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The Best Way to Save for Retirement

Start by picking the right savings account for the job. That might be a standard 401(k) or IRA, or it could be a different kind of account.
Sept. 19, 2018
401(k), Investing, IRA, Other Retirement Accounts
The Best Way to Save for Retirement-story
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A regular old savings account is a fine parking spot for money you need on hand the next five years or so. But it’s a poor place for money earmarked for expenses further down the road.

Yet a recent NerdWallet survey found that 39% of Americans are forgoing investment growth on their savings for long-term financial goals because they prefer to keep that money — intended to provide retirement income — in cash.

Cash is safe. It’s certainly easier to access in a pinch than money in stocks or mutual funds. But there are much more effective ways to save for retirement, including some account options if you don’t qualify for run-of-the-mill places like a 401(k) or IRA.

Retirement accounts vs. savings accounts

IRAs, 401(k)s and 403(b)s are specifically designed for long-term investment goals (retirement!) and have special features that cash savings accounts lack:

  • Preferential treatment by the IRS. Depending on the type of retirement account you choose, you’ll get either an upfront tax break through deductible contributions (normal 401(k)s and traditional IRAs) or a back-end break via tax-free withdrawals in retirement (Roth 401(k)s and Roth IRAs). Plus, the IRS doesn’t tax investments as they grow within these accounts.
  • Access to a broad array of investments. This might include individual stocks, mutual funds and even alternative investments like real estate investment trust funds or REITs.
  • An easy way to separate long-term savings from near-term spending money. This way, you’re not tempted to dip into your reserves, which will shortchange your future lifestyle.

Savers who fear tying up their cash should know: If you absolutely need to get to the money early, there are scenarios where tax- and penalty-free early withdrawals from retirement accounts are allowed. Roth IRAs even allow withdrawals of contributions at any time, though for the sake of your retirement, we caution against using that feature outside of emergencies.

And if you’re tempted to stash retirement cash in more obscure alternative investments like cryptocurrencies or art and collectibles, you should know that these niche products come with a lot of risks and not a ton of transparency.

» Learn more in our guide to investing 101

Where to save your retirement money

You’ve got choices. Retirement savings accounts don’t grow on trees, but they are available in a variety of places:

At work: If you have access to a workplace retirement plan — a 401(k) or 403(b) — that’s a good place to start, especially if your employer sweetens the pot by matching a portion of your contributions.

The IRS allows you to contribute a maximum of $18,500 annually if you’re under age 50, and an additional $6,000 if you’re 50 or older.

One benefit of IRAs is that they offer more investment choices than workplace plans. They also typically give you more control over administrative and investment costs.

On your own: IRA stands for individual retirement account and, like it sounds, it’s a savings vehicle you set up at a financial institution. Individuals can contribute up to $5,500 annually (plus $1,000 on top of that for the 50-plus crowd).

One benefit of IRAs is that they offer more investment choices than workplace plans. They also typically give you more control over administrative and investment costs.

For the reasons above, a good retirement savings strategy is to first contribute enough to your workplace plan to qualify for any matching funds, then max out an IRA. Review this analysis of top-rated IRA providers to compare your options.

Once you’ve hit the IRA fill line, direct any excess dollars to the 401(k) in order to take full advantage of the plan’s tax benefits.

» Read about how to save for retirement

Where to save outside of a 401(k) or standard IRAs

What if you don’t have access to an employer-sponsored retirement savings plan or don’t qualify to contribute to a deductible or Roth IRA?

See if you qualify for a specialty retirement savings account. There are other types of IRAs for the self-employed, small businesses and nonworking spouses that have different contribution and eligibility rules. See our guide to retirement plans for more on these types of accounts.

Consider a nondeductible IRA. If you have an IRA but don’t qualify to deduct your contributions — this happens if you earn too much income and you or your spouse has access to a workplace savings plan — there’s still a case to be made for contributing to it. That’s because investment gains in the account still grow tax-deferred and, in retirement, you only pay taxes on investment growth — not your contributions. Plus, if you’re willing to do a little administrative work, you can convert a nondeductible IRA to a Roth IRA — called a backdoor Roth — and gain the benefit of tax-free withdrawals in retirement.

Invest via a regular taxable brokerage account or automated investing service (robo-advisor). These accounts don’t offer tax breaks, but they’re still better than holding your long-term savings in cash, since they give you access to investments that have the potential to deliver much higher returns. And that alone can be worth a lot over time.

To see exactly how much, take the calculator below for a spin.

Through smart investment choices, such as holding assets taxed at a lower rate or hiring a robo-advisor that specializes in tax-savvy portfolio management, you can keep your tax bill in check and save smartly for retirement. See these picks for best brokers and top-rated robo-advisors.

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