Where to Save for Retirement After Maxing Out Your 401(k)
Aggressive savers can turn to taxable accounts, SEP IRAs and variable annuities after hitting the limit in tax-advantaged retirement plans.
You have several options if you’re already saving the maximum in your retirement accounts, or if you earn too much to contribute the maximum. In 2014, most employees can stash up to $17,500 in their 401(k), 403(b), federal Thrift Savings and most 457 plans. You can also contribute up to $5,500 to a traditional or Roth IRA. If you’re 50 or older, you can make “catch up” contributions of up to $5,500 to an employer retirement plan and $1,000 to an IRA.
But employers are required to limit contributions by highly compensated employees if an insufficient number of lower-paid employees participate in the plan. (For 2014, you’re a highly compensated employee if you earn $115,000 or more.) And you can’t contribute to a Roth IRA if you earn more than $129,000 in 2014 ($191,000 for married couples filing jointly), although there’s no income limit if you make after-tax contributions to a traditional IRA and convert it to a Roth.
Taxable accounts. Investing some of your savings in a taxable account is an especially good idea if you’re saving for both retirement and college. If you come up short while your child is in college, you can tap your taxable account without paying income taxes and early-withdrawal penalties.
Taxes on these accounts aren’t deferred, but most investors pay just 15% on long-term capital gains and qualified dividends; investors in the 10% and 15% tax brackets pay 0%. Meanwhile, withdrawals from your tax-deferred accounts will be taxed at your ordinary income rate, which currently ranges from 10% to 39.6%.
To keep taxes in check, select tax-efficient investments for this account, such as tax-free municipal bonds, as well as stock index funds and other investments that qualify for long-term capital-gains rates, says Michael Kitces, a certified financial planner for Pinnacle Advisory Group, in Columbia, Md.
SEP IRAs. If you have self-employment income from your own business or from freelancing, consulting or similar part-time work, these IRAs offer a way to put a lot of money away for retirement and cut your taxes, too. You can contribute up to 20% of your self-employment income (your business income minus half of your self-employment tax), up to a maximum of $52,000 in 2014. Contributions are tax-deductible and grow tax-deferred until retirement.
Variable annuities. Contributions to these accounts usually aren’t deductible, but investment gains grow tax-deferred until you take withdrawals.
In the past, the products were often encumbered by high fees that crippled investment returns. Now, though, a new generation of variable annuities features low fees and modest or no surrender charges. Investors can purchase annuities directly from Vanguard Group and Fidelity Investments without paying a commission.
Still, for most people, says Kitces, the expenses of variable annuities, even the low-cost versions, usually outweigh the benefits of tax deferral. Variable annuities are most appropriate for high-bracket taxpayers with income of at least $250,000 because they stand to benefit the most from compounded tax-deferred earnings.
Variable annuities also look more attractive now that high-income investors are nicked by a new 3.8% surtax on investment income, and those in the top tax bracket will pay a higher rate on capital gains and dividends, too.