One of the best places people deposit their savings for retirement is the 401(k) plan sponsored by their workplace. People favor this type of 401(k) plan because it offers them the opportunity to save automatically because the money will be deducted directly from their paycheck.
Under the 401(k) plan, you will not be encouraged to make unnecessary withdrawals from your retirement savings due to the plan’s withdrawal restrictions. When you don’t withdraw from your savings, it will grow to a considerable sum within a short period of time. Your investment in the 401(k) plan will also increase when you defer your taxes.
Regardless of the benefits of the workplace-sponsored 401(k) plan, you can still gain a lot by dumping your 401(k) plan for a taxable account.
Potential dangers to the 401(k) plan
The COVID pandemic’s impact on the global economy reduced the number of people who turn their savings into a 401(k) plan. The main reason for the downturn in the number of 401(k) plan contributors is that many companies have suspended their workers’ contributions. Simultaneously, the tax rates on income will be higher due to the enormous stimulus disbursed by the government.
A survey done in April shows that about 17% of organizations have suspended their employers’ matching contributions. This suspension is due to the pandemic. The Retirement Research Center also gives the number of companies that have suspended their employer’s matching contribution. According to their findings, the total number of people affected is 410,313 participants, and this number accounts for only 0.69% of participants on a 401(k) plan in America.
One of the most important features of the 401(k) plan is the employer-matching contribution. This contribution involves a free deposit, which covers up for some of the deficiencies with the 401(k) plans.
If the employer-matching contribution stops, you can continue to fund your savings in the 401(k) plan using your paycheck. But saving with your paycheck requires you to pay taxes. When you contribute, you pay taxes, but the earnings from your savings will increase without taxes. You should note that tax deferment is not useful if the tax rates on income rise before your retirement because you will pay more taxes when you retire.
Saving for retirement in a taxable brokerage account
There are various plans where you can place your retirement savings apart from the 401(k) plan. These plans include the Roth IRA, the traditional form of an IRA, and the taxable account. The IRAs have lower caps of contribution, and this is a major disadvantage. If you are under the age of 50, the maximum amount you can save in your IRA in 2020 is $6,000, but if you are above age 50, you can save up to $7,000 in your IRA.
There’s no limitation to the amount of money you can save in a taxable account, but there is no tax perk for your savings. These tax perks are the deferrals on your income and the deductions made from your savings. The tax perks will result in more taxes over time.
When you pay your taxes, you have the right to spend your money as you like since your withdrawal has no taxes over them. The free will to withdraw is not feasible with the 401(k) plan because your withdrawal from the 401(k) plan is like your monthly income, and this involves payment of taxes.
The taxable account allows you to retire any time, even at age 50, because you are not on the government’s retirement timeline. But before you make a decision, you should make sure that you save enough money that will suffice during retirement. Participants on the 401(k) plan can only make a withdrawal that is free from a penalty when they are 59 years old.
Also, when you save in the taxable account, you may decide not to withdraw under the IRS mandate. When you don’t withdraw your taxable account savings, you are leaving your money to grow. But in the 401(k) plan, you must make taxable withdrawals once you reach age 72 if you don’t want to be penalized.
Can I use a taxable account for my retirement savings?
Despite the numerous benefits of the taxable account, it does not apply to everyone. People that still have access to an employer match should not stop their 401(k) plan, because doing so will make them lose a lot of free money. Suppose you can not abstain from spending your savings. In that case, the 401(k) plan is your best option because the penalties for early withdrawal will limit you from spending your savings. The 401(k) plan will always give you some savings when you retire.
Saving for retirement in a taxable account is good, especially when the 401(k) plan is not favorable. With the taxable account, you will pay taxes on your savings annually, and this will make your money grow because of the discipline. Retirement savings in a taxable account allow you to retire at your free will.