Financial experts agree that everyone should save for retirement – Social Security and pension plans probably won’t provide enough money to sustain your current standard of living during your retirement years, so it is up to you to provide the difference. The two most popular retirement investing tools are the 401k (and similar employer-sponsored retirement plans such as the 403b and Thrift Savings Plan), and the Individual Retirement Arrangement, or IRA.
Maxing Out Your 401k and IRA
The tax incentives offered by TSP plans and IRAs allow investors to defer or avoid paying taxes on their retirement income, making these powerful retirement planning tools. These tax breaks are also why most financial experts advise people to use tax-advantaged retirement programs such as a Roth IRA, 401k, 403b, SEP IRA, etc., when investing for retirement.
Create a plan to max out your retirement investments. If your employer offers matching contributions to your 401k plan, then it is usually best to contribute enough to your 401k plan to get the matching employer contribution. Then work toward maxing out your Roth IRA. (Compare Roth and Traditional IRAs to see which is best for your needs). If you still have enough money left after maxing out your Roth IRA, contribute toward your 401k plan until you can max it out.
But where do you invest once you max out both your 401k and your IRA?
Retirement Investing After Maxing Out 401k and IRA
Maxing out your 401k plan and IRA is a great achievement and will provide most people with a sizable nest egg for retirement. But some people may wish to continue their retirement investing after maxing out these plans. Here are some tips if you find yourself in this position.
Reevaluate your financial plan. The first step is to reevaluate your investing and retirement needs. Do you have any other pressing financial needs? Do you have any non-mortgage debt? Are you saving for college, planning on buying a new home shortly, or saving for any other long-term goals? If the answer is yes to any of these questions, you may wish to use your additional funds elsewhere since it is usually a good idea to avoid taking on new debt.
Evaluate your retirement investment strategies. Next, determine if you need to save above and beyond a 401k and IRA. If you decide that maxing out your 401k and IRA should provide enough money for you in retirement, then you are done and can use your money for other needs. But if you determine you need more money than your 401k and IRA investments will provide, consider some of these options.
Invest in Taxable Investments
A taxable investment is simply an investment that isn’t sheltered in a retirement account or other vehicle that provides tax advantages. You can invest in the same types of investments, but you won’t enjoy the ability to defer or avoid paying taxes when you cash them in. On the flip side, you have more flexibility regarding when you can use the funds since you don’t have to worry about early withdrawal penalties.
What you do need to consider, however, is the tax implications of these types of investments since they don’t have the same tax advantages as 401k plans and IRAs. Because of this, you may wish to employ more of a buy and hold strategy (long-term capital gains are currently set at 15%), or utilize index funds, ETFs, or tax-efficient mutual funds. These investment strategies can help you grow your nest egg and minimize taxes. Check out these online brokerage firms for some good places to invest outside of traditional retirement plans.
Invest in Bond Funds or Tax-Free Municipal Bonds
Bond funds can expose your portfolio to a different type of investment without taking on as much perceived risk as investing directly in the stock market. Many bond funds feature some tax advantages over stocks and similar investments. Tax-free municipal bonds offer another way to invest in fixed securities with added tax advantages.
Invest in Real Estate
Real estate investments can provide a steady income stream and may provide additional long-term tax advantages, such as using a 1031 tax exchange when you buy and sell your properties. Real estate isn’t without its risks, but it also provides different benefits as it generally brings in cash flow in addition to the equity in your property.
Do you have other recommendations for investing after maxing out retirement plans?
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Greg L says
One question I can’t seem to find an answer to. If you can max out your 401k, but are above the income limits to contribute to a Roth IRA, should you put after tax money into a traditional IRA? Or only taxable brokerage accounts at that point?
DG says
I disagree with your advice. Assuming Jennifer’s mortgage rate is low, it makes no sense to use funds that are currently earning a much higher rate to pay it off. Plus, mortgage interest is tax deductible. Since their tax sheltered investments are maxed out and they are plenty of emergency savings, “risk” isn’t much of an issue anyway. Also, if they invest that extra cash after tax, it’ll be accessible (penalty free) if needed, further mitigating any possible risk.
Stonewall says
Jennifer, in your situation, I would pay off ALL remaining debt before investing further. Pay off that house. Why do you ask? Look at it this way. Let’s assume you have $50,000 remaining on your mortgage. If you pay that off early, then you have reduced your risk. You wouldn’t want to begin investing further with the mortgage hanging on your back. Look at it again another way. If your house was paid off, would you borrow $50,000 against it to invest? The answer, of course, is NO. Therefore, pay off your house (and any other debts you have)..then invest. Don’t forget to “give” more than ever too!
steve says
I will be retiring at the end of next month and required to withdraw my 401K at that time unless I leave it in for another full year without any access to it that does not involve heavy penalties. Everything I have is paid for. I have no debt at all. I have a small farm with a few head of livestock but nothing special. I would like to be able to invest my 401K into starting up a Hot-Shot trucking business as a partnership with 2 other family members. This business would require the purchase of vehicle’s and some equipment. Is there a way to use my 401K for this and minimize my tax exposure.
