If you have access to a 401(k) plan through your employer, you may be inclined to contribute as much money as possible to it. With a traditional 401(k), the more you put in, the more income you can potentially shield from taxes, up to the yearly IRS limit.
Plus, many 401(k) plans offer an employer match. So if you contribute enough to yours, you can snag a pile of free money on top of it.
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It generally makes sense to fund your 401(k) plan up to the matching amount your company is willing to give. So if your employer matches contributions of up to $3,000, you should make a point to put that much into its plan.
But you may not want to max out your 401(k), which, this year, means putting in $23,000 if you’re under age 50 or $30,500 if you’re 50 or older. You may find that another retirement savings plan better serves your needs.
An IRA might offer more investment choices and save you money on fees
One major drawback of 401(k) plans is that they don’t allow you to invest for retirement in individual stocks. Rather, you’re generally limited to an assortment of funds, from target-date funds that are suitable for hands-off investors to mutual and index funds.
The problem with that is twofold. First, by limiting you to investment funds, 401(k)s make it difficult to build a customized retirement portfolio. That could limit the growth of your savings.
Also, target-date funds and mutual funds are notorious for charging high fees, known as expense ratios, that can eat away at your 401(k)’s returns over time. While you can generally avoid that issue by sticking to lower-cost index funds, you may not find an index fund you’re thrilled with, depending on your plan’s choices.
The nice thing about IRAs is that they give you many more choices for investing your savings. If you want to handpick a portfolio of stocks based on your own research, you can. That could result in a portfolio with returns that outpace those of the broad market, leading to more retirement wealth. And an IRA could also help you cut down on unwanted investment fees.
An HSA could give you more tax benefits
While a 401(k) plan allows you to shield contributions from taxes (assuming you have the traditional type, not a Roth), an HSA gives you that benefit plus two others. HSA funds can be invested for tax-free gains, and HSA withdrawals used for qualifying medical expenses are tax-free.
It’s worth noting that an HSA isn’t strictly a retirement savings plan. You can take an HSA withdrawal at any age or stage of life to pay for healthcare expenses. But since HSAs don’t require you to withdraw your money within a specific time frame, you have the option to reserve your balance for retirement, when your healthcare costs might be highest.
You should also know that once you turn 65, you can take an HSA withdrawal for non-medical reasons without facing a penalty. This allows you to treat your HSA as a backup savings plan for general expenses. However, non-medical HSA withdrawals at age 65 or later are subject to taxes. If you want your HSA funds tax-free, you’ll need to use the money for qualifying healthcare costs.
There’s nothing wrong with funding a 401(k) plan with just enough cash to get free money in the form of an employer match. But before you decide that you’re going to try to max out your 401(k), consider putting some of your savings into an IRA or HSA instead — or both.
