A 401(K) is a valuable vehicle for employees to build savings for retirement.
But Americans shouldn’t put all their savings into their workplace plan, warned financial planner Georgia Lord.
Tax laws are constantly changing, so it’s crucial to diversify your retirement accounts to give you flexibility when it comes to accessing your savings later in life, she said, and to avoid getting caught with a higher tax bill.
The majority of retirement accounts contain tax-advantaged, tax-free or taxable funds.
“It’s important to keep your money in these different types of accounts based on their tax treatment so that you can be sure you’re covered when the time comes to draw on those assets,” she told DailyMail. com.
Americans shouldn’t put all their savings into their workplace plan, financial planner Georgia Lord warned
In the same way experts recommend diversifying any investment portfolio you have, Lord, a financial planner at Corbett Road Wealth Management, recommends diversifying the retirement accounts you hold.
A traditional 401(K) is a “tax-advantaged” account because employees make pre-tax contributions.
This allows you to defer paying taxes on your income while you work and gradually build up your savings.
When you retire, you pay taxes on this money. However, it is possible that your taxable income is currently lower than during your working years.
Roth IRA and Roth 401(K) accounts are classified as “tax-free” because they consist of after-tax contributions to help reduce your tax liability in retirement.
If tax rates continue to rise, Lord said, “why not have some of your assets so you can at least be tax free in retirement.”
“Taxable” funds include investment accounts that allow you to buy or sell a variety of investments, and these are often after-tax contributions.
“We can’t make decisions today based on tax law because there’s a good chance this will change in the future – especially when we’re talking about the retirement of younger people who still have so many years ahead of them,” she said.
For example, the Trump-era tax law introduced in 2017 is currently set to expire on January 1, 2026, bringing major changes for millions of US taxpayers.
It’s difficult to know what tax rates will look like in retirement, how much you’ll earn in retirement, how much you’ll have saved and what your lifestyle might look like, she added.
“By ensuring you have a mix of tax-advantaged, tax-free and taxable funds, you give yourself more flexibility to minimize your overall tax liability and stay below certain annual income thresholds,” Lord said.
Tax laws are constantly changing, so it’s crucial to diversify your retirement accounts to give you flexibility when it comes to accessing your savings later in life
Diversifying your retirement accounts provides flexibility for when to make withdrawals, known as required minimum contributions (RMDs), in retirement, she said.
By planning ahead, you reduce the risk that you will pay more in Medicare premiums or have a higher percentage of your Social Security benefit become taxable if you earn too much or withdraw too much from your retirement accounts, she added.
Not all employees will be able to invest in their 401(K) and then have money left over to contribute elsewhere, Lord acknowledged.
“First and foremost, I would play the game at least in a 401(K),” she said.
“Then it comes down to whether you can afford to save more, and in which vehicle you should do so.”
For those who may not have a large amount to contribute, Lord recommends looking into setting up a Roth account with your 401(K) plan.
This would help you diversify without having to open a separate account.
“Almost all 401(K)s have the option to have Roth dollars in them,” she said.