A 401(k) is a very popular account for retirement savings. Typically, 401(k)s are provided by employers, and companies may even match your contributions. Since the money can be taken out of your paycheck and invested directly into your 401(k), they are very convenient and simple to set up.
Like most people who have access to a 401(k), I invested some of my retirement money in this one. But I also put money into several other accounts to prepare for my later years, rather than just focusing on investing in a 401(k). Here are three reasons why I made this choice.
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1. I may wish to retire and access my money sooner
Because a 401(k) is a tax-efficient retirement plan, special rules apply. In particular, it is generally not possible to start withdrawing money before the age of 59.5 without incurring a 10% early withdrawal penalty.
Because of this rule, which applies to most tax-advantaged retirement accounts, I put some of my retirement money into a taxable brokerage account. I might want to retire before age 59 1/2. If I did, I would have to start relying on my investments to generate income sooner.
I don’t want to face a big penalty for early withdrawals and I want the flexibility to use my investments to support myself at a younger age. A taxable brokerage account allows me to do this.
2. I prefer a wider choice of investment options
Typically, 401(k) accounts offer very few investment options. Most offer about a dozen funds. You generally cannot invest in individual stocks when you have money in a 401(k). And because you have a limited choice of funds available, you may also end up with higher fees or not be able to achieve the specific risk exposure and diversification you want.
Although I invest primarily in index funds and own very few individual stocks, I want to have more control over my investments, especially since I am very focused on keeping my investment expenses at a low level. low level and on the avoidance of unnecessary costs. By investing in a retirement account with a brokerage outside of my 401(k), I can choose from a much larger pool of assets in which to invest my money.
3. I take advantage of various tax advantages offered by other accounts
The last big reason I chose to keep some of my retirement money outside of a 401(k) is so I can get better tax breaks with other types of accounts.
For example, I’ve never had access to a Roth 401(k), so I keep money in a Roth IRA. It allows me to defer tax breaks on some of my retirement money so I can make tax-free withdrawals as a senior instead of saving on taxes the year I contribute. It also allows me to reduce the risk of my future Social Security benefits being taxed. I also put money in a health savings account (HSA), which allows me to invest with pre-tax funds and withdraw money for eligible healthcare expenses tax-free.
All of these benefits are ample justification for diversifying my investments beyond my 401(k). While a 401(k) is generally worth investing in if you have access to it, it often shouldn’t be the only retirement account because there are so many options, each offering their own benefits.