An IRA Or 401k May Not Be Your Best Option For Retirement Savings.

Most of us have been told as far back as we can remember that you should always put as much as possible in your 401k, or you should max out contributions to your IRA. Employer sponsored 401k plans due frequently offer company matching contributions, which should certainly be considered. It will be important to verify what they are matching, and their vesting schedule (how much of the money you receive if you leave in a certain period of time). However, depending on your specific situation, as well as your individual or family's plans and goals, investing in a 401k or IRA may not be the optimal way for you to save for retirement.

The reason for this is different variables that come into play, the main one is taxes. A Roth IRA, or Roth contributions in your 401k are going to be some of the best options since they grow completely free of taxes provided you leave them until the normal retirement age. The problem with Roth is that many do not have the option to contribute to Roth options, or only a small amount if they are able. Roth IRAs have income limitations that excluded many from investing, and have very limited amounts that you can contribute on an annual basis. Roth contributions in an employer 401k is still something many employers do not make available. The other issue is limited access to the assets until you are retirement age. With Roth accounts, you do have the ability to access the amount you contributed before normal retirement age, however any earnings would be subject to tax and penalty if accessed early.

From there the choice becomes far more complicated depending on an investors unique situation. When you make an eligible pre-tax contribution to a 401k or Traditional IRA, you receive a tax deduction for that contribution. This money then is invested and grows over time until you retire, at which time many begins withdraws. At this point, everything that you contributed, pre-tax money, and everything it earned is going to be taxable when you withdraw any money. There are many potential problems here, and again it has to do with taxes. Your savings will be subject to federal, and state if applicable, income tax rates. In addition to that, this income could also create additional taxes on Social Security, and IRMAA. Compounding these problems further is there is no way to know what income taxes will be in the future when you retire. At this time, tax rates are scheduled to increase significantly at the end of 2025 when the current tax cuts legislation sunsets. The other issue of course is that you will be penalized if you need to access the account before you are normal retirement age. Any amount you access before normal retirement age is subject to income taxes, as well as a 10% penalty. Lastly a Traditional IRA or 401k are simply the worse type of account to use for legacy purposes. If you have any plans to pass on money to beneficiaries, these are easily the worst options for multiple reasons. These accounts are not only taxable to the beneficiary, but they also have to withdraw and pay the taxes in a very limited amount of time.

Another option for saving is a taxable investment account. When investing in a taxable investment account, you do not receive a tax deduction for your contribution into that account. The growth, or earnings, of this type of account is taxable however they are taxed at capital gains tax rates. Capital gains are taxed either as short term (you held the investment for less than 1 year), or as long term (you held the investment for a year or more). Short term capital gains are taxed as income, just like growth or earnings on a pre-tax 401k or Traditional IRA. Long term capital gains however are taxed at more favorable long term capital gains rates. As you can see below, Short-Term Capital Gains Tax Rate (which is the same as Income Tax Rates), are SIGNIFICANTLY higher in all situations.

Another factor of consideration is also how you plan to use these monies that you have been saving. Pretax IRA and 401k distributions require that you take money out, and pay taxes on the money, which is known as Required Minimum Distributions (RMDs). The amount you are required to distribute and pay tax on, is based on the IRS requires - not what you need. In addition, if you do not use all of these monies and pass them on to a beneficiary they will also have to pay federal and state income taxes when they withdraw; which for most beneficiaries will have to be done within a 10 year period of time.

As you can see, with most investment decisions, there are many variables that need to be considered as there is no one size fits all solution. We specialize in providing you with what is the optimal solution for you when it comes to all aspects of your financial plans and goals. Schedule a free consultation if you would like help with making sure that your financial plans are aligned in an optimal way for your specific situation.