It’s a problem that a lot of investors wish they had. Have a maxed out Roth IRA and wondering where to go next?
While it’s hard to top the tax-deferred growth and tax-free withdrawals that a Roth account allows, there are still plenty of other great options that can cut back on Uncle Sam’s bite into your earnings.
If you’ve hit the cap on your annual Roth IRA contributions—the limit is $5,500 for 2017 if you’re under age 50 and $6,500 if you’re 50 or over—you’ve probably already maxed out your employer’s match on your 401(k). That should be Step 1 for the roughly 90 percent of employees who work for companies that pitch in to your account.
Once you’ve put in enough to get the full match, Step 2 is often a Roth IRA, which generally offers a wider range of investment options than a workplace plan. And for younger workers, in particular, it makes sense to open a Roth now, when your income tax is relatively low, in order to get tax-free withdrawals after age 59½, when you’ll likely be in a higher tax bracket.
So what’s Step 3? Here are some other paths you’ll want to explore.
Go Back to Your 401(k)
After maximizing your employer’s contribution to a 401(k) and then funding an IRA, it may be time to go back to that employer plan and, if possible, put in the full amount that’s allowed. In 2017, employees under age 50 can kick in $18,000 per year. And if you’re 50 or older, you can take advantage of a catch-up provision that allows you to contribute an additional $6,000.
Sure, your investment choices are limited to the menu that your company offers, but the tax benefits will likely more than make up for it. Your contributions are tax-deductible and grow on a tax-deferred basis until you make a withdrawal in retirement. At that point, you’ll pay ordinary income taxes on any funds you pull out of the plan.
If you expect to reach a higher tax bracket in retirement, a Roth 401(k) may be an even better option. Your contributions aren’t tax-deductible, but you don’t have to worry about income taxes on qualified withdrawals that you make later in life. According to the Plan Sponsor Council of America, about 60 percent of companies now offer their employees a Roth option.
Bulk Up Your Health Savings Account
To the extent that they’re using health savings accounts (HSAs) at all, most investors only put in enough to take care of their short-term needs. What they forget is that these accounts are also an incredibly powerful investment tool.
Why? Because they’re unique in offering a triple tax benefit: You contribute after-tax dollars and watch your money grow tax-free. And when you take the money out for eligible expenses, it avoids the tax man then, too.
Some HSA providers only allow FDIC-insured accounts that offer skimpy interest rates, but others let you invest in mutual funds and index funds that open the door to long-term growth.
Of course, HSAs have limitations that other tax-friendly accounts don’t. In most cases, your withdrawals are only tax-free if they’re used for certain medical expenses (the lengthy list includes everything from prescription drugs and hospital stays to home care and smoking cessation programs).
However, statistics show that your spending on such things is likely to be substantial once you hit retirement. Fidelity Benefits Consulting concludes, for example, that an average couple retiring at age 65 in 2017 will spend as much as $275,000 (in today’s dollars) on medical expenses throughout retirement.
The IRS allows single filers to contribute $3,400 each year toward an HSA; joint filers can put in $6,750. The caveat is that you’ll need a high-deductible health plan in order to take advantage of the HSA’s considerable tax perks. If that’s the type of medical coverage you have anyway, funding an account can have huge long-term benefits.
Consider a SEP IRA
If you’re self-employed, a SEP IRA is a great investment vehicle because it can significantly increase the limit on your overall IRA contributions. As a business owner—and that includes freelancers—the IRS allows you to contribute either 25 percent of compensation or $54,000 to each employee (including yourself), whichever is less.
As with other IRAs, contributions are tax-deductible and tax-deferred. What’s more, you can contribute as much as $5,500 toward a Roth IRA ($6,500 if you qualify for the catch-up provision) and still contribute the full amount to your SEP.
The other cool thing about SEPs is that they’re relatively easy to set up online. There’s no special paperwork you have to file with the IRS, so it’s a hassle-free way to save a lot of money on your tax bill.
If you do have other employees, the SEP can become a trickier decision because you have to contribute the same proportion of wages for each person you hire. If you’re kicking in 10 percent of your compensation for your own account, that means you have to kick in 10 percent of your employees’ compensation, too.
Find Smarter Taxable Investments
There are still ways to keep your taxes in check, even when you’ve exhausted your tax-advantaged accounts. One example: stock index funds. Because they buy and sell securities less frequently than actively managed funds, they tend to generate fewer taxable gains. When they do, it’s generally at the favorable long-term capital gains rate.
By contrast, short-term capital gains—incurred when the stock is held less than a year—are taxed at your ordinary income tax rate. So if you’re in a higher tax bracket, less “churn” within the fund translates into a significantly smaller tax bill. Plus, index funds tend to have lower management fees that act as a drag on your returns.
On the fixed-income side, municipal bonds are worth a look since they’re not taxed at the federal level; if they’re issued by the state you live in, they’re likely tax-free there, too. When you’re investing outside of a tax-advantaged account, that feature can have a big impact on the actual yield you receive.