If you get an employer match for contributing, socking away enough money in your 401(k) to maximize your match should be your first investing priority. Once you get beyond that point, though, many 401(k) plans have limited choices and high fees that make them less-than-ideal places to invest your money.
If you have no 401(k) or are stuck with a plan like that and maxing out your match isn't enough to get you to a financially comfortable retirement on the timeline you'd like, you can invest money elsewhere. These three approaches are better ways to save for retirement than socking away too much money in a high-cost, limited-choice 401(k).
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No. 1: A Roth IRA
If you're eligible to put money into a Roth IRA either directly or through a backdoor contribution, they are a tremendously powerful place to invest for your retirement. Once you've put your money in your Roth IRA, it can grow tax-free inside the account for the rest of your life. In addition, you can take completely tax free withdrawals in retirement, making it one of the most tax efficient places to build retirement wealth available to most Americans.
In addition, many brokerages offer Roth IRA accounts with $0 maintenance fees and $0 stock trading commissions, making them incredibly operationally efficient ways to build wealth over time as well. Indeed, for those that are eligible, working to max out a Roth IRA is the best choice after maxing out a 401(k) match for retirement savings money.
There are a few things to watch out for, though, as you're building your plan. In 2021 and 2022, contributions are limited to $6,000 per year ($7,000 if you're age 50 or higher). In addition, if you're considered high income or are married and file your taxes separately from your spouse, you could be restricted from directly contributing to a Roth IRA. Also, you may pay taxes and penalties on any growth in your plan if you withdraw it before age 59 and a half.
No. 2: An ordinary brokerage account
If you manage your money carefully, an ordinary brokerage account can be a wonderful place to save money for your retirement. There are absolutely no limits or restrictions on the amount of money you can invest in an ordinary brokerage account, and you aren't penalized for withdrawing your money early. That makes ordinary brokerage accounts great places for investors who want to follow the FIRE (Financial Independence / Retire Early) approach to leaving the rat race early.
Recognize, though, that ordinary brokerage accounts have to be carefully managed to be good sources of retirement money. First, because there's no penalty for early withdrawals, it's tempting to take money out of those accounts early when "life happens." If the money doesn't stay in your account compounding on your behalf, then it and its potential growth won't be there when you retire.
Second, because they're not tax-advantaged, you'll be subject to taxes on the capital gains, interest, and dividends you receive on your investments in ordinary brokerage accounts. As a result, following a "buy with an intent to hold" strategy of keeping portfolio churn low can help your money compound more efficiently for you inside an ordinary brokerage account.
No. 3: A health savings account
The primary purpose of a health savings account is to enable people to cover the costs of healthcare. They allow folks to make tax-deductible contributions to the account, letting the money in the account grow tax-deferred, and then allow completely tax-free withdrawals to cover healthcare expenses. This triple-tax-advantage makes health savings accounts an incredibly powerful purpose-driven way to save for your future.
This is particularly true when you recognize that healthcare costs are one of the key costs that seniors face that tend to rise over time -- both because of their increasing ages and inflation. Should you reach retirement with more money than you need to cover your healthcare expenses, you can withdraw money from your health savings account penalty free once you reach age 65. That makes HSAs similar to Traditional IRAs that also offer taxed, but penalty-free withdrawals in retirement.
Recognize, though, that to contribute to a health savings account, you have to be signed up for a qualifying high deductible health insurance plan. As a result, you will need to cover the early portion of your actual healthcare costs either out of that health savings account or another source of money. Also note that annual health savings account contributions are limited in 2022 to $3,650 for single people and $7,300 for families, with a potential $1,000 catch up contribution for those 55 and up.
Start now to build a plan that gets you from here to retired
Between a Roth IRA, an ordinary investment account, and a health savings account, you will likely able to fill in the gap from either not having a 401(k) or only having expensive choices in your plan. Just remember that saving for retirement is best done over the course of a career. So get started now, and give yourself the longest runway possible to build your retirement nest egg.
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