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Beyond the 401k: The “Where to Invest Next” Order of Operations

Beyond the 401k: The “Where to Invest Next” Order of Operations

The goal of retirement is to live out your golden years in comfort, correct? Then it’s critical to make the most of your retirement savings strategy. And for many, contributing to an employer-sponsored 401k plan is the perfect starting point. These plans offer the opportunity to grow money tax-free and are usually matched by employers – in 2024, most companies are offering a 3% – 6% match on their employees’ contributions.

As we head into 2024, the elective deferral limit for anyone participating in a 401k plan will be $23,000 (an increase from $22,500 in 2023). With the catch-up contribution limit, that amount is $30,500 for those aged 50 and over.

For high earners, these annual limits won’t be enough to help you save what you need to continue your current lifestyle in retirement. So, to create that comfortable retirement you’ve always dreamed of, you’ve got to put your earnings to work.

Look Ahead as Far as Possible and Be Precise When it Comes to Anticipating Your Retirement Expenses

No matter what your retirement plans include – golfing, traveling, writing a book, lounging, or spending time with family – it’s always possible to outlive your assets if you’re not well prepared. Relying on just a 401k may put your ideal post-work lifestyle at risk.

Yes, you will want to take full advantage of the 401k match your employer offers. However, there may be additional investment vehicles worth leveraging to increase your retirement income streams.

Depending on your savings or income level, it may not make sense to choose the same investment strategies as the masses (especially if you’re looking to build generational wealth). Instead, look towards the future you envision, and use multiple techniques to create more volume, diversify taxes, and spread out risk.

UNDERSTANDING THE INVESTMENT ORDER OF OPERATIONS

Let’s quickly run through the investing order of operations, from the basics leading up to your 401k and then what comes next…

ESTABLISH (OR BOOST) YOUR EMERGENCY FUND

An emergency fund provides a financial shield against life’s unpleasant surprises. It’s your fiscal life raft, preventing the need for premature withdrawal from your retirement accounts – actions that often bring heavy penalties and jeopardize your financial future. An ideal emergency fund should cover 3 to 6 months of your living expenses.

This money also needs to be in easily accessible, low-risk accounts. Think money market accounts, high-yield savings accounts, or short-term certificates of deposit. These vehicles offer better returns than standard savings accounts, helping your emergency reserves to grow. If your emergency fund isn’t where it needs to be based on your risk tolerance, it may be time for a boost in savings.

If you don’t have enough money saved up for emergencies, you could end up dipping into your retirement savings earlier than planned. But be careful – taking money out of your 401k before you’re 59 ½ years old comes with a costly 10% penalty. Also, you’ll be missing out on the growth your money could have earned over time.

Ideal For: Those in need of a (greater) financial safety net.

MAX OUT YOUR EMPLOYER’S 401K MATCH

This is one of the most foundational steps in building your retirement savings: maxing out your employer’s match on your 401k.

Many employers offer a match to your 401k contributions, essentially free money added to your retirement fund. The common approach is a dollar-for-dollar match up to a certain percentage of your pay. Not taking full advantage of this is leaving money on the table.

Understand the specifics of your employer’s 401k matching program. This could vary – some might match 50% of your contributions up to 6% of your salary, others might match 100% up to 3%. Whatever the policy, make sure you’re contributing enough to get the full match. If you haven’t fully maxed out your employer’s match yet, do so before giving your attention to other investments.

Ideal For: Anyone eligible for a matching 401k program!

PAY OFF YOUR HIGH-INTEREST DEBTS

Paying off debt is often a crucial part of a savvy financial plan. However, not all debts are created equal. If you haven’t already, it may be a wise move to start paying down any high-interest debts — think anything with an interest rate above 6%.

Now, when it comes to low-interest debts the strategy may shift a bit. If, for example, you locked in your mortgage at a low interest rate, sticking to your regular payment schedule could work in your favor. Thanks to inflation, the real value of what you owe could shrink over time.

Plus, your investments in the stock market might just rake in higher returns than what you’re paying in mortgage interest. It’s a balancing act, really — comparing the surefire return from paying off debt against the potential for higher returns from your investments.

Each financial situation is unique, so it’s important to weigh these factors carefully as you decide to “invest” in paying off debts.

Ideal For: Those looking to breathe easier by reducing unnecessary debt.

CONSIDER FUNDING A HEALTH SAVINGS ACCOUNT (HSA)

Health Savings Accounts are lauded for their triple-tax advantage: they are funded with pre-tax dollars, experience tax-free growth, and qualifying medical expenses are covered with tax-free withdrawals.

No longer are HSAs used just to cover healthcare expenses today; they’re tools to save for healthcare and other costs in retirement.

A 65-year-old couple will spend an average of $315,000 in out-of-pocket medical fees in retirement. Why not start saving for future healthcare expenditures now? Or, withdraw the funds and use them as you need in retirement – once you reach the age of 65, the funds can be used as you see fit but will be taxed as income.

If you ensure that your HSA funds are well invested, you will accrue quite a lot by retirement.

Ideal for: Anyone with a high-deductible health plan.

MAX OUT TRADITIONAL AND ROTH IRAS

Individual Retirement Accounts (IRAs) are a common starting point after meeting your employer’s 401k match. Traditional and Roth IRAs offer tax savings, only differing in when those savings are captured.

Traditional IRAs utilize pre-tax money for contributions and are taxed upon withdrawal in retirement, whereas Roth contributions are funded with post-tax dollars, but retirement withdrawals are tax-free. Additionally, Roths have no Required Minimum Distributions (RMDs). In other words, this type of account allows you to begin withdrawing money on your timeline and not the one determined by the IRS.