Thanks, Steve
Ryan Guina says
Steve, I would talk to a financial planner or tax professional about this. There may be a way that you can roll your 401k into an IRA, which would give you more flexibility in how you can invest your retirement funds. If you have a self-directed IRA, you may be able to invest those funds into a business. Again, there would be paperwork involved and you want to ensure you do everything correctly. So retaining the advice of a financial planner or tax pro is essential here. Best of luck in your retirement and with your business!
Jennifer says
Perfect timing! This is the exact situation we are in. We max out our Roths and for the second year I will max out my 401K. We should have more money leftover ($1-2000/month) that we are trying to figure out where to put. (no debts, already re-financed down to a shorter mortgage, funded the emergency fund, and took that great vacation). We are investing some in taxable investments but we are looking for alternatives. We have been looking into the life insurance/investment option (whole life or variable). Any thoughts?
Ryan Guina says
My personal rule of thumb is to keep investments as investment, and insurance as insurance. You are probably at the stage where you would benefit from meeting with a financial advisor for more advice on investing, setting up your portfolio, estate planning, etc.
Ryan Lucio says
Some employers offer an HSA account when coupled with a high deductible medical plan, and some employers actually match your contributions similar to a 401k. Your HSA contributions can be invested in mutual funds (similar to a 401k), and if your employer matches your contributions (on any level) this should be the next investment vehicle after maximizing your employer contribution to your 401k. After maximizing your HSA, you should then return to your 401k up to the 2012 limit of $17,000. The 2012 individual contribution limit for an HSA is $3100. your The HSA, not to be confused with an FSA, has no “use it, or lose it” clause. You can use the account now for qualified medical expenses without tax ramifications, or you can have your money grow tax free and withdraw the money in retirement (age 65) and the monies would only be subject to income tax without penalty. Here’s an additional benefit: As an example, you could pay $1000 out of pocket from outside your HSA for medical expense this year(keep the receipt), and reimburse yourself 20 years from now for this expense. There are currently no restrictions to reimbursement. The benefit is that your $1000, if left in the account for 20 years will grow tax free! The HSA is the next best thing to a 401k. See if your employer offers this account.
Grace says
I have a question regarding Roth IRA. Let’s say if I have been able to contribute to Roth IRA because of my low income level. Then next year, my income will be above the limit amount, what will happen? Can I still contribute to Roth since I already had it open prior? If not, can the account still be open for earnings purpose without any more contributions?
Ryan says
Grace, here is some more information on IRA Contribution Limits. Basically, your ability to contribute to an IRA is limited to an annual bucket. Each year you can contribute to a new IRA, up to the contribution limits. You can keep all your investments within one IRA, but your contributions are limited on an annual basis. It is also a use it or lose it proposition.
For example, say you can contribute $5,000 max. If you contribute $5,000 this year, you maxed out your IRA and cannot contribute any more to that IRA. If you only contribute $4,000 you won’t be able to go back and contribute more to it after the contribution deadline has passed.
So to answer your questions: If you pass the earnings threshold for a Roth IRA, you will no longer be able to make contributions to a Roth IRA for that tax year. You also will not be able to make contributions to Roth IRAs from a previous tax year. You may, however, be able to contribute to a non-deductible IRA, then do a Roth IRA conversion.
Your previous contributions will remain in your Roth IRA and can continue to grow or lose value as they normally would. The only difference is that you wouldn’t be able to make additional contributions if you exceed the contribution limit (unless you first contribute to a non-deductible IRA, then do a Roth IRA conversion).
You may find it helpful to speak with a financial planner to help you better understand your options regarding your investment opportunities.
K.C. says
If you plan on retiring before age 591/2, you will need taxable investments to draw upon until those tax-favored plans can be tapped at age 591/2. My wife and I retired at age 56. We’re living off of a pension and those taxable investments until we can start withdrawing from the tax-deferred accounts.
The benefit of tax-deferred accounts is that the taxes that are deferred remain in your investment account. This increases the size of your investment account which through compounding of earnings results in a substantially greater retirement fund than you would have had had you paid taxes on the contributions up front. Yes, you have to pay taxes on the money when it is withdrawn, but you have had the use of that tax-deferred money for 10, 20, or 30 years. That’s a lot of time with which to pile up earnings with that money.
Ryan says
Great tips. I have no idea when I will retire, since I’m still quite a ways from the “traditional” retirement age. At this point I am working on increasing both my retirement accounts and taxable accounts, which should give me more options in the long run. I won’t have a pension, but hopefully I will have a large nest egg and several different investments from which to draw upon.
