If you are currently contributing the maximum annual amount to your 401k (or other employer provided retirement account), congratulations, you’re a step ahead of most Americans. In fact, according to the U.S. Government Accountability Office, you’re doing more in one year than close to half of all individuals age 55 and older have done in a lifetime - not saving anything in a 401k style account or IRA at all.
We’ve all seen attention grabbing statistics like this pointing to a looming “retirement apocalypse.” As a result, there’s plenty of experts offering advice revolving around how we can fix the issue (hint: save more, spend less).
But for individuals that are already making the effort to save and are looking to do more, it can be a bit overwhelming when looking for the best ways to save beyond your 401k. There are plenty of options, and like with most things when it comes to financial planning, there isn’t a clear-cut best choice that fits everyone in all situations. That said, below are 8 ways you can tuck extra cash away that will all put you in a stronger financial position no matter where you are at in your career.
While this is about the least exciting financial advice you can get, it’s important to be sure you have some cash stashed away to cover any unforeseen loss of income. Maxing out your retirement accounts is great, but they aren’t designed to be accessed before age 59.5. In an emergency, the last thing you’d like to do is pay taxes and an early withdrawal penalty in order to get your hands on your hard-earned savings.
A general rule of thumb is keeping 6-12 months of living expenses on hand. This is especially important if other people depend on you financially like children or a spouse, if you’re self-employed, or working for a start-up where that next paycheck may not always be a sure thing.
Be sure not to settle for your current bank’s cash interest rate also. Consider looking online for high-yield savings options so your cash can at least eke out a few more pennies each month.
A Roth IRA is one of the best retirement savings vehicles out there. In fact, for younger professionals who are likely to find themselves in a lower tax bracket early on in their careers, an argument can be made for funding a Roth IRA before maxing out a 401k. We’ll save that idea for another day but taking advantage of Roth IRA benefits (tax-free growth and tax-free distributions) any chance you can is generally a good idea.
For 2019, if your modified adjusted gross income doesn’t exceed IRS limits ($193,000 for a married couple filing jointly; $122,000 if single or filing separately) you can contribute up to $6,000 into a Roth. Have too much income to qualify even after maxing your 401k? There’s still a way around the IRS income limits.
It’s called a “Backdoor Roth IRA” and all it takes is an extra step in order to circumvent the limits. Instead of contributing directly to a Roth IRA, you’ll first contribute to a traditional non-deductible IRA. Then, by immediately converting that contribution over to a Roth IRA, you’ll have avoided any tax consequences since you haven’t allowed for any gains to be made.
Looking to save more even after funding your traditional Roth IRA? See if your employer allows for a MEGA Roth IRA strategy. That takes a bit more explaining than we have room for here but check out a blog we wrote previously that lets you in on a way you could push up to $36,000 into a Roth IRA each year!
Last plug for Roth IRAs. With the average person changing jobs roughly 12 times over the course of a career, it’s likely you’ll find yourself at some point with an old 401k from a former employer. Before rolling it over into your current 401k or a rollover IRA, consider if converting that old account into a Roth IRA might be better in the long run.
You’ll need to pay taxes on whatever amount you convert since your original contributions to the 401k were pre-tax. Using cash on hand to pay for a conversion now, will allow you to “invest” in lowering your future tax liabilities. Moving additional funds into a Roth will provide the dual benefit of tax-free growth and tax-free distributions down the road.
There is another type of retirement account that is even better than a Roth IRA. That’s the HSA, or Health Savings Account, which is relatively under used in regards to long term retirement savings potential.
HSA’s have a triple-tax benefit: contributions are tax-deductible, account assets grow tax-free, and withdrawals for qualified medical expenses are tax-free. So, in effect, it acts like both a Roth and Traditional IRA, but you get the added benefit of a tax deduction up front. Even better, if you wait until after age 65, you can access funds penalty-free even if distributions aren't for qualified medical expenses.
The catch is you must participate in a high-deductible health plan in order to contribute to one. That said, the threshold for plans to qualify as high deductible isn’t that high, so you may qualify without even knowing it. If you aren’t sure, make it a point to look into with your provider. For more details on maximizing the benefits of an HSA, check out our previous blog about The Best Retirement Account Your Aren't Using.
For anyone earning additional money outside of their regular full-time job, they can save beyond a 401k by contributing to a SEP-IRA or Solo 401k. If you've turned a hobby into an income producing side business or if you're a University professor and/or medical professional earning additional consulting income, you could make tax-deductible contributions to either type of account.
There are pros and cons to both, and which one will maximize your contributions depends on a few different factors like total income, administrative fees, etc. You can even complicate things a bit further and consider a Roth Solo 401k as well. Ultimately, you’ll want to be sure to walk through your specific situation with a financial advisor and tax professional to determine which would benefit you and your situation the most.
If you’re maxing out your 401k and knocking down a few, or more, of the above savings strategies at the same time as raising kids, kudos to you! Balancing long term savings with the seemingly endless expenses that come along with kids is no small challenge. But if you’re feeling good about how much you manage to tuck away for yourself then it may be time to consider throwing a few more bucks in their direction to help with the pending costs of college.
529 plans are the best savings vehicle for education expenses if you’re able to get a head start. They offer tax benefits in the way of potential state tax deductions along with tax-free growth and tax-free distributions if the money goes towards qualified education expenses. Those include K-12 school expenses now which can be another reason to consider starting early even if college seems too far off to worry about now.
A final savings strategy that shouldn't be forgotten is the use of a standard brokerage account. This could debatably fall higher in the pecking order depending on your circumstances since it may not always be wise to robotically stash as much as you can in tax-advantaged accounts. Tax advantages come at the cost of usually tying up your money for the long term unless you are willing to pay penalties. Similar to building up an emergency cash reserve, it’s also nice to have the tax flexibility that comes along with a less restrictive brokerage account for at least a portion of your savings.
Ultimately, the above 8 options for building wealth beyond your 401k are all great strategies to consider if you have the ability to increase your savings. After evaluating available choices, just be sure to pick one (or more) and commit to a savings plan in order to take advantage.