How To Invest For Retirement After Maxing Out a 401K

‍Should I Invest in an IRA?

If you’ve already maxed out your 401(k) — well done! — and you’re looking for other viable ways to invest for retirement, the first thing you should consider doing is opening an IRA. You’ve likely heard that term floated around more than a few times during your life, but many people don’t really know too much about an IRA including what it is, how it works, and what types of IRAs are out there. Let’s start from the beginning and go through a quick refresher.

What is an IRA?

An Individual Retirement Account (IRA) is a tax-sheltered and tax-advantaged retirement account that is opened by you and belongs to you only. This is where the individual aspect of the account’s name comes into play. IRAs can be opened by you with any of the major brokerages out there including Vanguard, Fidelity, Charles Schwab, and more. Opening one is super easy to do and can help you expand your retirement portfolio in a tax-advantaged way.

Inside of your IRA, you can choose to invest in whatever you see fit. If you think back to your 401(k) that you’ve maxed out, chances are high that you had a select number of investment opportunities to choose from. In an IRA, the finance industry is your oyster; you can choose to invest in anything you want. Stocks, exchange-traded funds (ETFs), mutual funds, bonds, real estate, and more.

Due to their tax benefits, the IRS has limits on the amount that you’re able to contribute to your IRA accounts. As of 2021, the annual contribution limit is capped at $6,000. If you’re 50 years old or older, then you can increase your contributions to $7,000 per year. These are the maximum amounts allowed for all of your IRAs combined, not per account.

Now that you know what they are, let’s take a look at why you want to invest in an IRA. Since IRAs are tax-sheltered accounts, you don’t have to pay income tax or capital gains taxes on any of your investment earnings while the funds remain in the account. So you can feel free to buy and sell within your account anyway you want. Taxes will be handled differently depending on what type of IRA you open, so let’s take a look at the two main IRA options to choose from.

Traditional IRA

The common type of IRA that’s opened in the US is a traditional IRA. If the 401(k) that you’ve already maxed out was a traditional 401(k) like the vast majority are, then you can think of a traditional IRA in much the same way. Just like the 401(k), you fund a traditional IRA with pre-tax dollars. And also like your contributions to the 401(k), any contributions you make to your traditional IRA are tax-deductible during the year you made the contributions.

Since you’re not paying taxes on the money you fund the account with, any contributions you make to the account are committed to the IRA until you reach retirement age at 59 ½. So if you withdraw the money from your account early, you will incur an early withdrawal fee and also be forced to pay the income taxes that you were able to previously deduct.

When you do reach 59 ½ and you’re able to start withdrawing from your traditional IRA, you will need to pay income taxes on everything that you withdraw, both your contributions and any earnings. So with a traditional IRA you are getting tax-break now, but the toll comes due later in life when you have to pay taxes on your withdrawals during retirement.

This is the single biggest difference between a traditional IRA and a Roth IRA.

Roth IRA

Roth IRAs are becoming more and more popular in the US due to their special tax benefits that people are starting to gravitate towards. In a Roth IRA, you fund the account with after-tax dollars. This means that since you’ve already paid taxes on those funds, you can withdraw your contributions at any time before retirement with no penalty or taxes due. You just can’t withdraw your earnings.

While that’s a big benefit in itself if something comes up and you need to get some cash out, what really makes a Roth IRA special is how the taxes are handled in retirement. Once you reach age 59 ½ and your account has been opened for at least 5 years, you can start withdrawing from your Roth and pay zero in income or capital gains taxes. Yes that’s right. Within a Roth IRA, your contributions and earnings are entirely tax-free in retirement since you funded it with after-tax dollars.

So both types of IRAs have huge tax advantages, and both offer advantages over one another. It really comes down to whether you want the tax-break now or during retirement. Whichever type of IRA you choose, this is the best way to invest after maxing out your 401(k).

Should I Contribute to a Health Savings Account?

If you have access to it, arguably the best way to invest for retirement is by maxing out a Health Savings Account (HSA). An HSA is only available to those who are enrolled in a High-Deductible Health Plan (HDHP) so they are not available to many people — and don’t necessarily enroll in an HDHP just for an HSA! But to those who have access to them, you absolutely want to take advantage.  

HSAs were designed to give people a place to stash money away for health-related expenses. You can put money in and invest it however you want, just like an IRA. That said, the money within an HSA is only allowed to be spent on healthcare, but, during retirement, healthcare is one of the biggest expenses that anyone will have. What many people don’t know is that HSAs have more tax benefits than any other account, even more so than a 401(k) or IRA!

What are the Benefits of a Health Savings Account?

HSAs are triple tax-advantaged. Yes, triple.

