401(k) or IRA: A common way to save for retirement is to put as much money as possible into your IRA or 401(k). However, some financial advisors say that you should spread your savings out among different accounts, like brokerage and Roth accounts, instead of focusing on just one type.
Their advice stresses the tax advantages of getting money for retirement from more than one source. Spreading out your savings could help you pay less in taxes and have more control over how you spend your retirement money. This method helps you balance the tax benefits you get now with the tax consequences you will face in the future. It also gives you more ways to get money when you retire.
According to Daniel Razvi, senior partner and chief operating officer of Higher Ground Financial Group, “you don’t want all of your money in tax-deferred accounts.” “Today’s largest tax scam involves IRAs.”
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Why is it bad for taxes to have only 401(k) and IRA accounts?
- Because 401(k)s and IRAs are tax-deferred accounts, your contributions are not taxed until you take them out, which is typically in retirement. The issue is that, although advisors predicted a higher tax rate, we have no idea what it will be in the future.
- Withdrawals from IRAs and 401(k)s are subject to income tax. Advisors stated that long-term capital gains tax from a traditional brokerage account is typically lower than income tax rates.
According to USA Today, Joseph Patrick Roop of Belmont Capital Advisors said, “If you have a net worth of $2 million and $1.7 million is in IRAs, think of how trapped you are if taxes go up.” “You only have a 401(k) and an IRA, and both are subject to taxes.”
- Regardless of whether you need the money or not, you must begin taking an annual required minimum distribution (RMD) and paying taxes at the age of 73. RMDs have the potential to raise your income to the point where you are subject to Medicare cost increases and additional taxes on your Social Security benefit.
“It’s great that growth is tax-deferred, but are you also tax-deferring into higher brackets?” stated Nicholas Yeomans of Yeomans Consulting Group, president and chief compliance officer.
Advisors say that new rules from the IRS about inherited IRAs could change how you manage your retirement accounts. Most beneficiaries must take out the whole IRA balance within ten years of the death of the original owner, according to these new rules.
This could make beneficiaries pay more in taxes, especially if they make a lot of money. Some beneficiaries may also have to take annual Required Minimum Distributions (RMDs) during the years when they make the most money, which could make their tax bill higher. This might change how you plan and handle your retirement savings so that your heirs aren’t affected too much.
How can various account kinds contribute to tax reduction?
Advisors suggest that using a mix of Roth, traditional brokerage, and health savings accounts (HSAs) can give you greater control over your income and taxes.
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- Roth Accounts: Contributions are made with after-tax dollars, so withdrawals are tax-free if you’re at least 59½ and the account has been open for at least five years. There are no Required Minimum Distributions (RMDs), so you can let the account grow. Non-spouse beneficiaries must deplete the account within ten years of the original owner’s death but can delay withdrawals until the final year, and these withdrawals are not taxed.
- Brokerage Accounts: Investments are taxed as long-term capital gains if held for over a year, with rates typically lower than ordinary income tax rates. There are no RMDs. Inherited brokerage accounts get a step-up in basis, meaning the asset’s value is adjusted to the current market value at the time of death, potentially avoiding capital gains tax if sold immediately.
- Health Savings Accounts (HSAs): Contributions are tax-deductible, and withdrawals for qualified medical expenses are tax-free. After age 65, withdrawals for any purpose are taxable like regular income but without penalties.
These accounts offer flexibility and tax advantages that can be strategic for retirement planning.
You can put money from your retirement savings into health savings accounts (HSAs). An HSA is a way to save money before taxes that you can use to pay for certain medical costs if you have a high-deductible health plan.
According to Lauren Wybar, senior wealth adviser at Vanguard, “you can choose to cover medical costs today, or invest and allow your contributions to grow, to cover future costs in retirement.” You can take out HSA funds tax-free against those eligible expenses in retirement if you save your medical receipts. According to her, there are three tax benefits associated with HSAs: “investment growth is tax deferred, contributions and qualified withdrawals are tax free.”
However, if the account owner died in a certain year, the fund’s non-spouse beneficiary would have to pay income tax and close the account.
How should you divide up your funds amongst accounts?
Make sure you consistently add enough money to those accounts if your employer offers contribution matches. “Never turn your back on free money,” Yeomans said. “That’s a 100% rate of return on your dollars. Get the full match.”
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Financial advisors offer different strategies for managing retirement savings:
- Wybar suggests first saving 12–15% of your income (including employer matches) in your 401(k) or maxing out the account to benefit from tax-deferred growth. Once you’ve done that, if you have additional funds, consider investing in traditional and Roth IRAs for more flexibility with investments.
- On the other hand, Yeomans recommends a more balanced approach: allocate half of your savings to tax-deferred accounts, 25% to Roth accounts, and the remaining 25% to brokerage accounts. This strategy helps spread your investments across various tax treatments and account types, potentially offering better long-term financial flexibility.
