Retirement accounts can be a great way to conveniently invest for your future. Whether they be employer sponsored plans like a 401(k) or your own personal account like an IRA or Roth IRA, the benefits and the process for investing in them is clear. However, the Federal government is equally aware of the unique tax benefits inherent in retirement accounts and thus places limits on how much an individual can contribute (or whether than can contribute at all) in a given calendar year. That said, after contributing up to the maximum in their retirement accounts many are left wondering, “now what?”
The good news is that there are options available to you to invest aside from retirement accounts. Some of these options even have tax benefits of their own! So without further ado, here are 3 ways to invest after maximizing your retirement accounts.
Non-Qualified or Taxable Accounts
Non-qualified accounts, also called taxable accounts, are funded with after-tax dollars. Unlike a retirement account, this account type has no limits as to how much you can contribute to it in a given year. If you hold investments inside a non-qualified account that pay a dividend (think stocks or mutual funds), those dividends are generally going to be taxed at ordinary income tax rates in the year that you receive them. Additionally, if you own mutual funds, you may also receive payments called “capital gains distributions”. These payments are a result of the fund managers making trades over the course of the year resulting in excess cash that is due to their shareholders. In a non-qualified account, capital gains distributions are taxed at the more favorable long term capital gains tax rates.
There are no taxes due on withdrawals from a non-qualified account, penalties for early withdrawals, or required minimum distributions. However, you do pay taxes on any gains that result from the sale of an investment (either ordinary income or long-term capital gains rates depending on if you held the investment for a year or more). If you are considering investing funds in a non-qualified account but do not want to deal with additional taxable income each year, you might consider investing in exchange traded funds (ETF). ETFs generally avoid taxable income as they typically do not pay out dividends or cap gains distributions. The bottom line is that, while non-qualified accounts do not have the exact same tax deferral benefits as a retirement account, they can still be a powerful investing tool due to the lack of contribution limits, the tax treatment of investment gains, and the absence of restrictions on withdrawals.
When most people hear the word “annuity” they have one of two responses: either visceral hatred or “aren’t those for old, retired people?” Truth be told, both of these responses are valid in their own way. Annuities in general have long been associated with producing income in retirement and can still serve that function today. Likewise, they have also earned the reputation of sleezy insurance product by the way they have been so predatorily sold to venerable adults. Both responses aside, I would urge you not to throw out the baby with the bathwater when it comes to annuities.
Like non-qualified accounts, tax-deferred annuities are funded with after-tax dollars and are not beholden to the normal IRS contribution limits or required minimum distributions. However, as the name would suggest, annuities are unlike non-qualified accounts in that all investment gains and income are tax-deferred until withdrawals are made from the annuity. When withdrawals are made, earnings and income are withdrawn first and taxed at ordinary income rates.
Due to their tax-deferred nature, annuities are also subject to early withdrawal penalties much like a retirement account. Annuities are also subject to early surrender charges by the issuing insurance company. These charges often start at around 6% of the account value and decrease to 0% over the course of 6-10 years.
I don’t want to delve too deep into the inner workings of annuities in this post (although we do have a couple of posts on our blog here and here) however, I would be remiss if I didn’t at least mention how an investor actually makes money in one of these insurance contracts. Very briefly, investors can purchase annuity contracts that pay a fixed rate of interest, are directly invested in the market, or track a certain market index while also offering floors on how much you can lose. The bottom line with tax-deferred annuities is that they can offer tax deferral and other benefits and guarantees that a non-qualified account cannot as long as you are willing and able to hold off on making any withdrawals until retirement and/or until your surrender charge falls off.
529 or HSA
We talked about 529 College Savings Plans and Health Savings Accounts in a recent blog post (check that out here) but they are worth mentioning again. If you have a high deductible health insurance plan (HDHP) then you also have the ability to contribute to an HSA. This type of account is meant to be a way for you to save money in order to cover your health insurance deductible and out of pocket costs. It accomplishes this by allowing you to make tax-deductible contributions that become tax-free if used for qualified medical expenses. For 2023, families are allowed to contribute up to $7,750 to an HSA. In much the same fashion, a 529 plan allows you to contribute funds with the intention of using them for educational expenses. One of the key differences is that you are only allowed to deduct contributions for state income tax purposes and those deductions are limited (in the state of MI they are limited to $10,000/year).
While both account types are intended for specific purposes, they have been used in the past as additional savings vehicles for high income earners. For example, some will fully fund their HSA for many years (and possibly even invest inside the HSA) with the intention of using those funds for long term care such as care in a nursing home. Recently, changes have also come to 529 plans which make them a more viable option for long term savings.
With the passing of the bundle of legislation known as SECURE Act 2.0, it will now be allowed for the remaining balance in a 529 plan to be transferred to a Roth IRA, however there are some ground rules. Beginning in 2024, 529 balances will be eligible for transfer into a Roth IRA as long as the owner of the Roth IRA is also the beneficiary of the 529. The 529 also needs to have been open for at least 15 years. Also, Roth transfers will be limited to the annual IRA contribution limits up to a lifetime max of $35,000 and the last 5 years of contributions and earnings are not eligible for transfer.
The 3 options that I described above are the most likely investment alternatives that will be available to you if you have already taken full advantage of your retirement accounts. Of course, there are other, less accessible options, but these are the most common. It would be a good idea to consult a professional before moving forward with any of the 3 options. If you would like to chat about this in more detail, grab some time on our calendar here. Thanks for reading today’s post!
Investing involves risks including possible loss of principal. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Content in this material is for general information only and not intended to provide specific advice or recommendations, or a substitute for specific individualized tax or legal advice. Fixed and Variable annuities are suitable for long-term investing, such as retirement investing. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply. Variable annuities are subject to market risk and may lose value.