There’s some good news during the coronavirus pandemic: A recent survey by Schwab indicates the average amount 401(k) plan participants contributed to their accounts this year is up 20% compared with last year.Â
Investing more for retirement is always smart. And those Americans who increased account contributions during the coronavirus-driven market crash made an especially prudent choice since market downturns often present buying opportunities.
But this good news is tempered by the fact that putting more money into a 401(k) isn’t necessarily always the best way to save more for retirement. For some Americans, there are far better choices.Â
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Why extra 401(k) contributions aren’t necessarily the right move
For employees offered a workplace 401(k) with an employer match, contributing at least enough to secure company-provided funds is the smartest course of action. Employer 401(k) contributions are free money to live on in retirement.Â
But once you’ve maxed out your match, think seriously about whether increasing 401(k) contributions is the ideal next step. You may be better off diverting some of your additional capital to other tax-advantaged accounts, like a traditional or Roth IRA or a health savings account (HSA). Most people can’t afford to make hefty contributions to all these types of accounts, and some of the others provide significant advantages that 401(k)s don’t.Â
HSAs, for example, offer a triple tax benefit for those eligible for one. You can contribute with pre-tax dollars, enjoy tax-free gains if you invest the funds, and make tax-free withdrawals when the money is used for qualifying medical expenses. While HSAs may not appear at first glance to be a retirement account, they can serve as one because so many seniors incur substantial medical expenses. HSAs provide a big pot of money to cover these costs without owing taxes on account distributions, as you would on 401(k) withdrawals. HSAs also let you take money out for any purpose after age 65 without penalty, although you would pay taxes at your ordinary rate, just as with 401(k) distributions.
Both traditional and Roth IRAs also provide advantages 401(k)s don’t. While a traditional IRA accepts pre-tax contributions just as a 401(k) does, a Roth IRA instead takes contributions with after-tax dollars but enables tax-free withdrawals. If you believe your tax rate may be higher in your later years, investing in a Roth IRA is smart, especially since doing so can also help you potentially avoid being subject to tax on Social Security. And both traditional and Roth IRAs often provide a broader choice of investments than a 401(k), some of which may come with lower fees. If you want the chance to purchase shares of stock in individual companies, IRAs make that possible, while 401(k)s generally don’t.Â
Because these other accounts have advantages that 401(k)s don’t, it’s worth looking into whether you should save in them before upping your 401(k) contribution. Saving extra money anywhere is a good thing — but when you’re working hard to invest for your future, you want the most bang for your buck.
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