Maxed out your 401(k)? Where to save next

Allworth Co-CEO Scott Hanson shares three savings alternatives for anyone who's already met the 2021 401(k) contribution limit. 

Even good savers have limits.

As we approach the end of 2021, many of you pre-retirees will have reached your 401(k) contribution limits, but still be in the mood to save.

Once you’ve put all the money in your 401(k) that you’re legally allowed to (amounts below), you’re what is referred to as “maxed out.”

But as we so often discuss on our radio shows, if you’ve reached your 401(k) contribution limits, now is not the time to stop saving.

This year, or every year, put the pedal to the metal and put even more money away using one of these three savings vehicles.

Contribute to a traditional IRA or a Roth IRA

One of the most mystifying rules the IRS has is how low IRA contribution limits are.

For those of you who don’t have access to a 401(k), or other employer sponsored defined contribution plan, it’s something I’ve always felt should be rectified by the IRS.

That’s because, while those of you who have access to a 401(k)) can put away $19,500 if you’re under age 50 ($26,000 if you’re age 50 or above), folks who contribute to an IRA are limited to $6,000 if you’re under 50 ($7,000 if you are 50 or older).

And, even if you have a 401(k), and you (or your spouse) have maxed out a 401(k), you still might be able to contribute to an IRA.

While other restrictions apply, for 2021, you can contribute the full tax-deductible amount to both a 401(k) and a traditional IRA, IF:

• You’re single and make $66,000 a year or less
• You’re married (and file together) and make $105,000 a year or less

Please note that there are graduated income standards for both scenarios where you can make more than those limits (up to $76,000 for singles, and up to $125,000 for married couples) and still benefit from a partial tax deduction but not receive the full exclusion of the $6,000/$7,000 limits referenced above.

Those income limits (to contribute to both) are, regrettably low, and it’s not too common that folks making $66,000 a year will max out their 401(k) and contribute to a traditional IRA, but it does happen.

What’s more common is that someone who maxes out their 401(k) will be “incomed out” of a traditional IRA but sitting in the sweet spot to contribute to a Roth IRA.

Now, Roth IRAs aren’t tax deductible, but the terrific thing about them is this: They allow folks to contribute after tax money that not only grows tax free, but later, when you use the money, no matter how much it’s grown, if you are over age 59½ and have held the account for at least five years, you won’t have to pay taxes on it.

As in none.  

However (and there is almost always a “however”), Roth IRAs do also have income limit phaseouts, but they are more generous than traditional IRAs. That means, for 2021, if you’re single, once your income hits $125,000, you’re allowed to contribute progressively less until your income reaches $140,000. The married folks’ phaseout begins when your income hits $198,000 and leaves you in the cold (unable to contribute) once your income surpasses $208,000.

Also, Roth IRA contribution limits ($6,000/$7,000) are the same as traditional IRAs (and, I should note, if you're saving in both, that's a combined contribution limit.)

Don’t sleep on HSAs

My experience has been that when people want to explore alternative avenues (other than a 401(k)) to save for retirement, when they hear about a savings vehicle with the name “Health Savings Account,” their eyes glaze over.

While, yes, Health Savings Accounts (HSAs) were invented to help you pay for healthcare related expenses (and while distributions for that purpose can be tax free), all things considered, they are probably an underutilized vehicle.

That’s because, like a 401(k) or traditional IRA, money in an HSA is invested pre-tax, and grows tax free. Yes, if you use it for non-healthcare related purposes before you turn 65, you’ll pay a stiff 20% penalty. But if you (and likely your employer) contribute to one year-after-year, and you don’t use it for healthcare, once you retire and turn 65 you should have built up a nice nest egg that’s been growing tax deferred.

Of course, you’ll be taxed on the withdrawals, but it’s also possible that your tax bracket will be lower (than it is if you are still working) after you turn 65.

The contribution limits for HSAs are $3,600 for single folks and $7,200 for those of you who have family health insurance coverage.

Just remember, however, that to open an HSA, you must participate in a high-deductible healthcare plan. So you need to be willing - and able - to shoulder higher out-of-pocket costs in the short term in exchange for the long-term tax benefits. 

The end of the year is approaching, and while it feels great to have maxed out a 401(k), why break the momentum? If you qualify, you should shift gears and contribute to one of the vehicles above.

If you have any questions about saving, investing, or anything related to finances and retirement, please call your advisor or your nearest Allworth office and schedule an appointment.