When you’re saving for retirement, you want to make sure that you’re making the most of your investments, so when that day finally comes, you have the most money possible. The account in which you invest can have huge implications for how much money you’ll have when you retire and how best you can minimize your tax hit.
Below, three seasoned Motley Fool contributors review the best ways to invest for retirement in order to make the most of the money you contribute.
A straightforward path to a million-dollar nest egg
Chuck Saletta: Perhaps the easiest path to millionaire status in retirement is to invest in your 401(k). If you start early enough and invest enough money consistently, you might even be able to retire a millionaire even with downright lousy returns just from the money you’re able to sock away in that account. That makes your 401(k) an incredibly powerful tool when it comes to investing for your retirement.
One of the best features of 401(k) investing is that the money comes directly out of your paycheck and gets automatically invested on your behalf. That means that once you go through the one-time effort to set up your contributions and investments, they can continue as long as you’re employed by the same company. It also means that once you get used to making the contributions, you just might find you’re not missing the money that you’re putting to work for you.
Another great feature of 401(k)-type investing is that there are pretty high annual contribution limits. In 2021, most people under age 50 can contribute $19,500 per year, while those age 50+ are generally eligible to sock away as much as $26,000. Combine those fairly high limits with automatic investing direct from your paycheck, and your 401(k) could easily become the largest source of your retirement savings.
In addition, 401(k)-type plans are tax-advantaged. In all such plans, money inside the account can grow tax deferred. In traditional-style plans, you get an immediate tax deduction for contributing, but the money gets taxed as ordinary income when you withdraw it. In Roth-style plans, you pay full income tax on money you contribute, but you can withdraw your money completely tax free once you reach age 59 1/2.
Still, there are downsides to 401(k) plans. Most notably, they are designed to save for retirement. If you expect to withdraw money early, you’re generally forced to pay a 10% penalty on top of any taxes you owe. In addition, with Roth-style plans, if you withdraw your money before age 59 1/2, the portion of your withdrawals that count as growth of your money is taxed as ordinary income. Those costs make it challenging to use 401(k)-style plans for money you may need to tap before a standard retirement age.
The easiest and most flexible retirement account
Barbara Bayer: While 401(k) plans are great investment vehicles, not everyone has a job with a traditional employer that sponsors them. According to Forbes, the self-employed workforce accounts for close to 30% of all Americans, and that number continues growing, especially since the COVID-19 pandemic gave everyone a taste of what it’s like to work from home and be independent.
But the problem is that self-employed retirement savers aren’t eligible for workplace 401(k)s. Instead, they have a (sometimes even better!) option to save for their senior years via individual retirement accounts, or IRAs.
These retirement accounts were started in 1974 to aid people who weren’t eligible for pension benefits. They’re tax-advantaged accounts, so depending on the type of IRA and your income level, you may get a tax break on your contributions. The money you invest will continue to grow tax-free until you start withdrawing the funds, at which point, depending on the type of IRA you choose, you may have to pay taxes.
The two main types are a traditional IRA and Roth IRA. In 2021, they both have contribution limits of $6,000 (and you can add another $1,000 if you’re over 50). With traditional IRAs, your contributions are tax deductible if your income is less than $65,000 for a single filer and $104,000 for joint filers. Once you turn 59 1/2, you can withdraw the money, which has been growing tax-free, but you’ll pay taxes at regular income levels.
The second type is a Roth IRA, which is funded with after-tax money. You don’t get the tax deduction upfront, but all your withdrawals are tax-free once you begin making them after the age of 59 1/2. This is great because your investments can accumulate, and you won’t have to pay taxes on your investing profits during your senior years. However, there are eligibility requirements and contribution limits for those who wish to fund a Roth IRA.
Small-business owners or self-employed individuals can also open SEP-IRA or SIMPLE IRA accounts, which have higher contribution limits.
The best part of all these accounts is that, unlike 401(k)s, which have limited investment choices, IRAs are self-directed, so you can invest in stocks, exchange-traded funds (ETFs), and mutual funds. That gives you the most flexibility to invest for your future.
Make the middleman work for you
Eric Volkman: I would suggest opening a traditional brokerage account. In my opinion, it’s the best choice for retirement investing because it offers so much flexibility.
These days, even the most bare-bones trading account offers a raft of securities to invest in — ETFs, stocks, bonds, mutual funds, derivatives, etc. A brokerage is happy to allow a client to basically invest in anything they’re interested in plowing money into.
It’s nice to have such a wide variety of choices available, not least because it makes it easy to tailor a portfolio to an eventual retiree’s investing style and goals. Are you a frequent risk taker who likes to buy derivatives? A blue chip stock buy-and-holder? A set-it-and-forget-it type? A mix of all of the above? A good broker can provide the opportunities and the resources that best fit your profile.
For retirement savers, another positive with traditional brokerage accounts is the many tools available with most of them. These include, but are by no means limited to, access to analyst research, advisory services, and educational resources that allow you to acquire or brush up on your knowledge of financial securities and trading.
For example, my brokerage — TDAmeritrade, not long ago swallowed by its big peer Charles Schwab (NYSE:SCHW) — has a “market update” news feed that pumps in stories about macro- and microeconomic developments and moves made by individual companies. TDAmeritrade/Schwab also provides a handy stock screener that allows me to narrow down potential investments based on criteria I can adjust.
Another plus with brokerages is that, thanks to a fee war that broke out a few years ago, trading commissions today are basically non-existent. So buying even a large block of your favorite company will generate exactly $0 in such fees at many brokerages. (Schwab, by the way, was a commission-free trading pioneer.)
Since the late 20th century, American finance has undergone a radical change. Gone are the days when securities trading was the near-exclusive province of people working in the finance industry or their rich clients. Today, ownership of such financial instruments is commonplace, even among people of modest means.
This leads to perhaps the greatest advantage of brokerage accounts for retirement savers in our modern age — convenience.
With the explosion of online and mobile trading, opening and maintaining an account is as simple as starting an app or visiting a website. Also, many brokerages have low, or even no, minimum amounts to open. For example, Schwab’s is $0. Researching, soliciting investment advice, and finally trading can be done with a set of mouse clicks or taps on a smartphone.
In short, a decent securities brokerage can offer nearly every service and resource a determined retirement saver needs. It’s a one-stop shop for those dreaming of a big golden nest egg for their golden years.
