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Can I retire on my 401(k) alone?

There are many advantages to saving beyond your 401(k)

Key takeaways:

  • Even if you’re contributing the max allowable to your 401(k), it may still not be enough.
  • There are a lot of good reasons to invest in your 401(k), but consider other ways to save, including IRAs, investment accounts and savings accounts.
  • Taxes can take a big bite out of your retirement savings, but there are ways to balance the impact.


Are you contributing the maximum allowable to your 401(k)? If so, good for you!

But did you know it still may not be enough?

While it’s good to max your 401(k) contributions, it’s a little known fact that doing so may still not get you what you need to retire. Because the IRS limits the amount you can contribute each year, distributions from just your 401(k) fund may not be enough to last you through retirement. 

How much you can save is not the only issue. Taxes can have a huge impact on how long your retirement income will last, so it helps to diversify how you save. Withdrawals from a 401(k) are subject to income tax, so it may be worthwhile for you to contribute to another type of account where distributions are not taxable.

There are many issues to consider. Let’s take a closer look.


Reasons to invest in your 401(k)

Your 401(k) or other employer-sponsored retirement plan should be the first place you go when saving for retirement. Here’s why.


1. Employer-matching funds

If your employer offers matching funds, take full advantage of it—it’s free money. For example, your employer may add $1.00 for every $1.00 you contribute, up to 3% of your earnings. This means that if you earn $60,000 and set aside 3% of your own earnings for your 401(k), your employer will also contribute $1,800 each year towards your retirement, essentially doubling your annual investment. 

If you do only one thing for retirement savings, make sure it’s to participate at a level which allows you to take full advantage of your matching funds.


2. Tax-deferral

Tax savings are another great reason to invest in your 401(k).

Contributions to a traditional 401(k) are taken from your paycheck before your taxable income is calculated. This reduces your taxable income and the amount of income tax you must pay. Theoretically, this also means that because you pay less in income tax, you’re left with more money to invest, which helps your savings grow even faster. 

With a traditional 401(k), you’re only taxed when you withdraw money from the account during retirement. Most people are typically in a lower tax bracket at that age, so your 401(k) distributions are taxed at a lower rate. 

If your employer offers a Roth 401(k) option, your contributions will be taken from your salary after tax, but when you withdraw the money during retirement, your money and earnings are tax-free. You may have to pay taxes on any matching funds your employer provided; check with your tax advisor.

If you have access to both a traditional and a Roth 401(k), you may even want to split your contributions between the two, although your annual max amount remains the same. The best option for you depends on several factors, including the income taxes in your state; check with your tax advisor to see which is the best way for you to invest. And keep in mind that this may change as you get older. Some financial professionals advise that you use a Roth 401(k) early in your career and then shift to a traditional 401(k) as you earn more.


Have an old 401(k) or two sitting around? Here’s what to do.

If you’ve changed companies over the years, you may have left a trail of old 401(k)s behind. There are four things you can do:

  1. Leave your money where it is, in the old 401(k)
  2. Roll it over to your new employer’s 401(k)
  3. Rollover the 401(k) to an IRA
  4. Cash it out (but this is not recommended)

Before you decide what to do, learn more about your options and then discuss them with a financial professional.


Reasons to invest in more than your 401(k)

Once you’ve taken full advantage of your employer’s matching funds, consider your other options. There are many advantages to investing in something other than just your 401(k). 

When you save beyond your 401(k), you can …


1. Diversify your tax obligations

The way in which your money is invested determines how it is taxed, so when you have different pools of money from which to withdraw funds during retirement, you can balance the amount of tax you must pay.

For example, with a traditional 401(k), you will pay taxes on the money only when it’s withdrawn. But when you withdraw money from a Roth 401(k) or a Roth IRA, those distributions are tax-free. When you have money invested in a taxable brokerage account, you’ll pay taxes on capital gains and any dividends you earn in a year. But these are taxed at a long-term capital gains rate, which can be lower than your regular income tax rate. And interest you earn from a savings, money market, or certificate account is taxable in the year it is earned. No additional taxes are assessed when you withdraw the money.

