More and more today, retirees are leaning heavily on their own savings to make up a huge portion of their retirement income. With pension plans nearly non-existent in the private sector, the 401(k) plan is the main vehicle through which these employees sock away money for their golden years. However your contributions to such a plan are limited to a certain amount annually. If you're a super saver looking for the best alternatives beyond an employer-sponsored qualified plan to tuck away retirement savings, the article by Bill Bischoff below does a great job of detailing where your additional money should go.
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Got a 401(k) plan at the office? Is there employer matching? Are you contributing the maximum amount you’re allowed each month? Then all this should add up to a healthy chunk of savings for retirement, one that you’d be hard-pressed to match without the tax-deferred compounding a 401(k) offers.
Think of it this way: What other investment gives you the equivalent of a 25% or 50% return on the first day? But, there’s only one problem. The federal government puts a lid on the tax-advantaged salary reduction amount you can contribute to your 401(k). In 2015, employee salary-reduction contributions max out at $18,000 ($24,000 if you are 50 or older). So, if you still have money you want to save after filling up your 401(k), our research shows that you should follow this pattern:
Roth IRAs
After you’ve maxed out the company match, then turn to a Roth IRA — if you qualify. (To make contributions for 2015, your modified adjusted gross income must be less than $131,000 if you’re single or less than $193,000 if you’re married, although the amount you can contribute begins phasing out at $116,000 and $183,000, respectively.)
Unmatched 401(k)
Keep putting your excess savings into the Roth until you’ve used up the $5,500 limit ($6,500 if you are 50 or older) that you’re allowed to contribute to it for 2015. Then, if you want to save even more than that, make whatever unmatched contributions you are allowed to your 401(k). In 2015 the government caps tax-advantaged salary-reduction 401(k) contributions at $18,000 ($24,000 if you are 50 or older as of year-end).
Taxable investments
If you plan to invest in equities, a taxable investment account with a brokerage firm is probably the next best thing given the current 15% or 20% federal rate on long-term capital gains and qualified dividends (the 20% maximum rate only affects high-income folks). The key to choosing taxable investments for your retirement savings, however, is to keep your expenses down and get the most benefit from that 15% or 20% rate. That entails holding your stocks for more than 12 months — longer, if possible — and choosing mutual funds with a low annual turnover (the rate at which the fund manager buys and sells holdings). Since the tax law strongly encourages funds to distribute all gains from selling stocks to their investors, the higher the turnover rate, the bigger the annual taxable distribution (other things being equa0, and that distribution may be taxed at higher federal rates (up to 39.6%) to the extent it consists of short-term capital gains.
Non-deductible IRA
Here the contribution limit for 2015 is $5,500 ($6,500 if you are 50 or older as of year-end). Unlike a deductible IRA, anyone with earned income from a job or self-employment can open one. And since these accounts grow tax deferred, if you have a long investment horizon, the tax-savings can be significant. That said, withdrawals are taxed as ordinary income, rather than at the lower long-term capital gains rates applied to taxable accounts. Given the current 15% or 20% maximum federal rate on long-term capital gains and qualified dividends, these accounts aren’t as attractive for those with a relatively short investment horizon.
Variable annuities
Forget them. Their high expenses often overwhelm the tax-deferral advantage of these contracts. Variable annuities make sense only for a fixed-income asset such as bonds or cash, and only if you are saving for many years. In that case, the gains from compounding your interest free of any current tax hit may eventually outweigh the drag created by higher fees. The exact number of years necessary to come out ahead depends on your tax bracket and the income yield from your investments.