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ASK A FINANCIAL PLANNER: What’s the next best place to put retirement savings after maxing out my 401(k)?

Summary List Placement A Roth IRA is a good complement to a 401(k) for retirement savings.  Though annual contribution limits are lower, investment options abound and your money grows tax-free. There's a "backdoor" strategy for anyone who makes too much to qualify for a Roth IRA. Have a personal-finance question for Tanza? Fill out...

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Summary List Placement

  • A Roth IRA is a good complement to a 401(k) for retirement savings. 
  • Though annual contribution limits are lower, investment options abound and your money grows tax-free.
  • There’s a “backdoor” strategy for anyone who makes too much to qualify for a Roth IRA.
  • Have a personal-finance question for Tanza? Fill out this anonymous form

Question: What’s the next best place to put retirement savings after maxing out my 401(k)?

Answer: First of all, nice work prioritizing your 401(k). You’re making the most of one of the best wealth-building tools available, especially if your employer matches your contributions. 

But step back for a moment and look at how much you’re paying in fees. 401(k)s are expensive for companies to maintain and some of that cost trickles down to the investor. “Maxing out” a 401(k) has become a sort of gospel in personal finance, but throwing every last dollar at yours might not be the most cost-effective strategy.

You can’t avoid fees charged by the investment funds themselves, but if your 401(k) administrator charges more than 2% just to “manage” your account, you might want to direct some savings elsewhere (just make sure you’re still saving enough to score the match).

Enter: IRAs. IRAs are tax-advantaged accounts operated by banks and brokerages, rather than your employer, and come in two forms — traditional and Roth. The main difference between the two is tax treatment.

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Here’s a quick rundown of the popular retirement accounts:

  Traditional IRA Roth IRA 401(k)
Max contribution if you’re 49 or younger in 2021 $6,000* $6,000* $19,500
Max contribution if you’re 50 or older in 2021 $7,000* $7,000* $26,000
Do you pay income tax on withdrawals after age 59.5? Yes No Yes
Can you get an income tax deduction this year for contributing? Maybe No Yes
Are there restrictions on who can contribute? No — amount you can deduct varies based on income, marital status, and whether you or your spouse have a work retirement plan Yes — to contribute the full amount in 2021, you must earn <$125,000 if single and <$198,000 if married. Earning above those limits will reduce the amount you can contribute No — Your employer may have requirements before you’re eligible to contribute or qualify for a match

*Combined annual contribution to a Roth IRA and traditional IRA.

Roth IRAs are surprisingly flexible

You might be tempted to jump on the Robinhood train to grow your money, but that isn’t the most reliable way to build a retirement nest egg. IRAs are tax beneficial — and your everyday brokerage account is not.

A Roth IRA is a really good option for young people who expect their income to go up in the future. It’s funded with after-tax dollars, up to $6,000 in 2021, so you can withdraw the money later in retirement and pay no income tax. This is a smart way to diversify your retirement income, since the money you withdraw from your 401(k) will be taxable. 

The investment options in a Roth IRA are only limited by what the brokerage that houses your IRA offers (401(k)s, by contrast, can be pretty selective). That means you have the power to choose low-cost funds that align with your overall investment goals. And since the investments are self-directed, there’s usually no account management fee collected by the brokerage.

But the flexibility doesn’t end there. You can withdraw your contributions to a Roth IRA at any time, tax- and penalty-free, since you already paid taxes on the money before funding your account. Withdrawing earnings before you turn 59 and a half can trigger a penalty, but there are even exceptions to that rule, including if the money is being used for college tuition or a first-time home purchase.

Of course, it’s best to leave retirement savings untouched for optimal growth. But it’s reassuring to know you can dip into it if needed.

A Roth IRA strategy for high earners 

Alas, the benefits of Roth IRAs are so good that the IRS only lets people under a certain income level contribute. In 2021, single tax filers who earn less than $140,000 and married joint filers who earn less than $208,000 can add money to a Roth IRA.

Anyone who is indeed maxing out their 401(k) — contributing up to the annual limit — likely has a high salary. If a Roth IRA is off the table for you, there is a way to get around it: the so-called backdoor Roth IRA.

This strategy enables high earners to contribute to a traditional IRA first, without claiming a tax deduction for the amount contributed, and then roll it over into a Roth IRA to enjoy tax-free growth and withdrawals. 

Most brokerage firms are familiar with the backdoor strategy, as are many financial planners and tax advisors. If you’re considering this strategy, reach out to an expert who can guide you through the process and make sure you’re doing the most to maximize your retirement savings.

Tanza Loudenback, CFP®, is the personal-finance correspondent at Business Insider. She writes most frequently about saving money, planning for retirement, taxes, debt management, and strategies for building wealth. Have a money question for Tanza? Fill out this anonymous form.

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