade infrequently and therefore tend to have low annual taxable distributions
  • Tax-free municipal bonds and municipal bond funds generate income that is free from federal and/or state income tax

The other big benefit of a taxable account is that if you don’t use the money in the account and it is invested in appreciating assets (like growth stock funds, for example), when you die, your heirs will be eligible for a step-up in basis on the asset value. This way, when the heirs sell the assets, they will only be taxed on growth of the assets after your death. The growth from the time you purchased the asset until your death is completely tax-free (subject to possible estate taxation at state and federal levels).

Always keep the big picture in mind

Your investment decisions should be based on your individual goals, time frame, risk tolerance, and investment knowledge. You should evaluate every investment decision with an eye toward how the investment will fit into your overall investment portfolio, and whether it will meet your general asset allocation needs. A financial professional can be invaluable in helping you evaluate your options.

For many, it can be useful to have some of your money invested in the three different types of tax-treated accounts: tax-deferred, such as a 401(k) or traditional IRA; ultimately tax-free, such as Roth IRAs; and taxable investment accounts, which take advantage of the flexibility of withdrawal and low capital gains rates. With a three-pronged approach you can plan your tax impact when you need to withdraw money. Instead of only having purely taxable withdrawals from a 401(k) plan, you might take only a portion of the withdrawal to be taxed in that fashion, and a portion to be taxed at capital gains from your non-deferred account. This provides you with the best of all worlds!

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