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Where to Invest After Maxing Out Your 401(k) Contribution Thumbnail

Where to Invest After Maxing Out Your 401(k) Contribution

Jonathan M. Gardey, MBA, CFA®, CFP®

President and Chief Executive Officer 

For many people, making contributions to a 401(k) plan is an easy call. The plan offers tax benefits, including reducing current taxes while allowing earnings inside the account to accumulate and grow tax-deferred. That's a big incentive for those who have the means to max out their contributions, which can top out at $20,500 in 2022. People over the age of 50 can also make a $6,500 catch-up contribution 2022.

But what about people with cash flow to spare who want to maximize their savings towards retirement further? What's beyond the 401(k) plan that can help them maximize what they can to grow their retirement capital even faster? Several retirement investing strategies can be layered on top of a 401k, which can actually enhance your overall retirement plan by adding flexibility and tax diversification in retirement. 

Invest in a Taxable Brokerage Account

There are several advantages to investing in a taxable brokerage account to augment your retirement savings plan. The first that stands out is flexibility. Because you are contributing after-tax dollars to a brokerage account, there are no limitations to how much you can contribute at any time. You can take your money out at any time without penalties, giving you greater flexibility should you need to access funds before age 59 ½, which is the cut off age for early withdrawal penalties from tax deferred accounts. Plus, your brokerage account is not subject to the required minimum distribution (RMD) rule requiring you to take withdrawals from your qualified plans (401(k), 403 (b) and IRA) starting at age 72.

In addition, with a brokerage account, you are not limited to investing in whatever the 401(k) plan sponsor offers. You have access to the entire universe of stocks, bonds, mutual funds, and ETFs to create your own asset allocation strategy.

From a tax standpoint, any gains in your portfolio are not taxed until you sell the securities. So, in that sense, your earnings are tax-deferred. When you do sell your securities to access funds, the gains are taxed at the more favorable capital gains tax rate as long as you hold the securities for longer than a year. Currently, the maximum capital gains tax rate is 20%, which may be lower than the tax rate you pay on withdrawals from your 401k.

You can also lower your tax bill by strategically harvesting tax losses—selling securities for a loss to offset capital gains in securities you sell for a profit. That strategy is not available in a 401(k) or traditional IRA.

Finally, for people concerned about leaving a legacy for their heirs, when a spouse or children inherit a taxable brokerage account, the assets can pass on a "stepped-up" basis. That means your heirs' cost basis for the assets will be their value on the date of your death.

Consider a Roth Conversion

Roth IRAs are becoming the retirement savings vehicle of choice because, as opposed to 401(k) plans and traditional IRAs in which withdrawals are taxed as ordinary income, Roth IRA withdrawals are tax-free. That's because contributions are made with after-tax dollars. This can be advantageous if you expect to be in a higher tax bracket in the future.

The caveat for high earners is the income limitation on Roth contributions. If your 2022 income exceeds $144,000 as an individual ($214,000 as a married couple), you cannot contribute to a Roth IRA. However, there is a workaround to that limitation. You could contribute to a traditional IRA and then convert it to a Roth IRA, referred to as a backdoor Roth IRA strategy. You execute that by opening a traditional IRA and making nondeductible contributions to it. Then, at a later date, you roll those funds to a Roth IRA. At the time of the rollover, you have to pay taxes on any appreciation that occurred before the conversion. Some additional rules may apply, so it's advisable to seek the assistance of a financial advisor.

The most significant advantage of having multiple sources of retirement income is the ability to diversify your taxes in retirement. If all your retirement funds are inside a 401(k), all the income you receive from it is taxable at your ordinary income tax rate. By having your funds spread among a taxable account and a Roth IRA, you have more planning opportunities to minimize your taxes in any given year. For example, in years when your income is higher, you can take more funds from your Roth IRA or brokerage account.

The significant tax bonus your Roth IRA offers, which also won't trigger the RMD rule, is income from a Roth is not included in the calculation for determining how much of your Social Security benefits are taxable.

This is subject to potential law changes with the Biden Administration’s “Build Back Better” legislation.

Other options for spreading your retirement savings around include tax-deferred annuities and a health savings account, each with advantages and disadvantages depending on your circumstances and financial objectives. If your goal is to maximize your retirement savings and optimize your retirement income, your best course of action is to work with your financial advisor to create a customized strategy.

Let Gardey Financial Advisors Lead the Way

Backed by more than three decades of industry experience, our team of Registered Investment Advisors have just one collective goal - to always hold your financial needs and desires as our highest priority. Acting as your personal Fiduciary, we proudly adhere to the strictest guidelines of the National Association of Personal Financial Advisors. Find out how our passion for the financial planning industry and our commitment to you can benefit your financial future by contacting us today. We look forward to welcoming you to the Gardey family.

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