For most people, retirement accounts are where they do the bulk of their investing, and it’s important to take full advantage of them. However, if you’re maxing out your contributions and have extra income to invest, it may be time to look at additional options.
Retirement investment accounts: the basics
As a group, retirement accounts are known as “qualified” investments because they qualify for beneficial tax treatment:
- Contributions are either pre-tax or tax-deductible
- Earnings are tax-deferred until you take money out the account
Retirement accounts have annual contribution limits and penalties for early withdrawal, generally before you reach the age of 59½. Qualified accounts include employer-sponsored retirement plans like 401(k)s and 403(b)s. Individual retirement accounts (IRAs) are also considered qualified due to the annual contribution limits and preferential tax treatment.
One reason employer-sponsored plans are popular is that many employers match contributions, up to a limit. However, there’s another reason most people invest primarily through retirement accounts.
“Folks are comfortable investing in their 401(k)s or 403(b)s because the funds come out of their paycheck automatically. They don’t really have to think about it,” says Jake Kujala, vice president and group product manager at U.S. Bank Wealth Management. At a certain point, convenience becomes inertia and, as Kujala says, “folks just tend to put off” looking into other investments.
The benefits of non-retirement investments
Non-retirement investments are “non-qualified,” which means you’re investing with after-tax dollars and not subject to special tax treatment. If you’re maxing out your 401(k) contribution and want to keep investing, that’s where non-qualified accounts may come into play.
One benefit of non-qualified investments is the amount of control you have over them. With employer-sponsored plans, you may be limited by what investments are available to that plan. Non-retirement accounts, on the other hand, allow you to choose your own investments.
Another benefit, according to Kujala, is tax diversification. “Non-qualified accounts allow you to be more strategic about how and when you access your money.” Retirement accounts have rules around and penalizations for withdrawing money before you reach a specific age, generally 59 ½. With non-qualified accounts, you can withdraw money at any time, although any earnings are subject to capital gains tax.
Finally, there are no limits on how much money you can contribute each year to non-qualified investment accounts.
Popular non-retirement investments
Options abound when it comes to non-qualified accounts. Here are some common types:
- 529 education plans: Funded with after-tax dollars, any gains in a 529 plan are tax-deferred and funds can be used tax-free when applied to qualified education costs.
- Brokerage accounts: You can buy and sell taxable investments –such as stocks, bonds, mutual funds and exchange-traded funds (ETFs) – through a licensed broker or using a self-directed brokerage account. Trades made via a broker generally carry commissions and fees.
- Automated investment accounts: Run by algorithms that are programmed to make investments for you, with guidelines determined by a questionnaire. Also called robo-advisors, these accounts generally carry fees that are lower than more actively (human) managed funds.
Finding the right investments for you
Ready to invest beyond your retirement accounts? You may want to work with a financial professional to create and tailor a portfolio to reflects your financial goals. You should consider the following when determining the right investments for you:
- Fees: Brokerage and automated investment accounts have variable fees related to the amount of engagement required to open and maintain them. “The more hands-off the investment account, generally speaking, the lower the fees,” says Kujala.
- Risk tolerance: “Risk tolerance is the ability to handle volatility and not disengage from the investment strategy when the markets fluctuate.” Kujala uses risk tolerance questionnaires and a review of the client’s past investment behavior to identify how comfortable they are with different types of investment and market conditions.
- Time horizon: Next, Kujala works with clients to determine which investments might help them meet particular short- or long-term financial goals. “The shorter the duration, the less volatile we want the investments to be. The longer the duration, the more ability we have to take some of those risks to potentially yield a higher return on their investment,” he explains.
When it comes to finding the right allocation mix between retirement and non-retirement investments, Kujala says, “We make our decisions client by client. There’s no rule of thumb, but some diversification is key.”
Your mix of retirement and non-retirement investments should evolve throughout your life. Learn more about different investment strategies by age.