This means that they have tax-deductible contributions, tax-free earnings, and tax-free withdrawals. In other words, if used correctly, the money committed to an HSA is never taxed. That’s something you won’t find anywhere else in the world of finance. Due to these massive tax benefits, the IRS also limits what you can contribute to an HSA. As of 2021, an individual with self-coverage can contribute a maximum of $3,600 per year. With family coverage, this increases to $7,200 per year. At age 55 or older these limits increase by $1,000.

With all of their tax advantages, you have to use HSAs properly or risk incurring major penalties. If you withdraw funds from an HSA for non-qualified healthcare expenses before age 65, you will have to pay a 20% penalty as well as the taxes. Once you’re age 65 or older, you’ll still have to pay income taxes on non-healthcare expenses but the penalty will be waived.

So if you have access to an HSA and understand to only use the money for healthcare related expenses, then by all means take advantage of them. Having a big nest egg dedicated to healthcare expenses in retirement can be a massive weight off your shoulders during your golden years.

Can I Invest in a Taxable Brokerage Account?

If you’ve already maxed out your 401(k) and you’re taking advantage of the tax benefits of your new IRA or HSA, then consider opening a regular taxable brokerage account to invest more of your money. As the name implies, a taxable brokerage account does not have any of the same amazing tax benefits for retirement that the other accounts listed above have. But that doesn’t mean they should be avoided altogether. Not by any means.

What is a taxable brokerage account and how do they work?

Taxable brokerage accounts, or simply brokerage accounts, are investment accounts that you can easily open with any major brokerage out there and even many banks. For example, you can open a brokerage account with Vanguard, Fidelity, Charles Schwab, TD Ameritrade, Ally, Robinhood, WeBull, and on and on. Your options are limited and it’s super easy to open.

Brokerage accounts are basically just accounts that you fund with after-tax dollars and you can invest in anything you want that’s listed on the market. Similar to an IRA in that aspect, the brokerage account is owned and operated by you, so you can buy anything you have your eye on. Maybe you want to invest in some big blue chip stocks or you want to start getting some dividend income flowing. You have the options to put your money anywhere.

The big downside to a taxable brokerage account when compared to a 401(k) or IRA is that there are not any tax benefits. You fund it with after-tax dollars, but any earnings within the account are subject to income tax or capital gains tax depending on how long you hold onto the investment. For example if you invest $10,000 in a stock in your brokerage account and sell that investment six months later for $15,000, you’ll have to pay income tax on that $5,000.

While there are no tax benefits to these accounts, there are also then no penalties when you use the money in them. You can add money, withdraw money, buy and sell investments, and use the earnings at any time during your life without having to pay any penalties. This also makes brokerage accounts great to invest in if you’re planning (or hoping) to retire early. You don’t want all of your money locked up in retirement accounts behind early withdrawal penalties.

So it may not be tax-sheltered or tax-advantaged, but a brokerage account can be a valuable part of your portfolio if you ever need cash for anything and don’t want to incur penalties for withdrawing from your retirement accounts.

Should I Add Real Estate to My Portfolio?

Another investment option that you can consider for retirement after maxing out your 401(k) is to delve into the world of real estate. Now real estate is such a broad topic with so many different opportunities, countless articles just on various aspects of the real estate industry could be written. But we’ll keep it a bit more short and sweet here just so you can think about dipping your toes into the real estate investment industry.

One of the easiest ways to add real estate to your investment portfolio doesn’t actually involve you personally buying any real estate for yourself. Rather you buy into real estate investment trusts (REITs) within your aforementioned IRA or brokerage account. REITs are companies or investment firms that own income-generating real estate themselves. And when you invest in a REIT and their properties generate income, you get a portion of that in the form of dividends.

This is a pretty much hands-off approach to real estate investing but a simple and much less risky way of getting involved. But as you are likely thinking to yourself, when people consider investing in real estate they are usually talking about the physical real estate properties themselves. Not just effectively a real estate mutual fund. And that is, of course, the other big option with real estate.

The most common way to invest in real estate for retirement is rental properties. The process can be difficult and stressful but it’s pretty straightforward. You purchase the property (either with cash or a mortgage) and do any necessary repairs. Then rent it out to cover your monthly payment and start generating some steady income from the property. Keep that up during your working career and by the time you go to retire, the property should be paid off (or nearly paid off) and hopefully it will have also appreciated in value.

This means you were generating positive income during the entire time you were renting it out, the value of the house went up due to appreciation, and by the time you retire you have substantially positive net equity on the property. Now imagine doing this with just a few properties and voila, that’s your retirement right there. Real estate can be a difficult process but it can also be very rewarding. Just make sure to do your research before diving in.