In 2024, you’ll be able to contribute up to $7,000 to both types of IRAs – $8,000 for those over 50.

Take note that Roth IRAs do have income limits:

  • For single filers: $146,000 to $161,000
  • For married couples filing jointly: $230,000 to $240,000
  • For married and filing separately: up to $129,000

Don’t worry – even those exceeding the income limits can convert a traditional IRA into a Roth later through a legal loophole known as the backdoor Roth IRA.

Ideal for: Young professionals who expect their tax bracket to stay the same in retirement.

529 EDUCATION SAVINGS PLAN(S):

College Savings 529 Plans are more than just a savings tool; they’re strategic investments in your child’s future education.

Contributions made with after-tax dollars grow tax-free, and withdrawals for qualified educational expenses are exempt from taxes. If college costs are only expected to rise, why not start building that educational nest egg as soon as possible?

You can use the funds for tuition, textbooks, room and board, and other schooling-related costs, providing a solid foundation for your child’s next academic step.

You may also want to think about ‘superfunding’ your 529 Plan. This involves making a significant contribution that leverages your annual gift tax exclusion.

Under current regulations, you can invest up to five times this annual limit in a single year without incurring gift taxes, allowing the substantial funds to grow tax-free over an extended period. Keep in mind, however, that after such a large contribution, you would not be able to make additional annual exclusion gifts to the same beneficiary for the next five years without affecting your lifetime gift tax exemption.

In an exciting update for 2024, the SECURE 2.0 legislation now permits transferring up to $35,000 from a 529 plan to a Roth IRA for your child. This transfer is limited to $6,500 annually and is available only for 529 accounts active for 15+ years.

Note, contributions from the past five years are ineligible for this rollover. If you follow these rules, you can effectively extend your financial support to your child’s future beyond just education, helping them to invest beyond their own 401k someday.

Ideal for: Parents looking to secure their children’s educational future without the burden of student loans.

FULLY MAX OUT YOUR 401K

Securing your employer’s match to your 401k is a great start. However, you may not want to stop there. If you haven’t already, you may want to consider fully maxing out your employer’s retirement plan. It can be a game-changer whether you’re using a Traditional or Roth 401k.

Both types of 401k plans come with distinct tax advantages, paralleling the benefits of Traditional and Roth IRAs. In a Traditional 401k, your contributions reduce your taxable income, providing immediate tax relief. Conversely, the Roth 401k, funded with after-tax dollars, offers tax-free growth and withdrawals, aligning with a future-focused tax strategy.

What’s more, 401ks allow you to save much more than IRAs in a tax-efficient way. And if you’re 50 or older, there’s an added bonus: you’re eligible for extra ‘catch-up’ contributions, which can be quite substantial.

Ideal For: Those who have already met their employer’s match and have maxed out a Roth IRA (if they’re eligible).

YOUR NEXT OPTIONS: ALTERNATIVE INVESTMENTS

If you are maximizing savings in a retirement account or like to spread your savings between various types of accounts, the following options can help ensure well-rounded savings for retirement.

Taxable Brokerage Account – This option is hands down the most flexible for high-earners with a substantial capacity to save. There are no income limits or annual funding limitations, and unlike other retirement accounts, the assets here can be accessed anytime, for anything.

While you won’t benefit from tax breaks, you will be in control of buying and selling a wide variety of securities, and with careful planning and strategy, taxes can be controlled.

You can even consider using advanced trading strategies, like trading on margin, that are not available in retirement accounts. Trading on margin involves the use of leverage with the goal of amplified returns. Beware, returns fluctuate more in good markets and bad markets. You will want to educate yourself and exercise caution before determining if trading on margin is appropriate for you.

Ideal for: Investors with extra savings and high-risk tolerance.

Real Estate Investments – If you’re looking to diversify your portfolio, real estate is a great option. Whether you invest in residential properties to rent out, buy and flip houses, or purchase a commercial property to lease, the possibilities for curating passive income streams into your retirement are endless (not to mention the considerable tax advantages for those who own rental properties).

Ideal for: Investors with large cash reserves and an understanding of the real estate market.

Invest in a Business – Since 2015, the US Securities and Exchange Commission (SEC) has allowed startups and small businesses to seek investors through brokers or equity-crowdfunded campaigns. In other words, many online crowdfunding platforms now allow anybody to invest in a small business or startup. Keep in mind this option is exciting but risky. Do your homework and familiarize yourself with the process, risks, and the company you’re considering investing in. Alternatively, you could assist a friend or family member with starting their own business.

Ideal for: Investors passionate about entrepreneurship and comfortable with the potential risks.

Life Insurance and Annuities– While these products are typically used as a benefit upon death, some people like the features associated with insurance contracts, especially the tax deferred growth.

However, like everything in life, there are pros and cons to consider. Insurance products are not our first pick of solutions for someone who has a strong growth objective. They can work well for estate planning reasons, income strategies, and for conservative investors.

Creating a Long-Term Plan

If you’re expecting your existing quality of life to follow you into retirement, it’s important to prioritize a retirement plan that will provide reliable income. That means investing in more than just your company’s 401k plan. If you’re ready to put your extra money to work, set up a call. We can help you determine which of the savings vehicles discussed above will make the most “cents” for the long, happy, and comfortable retirement you desire!

Editor’s Note: This article was originally published in December of 2022. It was last updated in January of 2024.

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More About the Author: Sheena Hanson

Sheena is a highly regarded financial expert known for her clear explanations and practical advice on complex financial matters. She earned her CERTIFIED FINANCIAL PLANNER™️ designation in 2010 and holds a Bachelor of Science degree in Finance from the University of Wisconsin LaCrosse.