By having a variety of retirement savings funds, you can spread out your tax obligation.


2. Diversify your investment portfolio

A diversified investment portfolio protects you from the risk of having too many of your eggs in the same basket. But when you have a 401(k), your investment options are limited to what your employer offers in their plan. That’s not the case with an IRA or a brokerage account. 

Both traditional and Roth IRAs offer broad options in terms of how you can invest your money, and can include anything from stocks, bonds, and mutual funds to annuities, exchange-traded funds (ETFs), and even real estate investment trusts (REITs). You may also find that the investment options in an IRA have lower fees than those found in your 401(k) fund.


3. Avoid early withdrawal penalties

Both 401(k)s and IRAs have significant early withdrawal penalties. Although there are a few exceptions, if you withdraw money from an IRA before turning age 59 ½ or from your 401(k) before you turn 65 (or before your plan's normal retirement age), you'll pay an additional 10 percent in income tax. That’s why most financial professionals urge you to keep a portion of your retirement savings in a savings, money market or certificate account, or in a brokerage account. Just make sure you resist the urge to withdraw money for anything other than retirement.


4. Save beyond the contribution limits

This one is particularly important if you didn’t start saving for retirement until later in life. In 2023, the IRS limits your pre-tax employer-sponsored retirement plan contributions to $22,500, and total contributions (from you and your employer) are capped at $66,000. If you are age 50 or older, your maximum is $30,000 ($73,500 total) due to extra allowable catch-up contributions. But if you’re nearing retirement and only recently started saving, you won’t be able to save what you need. So, if you’re trying to make up for missed savings over the years, these contribution limits may keep you from reaching your retirement savings goal. 

There’s no limit to how much you can save using a savings, money market, or certificate account, or how much you can invest in a brokerage account.


Other ways to save for retirement

While 401(k)s give you a great way to save, don’t forget about these other great retirement saving options.


Individual retirement accounts (IRAs)

Even if you are contributing the maximum amount allowed by the IRS to your employer-sponsored retirement plan, you can still contribute to a traditional or a Roth IRA, up to a certain limit. The IRS limits your 2023 contributions with either a traditional or a Roth IRA to $6,500 a year if you’re under age 50, or $7,500 if you’re 50 years or older. When you’ve retired, the distributions from a traditional IRA are taxed, but those from a Roth IRA are not. 

Roth IRAs are not available to everyone, so ask a financial professional about your options.


Investment accounts

Anyone can open a brokerage or other investment account for retirement savings, and they provide three important advantages. First, the money is available anytime, without early withdrawal penalties. Tax advantages are another benefit, since capital gains realized on the sale of securities are taxed at a lower rate than regular income. And finally, there are no contribution limits, leaving you free to invest and save as much as you like.


Health Savings Account (HSA)

If your employer offers an HSA, you can use this to pay for healthcare expenses when you’re retired, which makes it, in essence, a retirement savings plan. In fact, an HSA offers even more tax benefits than a 401(k) or IRA. Your contributions are made before tax; the gains in your HSA grow tax-free; and when the withdrawals are used to pay for qualified medical expenses, they are also not taxed. The funds you put into your HSA can be used for Medicare premiums and copays and can even be used for things like dental or vision care.


Final thoughts

When you limit your retirement savings to only using a traditional 401(k), you limit your future, both in how much you can set aside for retirement and in the way your money will be taxed when you need it.

As a smart saver, you should balance your need to save with the tax implications of the ways in which you’re saving by using a combination of 401(k)s and IRAs, as well as other things like brokerage accounts, savings accounts, and others.

When you diversify your savings and balance the way in which those savings are taxed, you can be more confident that your money can last as long as you need it.


Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.

A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.

Need help? We’re right here.

Retirement planning is complicated, so make plans to meet with a financial professional who can help you develop a comprehensive strategy for your golden years. This is what we do; take full advantage of our expertise.

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