Brokerage Account Vs Retirement Plan: Which is Best
So you’ve successfully saved for an emergency fund and now you’re wondering: what next? 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 your options and decide how to focus your resources.
What is the best retirement savings 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. Retirement accounts offer tax benefits — by either reducing your taxes now or in retirement in exchange for saving for your future. They have limits on how much you can contribute each year and when you can withdraw that money.
401 k plan
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 deducted from your paycheck. The money saved is often deducted pre-tax, but these days many employers offer post-tax (Roth) options too.
There are many other forms of retirement accounts beyond the 401(k). For example, there’s the traditional Individual Retirement Account (IRA), which allows you to take a tax deduction for your contributions. There’s also the Roth IRA, which is after-tax savings that you can withdraw tax-free in retirement. Less common IRAs include the SEP IRA and the SIMPLE IRA, which are most commonly used by solopreneurs or small businesses.
What is a taxable brokerage account?
A taxable brokerage account allows you to invest for any goal, not just retirement. These accounts are more flexible because they don’t have annual contribution limits or penalize you for withdrawing your money before your reach retirement age. They also have a wide range of investment options than you can get through most 401(k)s.
You contribute to the account by linking it to a bank account or through other money transfer methods such as check, cash, or wiring. Depending on which investment company you use, you may pay someone a fee to manage your investments or you can manage them yourself.
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 this: how much do you contribute to each type of account? 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 invest 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 at least 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 of what the later years of 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 reduce your taxable income now, they can help with your tax burden, especially as your income increases throughout your career. Alternatively, you might like the security of having a smaller tax burden in the future if you contribute to Roth accounts. Knowing how to optimize your contributions in line with your tax situation can influence your decision of where to put your money.
This doesn’t necessarily mean that you have to put all of your extra cash into retirement savings, 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.
Need help deciding how much to save and invest?
To get started, schedule a free 20-minute consultation call to speak to a member of our team. We will ask you a few basic questions to get to know you more, walk you through our financial training program steps, and answer any questions you may have. No pressure to join! Need advice quickly? Talk to one of our Trainers on Demand.