Many people never notice the contribution limits on their 401(k). They aren’t coming close to saving that much anyway. But others, especially high-income individuals, may find these limits too constraining for the amount they want to save. If you’ve maxed out your 401(k) contributions and want to save more for your retirement, you’ll need to explore other vehicles.
Do You Need to Save More?
It’s important to note that many people who think they should be maxing out their 401(k) don’t really need to. That number is a maximum, not a requirement. By speaking with a professional or using an online calculator, you can figure out approximately what you should save each year. That number can range from a few percent of your income, if you’re early in your career, to 20% later on for some high earners. The actual number will depend on your expected age at retirement, your current expenses, and how much growth your advisor thinks you can expect during the saving period.
But for some individuals, it’s true that they really need to save more than the 401(k) maximum, which is currently $22,500 per employee. This does not include employer contributions. Also, people over 50 may contribute an additional $7,500 in catch-up contributions. If your employer offers a different type of retirement plan, such as a 403(b) or 457 plan, the limits might be different.
Remember, however, that there are many ways to invest in your future besides maxing out your 401(k). If you have a lot of extra money and can’t contribute any more toward retirement, you can work on building an emergency fund, paying off old debt, or saving for your children’s education.
Ways to Save Outside of Your 401(k)
The first alternative place to turn for retirement saving is an IRA. While the maximum contribution for an IRA is lower than that of a 401(k), you can stack one on another. This allows you to contribute an additional $6,500 a year. However, if you also have a 401(k), not all of your contribution may be tax deductible.
Next, consider investing the money outside of a retirement account. While money invested on your own does accrue taxes, you have almost infinite choices for how and where to invest the money. You could choose to invest it aggressively in stocks or choose low-risk investments like government bonds.
The advantage to retirement investing over other investing you might do is that you know the exact date when you will want the money well in advance. That allows you to take advantage of investment types that aren’t very liquid, because you know you won’t need to pull the money out. This includes certificates of deposit or annuities.
Whole life insurance is another popular option. This is life insurance which accumulates cash value as you pay the premiums. Not only can it protect you and your family if you die, but you can also withdraw the cash value as needed.
Reducing Your Tax Burden
The only downside of investing outside of a 401(k) is that you don’t get the same tax benefits. Especially if your income is high, reducing your taxable income may be one of your top goals in using a 401(k).
Retirement isn’t the only thing that comes with a tax advantage, however. You can also contribute pre-tax money to an HSA, FSA, or 529 account. An HSA can be especially helpful because you are almost certain to have high medical expenses during your retirement. By using an HSA for these, you can save the money in your 401(k) for living expenses. HSAs are only available to people with a high-deductible health insurance plan.
When it comes to reducing taxes on your investments, there are many possible strategies. One basic tip is to hold investments for as long as possible, because taxable events only occur when an investment is sold. Also, you will pay a lower tax rate on long-term capital gains than on gains from investments you’ve held for under a year. A financial advisor can go through all your investments and show you how to optimize them for tax efficiency.
Make a Plan
Saving for retirement isn’t just about throwing the largest amount of money you can into your 401(k). You’ll need to work out your savings goals and then plan a strategy that will take you there. A financial advisor can show you how your current savings rate will accumulate over time, point you toward alternative investments that make sense for you, and create a strategy to reduce your tax burden. Meet the right financial advisor for you by contacting us.
