If you work for a company that offers a 401(k), you might be inclined to sign up. And if you’re offered a match with an employer, it’s definitely worth putting enough money into that plan to claim all of that free money.
But you might want to think twice before making a 401(k) plan your only retirement account. In fact, all three accounts offer their share of benefits, without some of the drawbacks associated with 401(k).
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1. Traditional IRAs
With a traditional IRA, you get tax relief on your contributions, just like you would with a traditional 401(k). But one big difference is that IRAs offer many more investment choices.
With a 401(k), you are limited to a dozen funds. If you’re lucky, your plan will have a nice selection of low-cost index funds, which are heavily managed and therefore don’t charge the same high fees as actively managed mutual funds. But you can forget about manually selecting stocks in a 401(k).
With an IRA, you can invest in the businesses of your choice. And if you’re a sophisticated investor whose goal is to outperform the broader stock market, that alone is reason enough to house some of your retirement dollars in a traditional IRA.
2. Roth IRA
Roth IRAs, like traditional ones, let you choose individual stocks to invest in, and they often allow you to avoid the expensive fees that 401(k)s tend to charge. With a Roth IRA, you won’t get immediate tax relief on your contributions. What you will be however, get tax-free growth in your retirement plan and tax-free withdrawals in your retirement years.
Roth IRAs also offer another advantage: they are the only tax-efficient retirement account that does not impose the required minimum distributions. This gives you a lot more flexibility with your money later in life.
3.HSA
Technically, a health savings account is not a retirement plan. But it can work as one.
An HSA allows you to set aside money for healthcare expenses. You can use your funds immediately or invest the money you don’t use to grow and carry over into retirement.
HSAs actually offer more tax advantages than any of the aforementioned plans. This is because contributions are tax-free, investment earnings are tax-free, and withdrawals are tax-free, provided they are used to pay for eligible healthcare expenses.
If you make a non-medical withdrawal from an HSA, you will be hit with a hefty penalty — an even greater penalty than you would face for an early withdrawal from an IRA or 401(k). But once you turn 65, you can withdraw HSA funds for any purpose and avoid penalties. The only catch in this scenario is that you will pay taxes on your withdrawal, but these are the same taxes that apply to withdrawals from a traditional IRA or 401(k).
Putting money into a 401(k) is by no means a stupid decision, especially if there are employer matching dollars involved. But you may want to diversify beyond your 401(k) as part of building retirement wealth. And a traditional IRA, Roth IRA, and HSA are all good options to consider for your money.