How Much Should You Contribute to a Retirement vs. a Taxable Brokerage Account?

Photo by Eric Froehling

Photo by Eric Froehling

So you’ve successfully saved for an emergency fund and now you’re wondering: what next? While you can save for multiple financial goals at the same time, many people choose to focus their savings on either long-term retirement or more short-term goals, such as putting funds into a taxable brokerage account. 

Knowing where to focus most of your money depends largely on your personal goals and the amount of risk you’re personally willing to take on in your investments. Here’s how to weigh each method and decide how to focus your resources. 

What is a retirement account?

In the United States there are several different types of retirement accounts you can consider based on how much you earn, your employee benefits and what you want your retirement to look like. 

The most common plan is a 401(k) retirement plan because many employers will offer a 401(k) match as a benefit. Your contributions to a 401(k) are typically deducted from your paycheck. The money saved is deducted pre-tax. 

There are many other forms of retirement accounts beyond the 401(k). For example, there’s the Individual Retirement Account (IRA), which earns interest in a tax deferred account. 

There’s also the Roth IRA, which is after-tax income that you can withdraw in retirement tax free. Added to these are additional versions of the IRA such as the Simple IRA or the SEP IRA. Saving for retirement is customizable once you start investigating into the various options that can fit different time frames of your career. 

What is a taxable brokerage account?

An investment firm can help you set up a taxable brokerage account, which is an investment account that allows you to buy securities. You contribute to the account by linking it to a bank account or through other money transfer methods such as check, cash or wiring. There are many different investments you can purchase through this account, which your brokerage normally manages. 

Mutual funds, exchange traded funds, stock and bonds are all common investments you might make through a taxable brokerage account. You pay your brokerage a fee for managing these investments for you. 

How to decide on your contributions

Your savings and investment strategy is likely going to involve making contributions to multiple accounts at the same time. The question for you is — how much do you contribute to each method? This number is likely to change at different points in your life so here are some ways to evaluate that decision each time it comes up. 

1. How soon do you need the money?

If you want to save money for a purchase that you’ll make before heading into retirement — such as buying a home or going back to school — you’ll likely want to invest that money in something you can access without penalty whenever you’re ready for your big purchase. 

While retirement accounts like the Roth IRA allow you to use some of the funds tax free for qualified purchases before retirement, for the most part you’ll have to pay a penalty if you withdraw funds from your retirement savings accounts early. 

In this case, you might want to contribute money that you expect to use for large purchases toward a taxable brokerage account, so that it’s easy to access your funds in the near future. 

2. How much risk can you tolerate?

While a taxable brokerage account can seem like a great way to put your money to work, keep in mind that there is some risk involved when it comes to the stock market. 

You can choose to make more conservative investments, but at the end of the day how much money you spend in the stock market is going to come down to how comfortable you feel taking a chance with your finances. 

3. Is your employer matching?  

Some employers help workers save for retirement by offering a matching program toward retirement contributions. This extra boost to your savings can be a huge lift and financial experts typically recommend contributing to the maximum match amount. Not doing so is basically like leaving extra cash on the table. 

4. What lifestyle do you want in retirement?

Everyone’s retirement goals differ, which is why not everyone’s retirement savings strategies are going to look the same. Do you intend to work deeper into retirement? Do you want to travel? Live in a tiny home? Own a vacation home? Move in with your kids? 

You might not have a strong idea of what you want your retirement to look like right now. As you develop a picture for what the later years in your life will be like, however, save to match that dream. If you imagine yourself living off the grid in a small cabin, you might not need to save as much as if you’re hoping to jet set between multiple homes. 

5. What is your tax situation?

Because some retirement saving options allow you to make deductions on your taxes they do end up helping with tax planning, especially as your income increases throughout your career. Knowing how to maximize your contributions to receive the highest deductions can influence your decision on where to put your money. 

This doesn’t necessarily mean that you have to put all of your extra cash into retirement savings in order to take advantage of your deductions, but it does give you an extra element to consider, especially if you’re trying to decide what to do with funds that you’ve saved over the course of the year. 

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