Kevin@RothIRA says
The advice on taxable investments is sound, especially in regard to retirement. What few people realize is that you could end up in a higher tax bracket in retirement than you have now, especially when required minimum distributions kick in on the tax deferred plans (401k’s, 403b’s, traditional IRAs).
It’s best to offset these with investments from which withdrawals won’t be taxable, like taxable investments and Roth IRA’s. Flexibility is so under-rated as an investment strategy!
Brad says
Hi Ryan,
I assume the above assumes zero debt? If not, pay off that mortgage, car, boat, etc. I was going to suggest ETFs but then remembered you had that covered. Good article.
Brad
Ryan says
That is correct, Brad. I mentioned that in the section under “Reevaluate your financial plan.” It doesn’t make sense to continue shoving money into an investment account if you have non-mortgage debt. Some people may prefer to prepay their mortgage, or some may prefer to invest instead of prepaying their mortgage. With mortgage interest rates as low as they are, it may make sense to invest as long as your cash flow and emergency fund are sufficient to handle any bumps in the road.
Randy Schaller says
For many people maxing out a 401k and an IRA could be very difficult. A good rule of thumb is to try and save 10-15% of your gross income each year. For most, this will amount to far less than the maximum contributions allowed in a 401k, but can be a great step toward reaching retirement and savings goals. While taxable accounts have advantages, for most investors the benefits of tax deferred growth that come with a traditional 401k are tough to beat, especially when long term growth is the primary goal.
Ryan says
Agreed, Randy. Not everyone can or should max out both a 401k and an IRA. This article is directed toward the lucky few who are able to do so while meeting their other financial goals. For people who are meeting their financial goals and are able to max out both retirement plans, then it’s essential to investigate where to put their money next, whether that be paying off debts, working toward other financial goals, or continuing to invest.
krantcents says
Very few people ever talk about a taxable investment. Yes, you have to pay taxes on dividends and capital gains every year, but it is taxed at 15%. I like a mix of investments because we do not know what changes may occur.
Ryan says
krantcents, I like the idea of taxable investments simply because it gives you more long term flexibility, especially if you aren’t close to retirement age — that way you have the ability to cash in your investments at any time without having to worry about penalties or additional taxes cased by early withdrawals.
Craig Kessler says
If you can do both, all the power to you. That’s amazing and will greatly help over the years. At that point, I recommend enjoying life now and taking a vacation, or buying that present for yourself. I know that goes against the grain here, but that’s a ton of money to put away for retirement in a year, and after that, you need to enjoy yourself.
Ryan says
Agreed, Craig. Living for the now is important and highly recommended. But there are some people who earn a lot of money and are able to balance living for the now while maxing out their retirement plans. And in that case, it’s important to know your investment options!
bernard says
Why would you invest in a 401k and a Roth IRA? You are deferring taxes on one end and paying taxes on the other. Isn’t that like driving down the highway with one foot on the pedal and the other on the brake?
Ryan says
Not really. Roth IRA contributions are made after paying taxes on your income and withdrawals made during retirement are tax free. There aren’t many other investment opportunities available to the general population that have similar tax advantages. I wouldn’t hesitate to recommend a Roth IRA to anyone.
Roth 401k plans are similar to Roth IRAs, though not all companies offer a Roth 401k option. In that case, a Traditional 401k plan is still a great option as it offers tax benefits now, and may have the added benefit of matching employer contributions (though not all employers offer matching contributions).
Even if one chooses not to use a Traditional 401k it’s important to invest for the future.
bernard says
My questions is why do both. With a 401k, you are deferring taxes to the future but with a Roth IRA, you pay taxes now. Why do both?
Why not just pay the taxes now and be done with it. We know that taxes are only going up. If you wait and pay taxes in the future, you pay on the harvest.
If we’re talking about tax benefits, why use two opposite strategies…pay now and later.
Ryan says
bernard, Roth IRAs are a great way to invest – you pay the taxes when you earn the money, then you don’t pay taxes on your retirement withdrawals. That can add up to a substantial tax savings for someone who has a timeline of 20, 30, or 40 years.
Some 401k plans are available as Roth 401ks and offer similar benefits as a Roth IRA. Again, the tax advantages are enormous in the long run.
Even traditional 401k plans have their advantages, especially if the employer offers matching contributions. This is basically free money as long as you meet the requirements. I can’t envision why many people would pass on that opportunity if it were available and they were able to invest without causing financial hardship.
Granted, not all companies offer a matching contribution. In that situation, I recommend reading the following article, which covers some of the ins and outs of investing in a 401k without an employer match.
Finally, using two different tax strategies for retirement investing can help create a diversified approach to investing which offers some tax advantages now, and other advantages later. We cover some of these topics in the following article: Where Should You Invest First – 401(k) or IRA.