3 Retirement Accounts That Run Circles Around a 401(k) | personal-finance


(Adam Levi)

If your employer offers a 401(k), it can be a great tool for building your retirement nest egg. You can easily set up automatic deferrals from your paychecks, and thanks to the immediate tax advantages and (in many cases) the opportunity to score a company match on your contributions, these accounts can make saving for retirement relatively painless.

But a 401(k) isn’t always the best vehicle for investing your retirement funds. In particular, once you’ve contributed enough to receive your maximum company match, many 401(k)s become a less effective way to save money. Here are three other types of retirement accounts to consider.

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individual retirement accounts

Individual Retirement Accounts, or IRAs, have many similarities to 401(k)s, but the differences are important.

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The first is in their annual contribution limits. In 2022, you can contribute up to $6,000 to an IRA, whereas you can contribute $20,500 to a 401(k). Workers 50 and older can make an additional catch-up contribution each year of up to $1,000 to an IRA and $6,500 more to a 401(k).

Another difference is in the tax advantages offered by these accounts. IRA contributions are not always tax deductible. If you also have access to a 401(k) or other employer-sponsored retirement plan and your income exceeds a certain threshold, you won’t be able to deduct your contributions to a Traditional IRA.

You could open a Roth IRA. With these accounts, you pay taxes as normal on your contributions, but when you make withdrawals in retirement, the money (including the profits on your investments) comes out tax free. But Roth IRAs also face income limitations. If you earn too much, you won’t be allowed to contribute to one. (For high earners, there’s a technique called a “backdoor Roth” that’s worth exploring.)

While the lower contribution limits and the income limits for IRAs are big drawbacks, the other differences might make them a better option for you.

For one, you have full control over your IRA. You can choose your broker and use the funds in your account to invest in almost any option you like — individual stocks, ETFs, mutual funds, etc. By contrast, your company’s 401(k) will typically be managed by the specific provider of its choice, and your investment options within it will likely be limited to a small set of mutual funds and ETFs (and in many cases, your employer’s own stock ).

Furthermore, you can usually find a broker with everything you want in a retirement savings account that won’t charge any fees for the service. Among the biggest drawbacks of 401(k)s are the annual fees associated with them.

Health savings account

Health Savings Accounts (HSAs) aren’t available to everyone, but if you have chosen to use a qualifying high-deductible health insurance plan, you can open one and set money aside in it.

Now, HSAs are primarily designed to help people prepare for medical expenses, but if your medical bills are low, you can invest the money in those accounts for the long term and use it to help fund your retirement.

The big benefit of the HSA is its tax advantages. You get a tax deduction on your contribution, your investments within it grow tax free, and if you use the funds to pay for qualifying medical expenses, you won’t pay taxes on the distributions. Once you turn 65, distributions are tax free no matter what you use them for. If you set it up to contribute directly from your paycheck, you also won’t pay any FICA taxes on your contributions.

Importantly, an HSA is fully under your control. Your employer may only work with one provider, but once the funds are in your account, you’re free to move them to a service provider of your choosing. You should be able to find a provider offering a brokerage account with access to lots of investment options and minimal fees.

The biggest drawback of the HSA is that annual contributions are capped at $3,650 for individuals or $7,300 for families.

Small business retirement accounts

If you have a small business of any kind, even a side hustle, it might be worth it to open a small business retirement account like a SEP IRA. If you’re a one-person operation, a Solo 401(k) could be an even better option.

Small business retirement accounts have a few advantages over a regular workplace 401(k). The biggest for most side-hustlers who also have a 401(k) through work is that they offer greater freedom to choose your service provider and investments, and the fees are usually lower. You can typically set up a boilerplate SEP IRA or Solo 401(k) through a discount broker with no fees, and within those accounts, you can invest in any stock, mutual fund, ETF, or other security available through the broker.

If you generate significant income from your business, you may be able to contribute more to your own retirement plan than you can to your employer’s. The annual contribution limits on SEP IRAs and Solo 401(k)s are $61,000. The Solo 401(k) also offers an additional catch-up contribution of $6,500 for workers over 50.

The catch is, you’re also limited by your net income, so you may not be allowed to make the maximum contribution. Also, be aware that if you contribute to a workplace 401(k), that could reduce the amount you can contribute to your Solo 401(k).

Still, even if you’re limited in the amount you can contribute, the benefits of a SEP IRA or Solo 401(k) can be extremely appealing.

Consider all your options

The 401(k) is a great retirement account, but when it comes to preparing financially for your golden years, be sure you consider all the options at your disposal. The biggest drawbacks of most 401(k) plans are the fees they charge and the extremely limited investment choices they offer. If you can use other vehicles to save 1 percentage point a year in fees and put your funds into stronger investments, that could add up to quite a bit of extra money in your portfolio by the time you’re ready to retire.

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