Investing Outside of a 401k

If you’re a “supersaver,” a savings-oriented investor, you may want to consider saving outside of your company’s retirement plan. Investing outside of a 401k can provide a greater range of investment options and potentially lower your tax bill over the long term. The key is to make sure you’re saving in the right place at the right time.

Most companies that offer a 401(k) also offer an Employee Stock Purchase Program, where employees can invest pretax dollars into company stock. Those investments can grow tax-deferred until they are withdrawn in retirement. It’s important to diversify your retirement accounts by investing in a variety of stocks and bonds, so that if a single company fails, it doesn’t wipe out your entire retirement.

However, you may find that the 401(k) plan’s investment options do not include all of the stocks and bonds that make up your target portfolio. If this is the case, it might be advantageous to have a taxable brokerage account that allows you to invest in your targeted asset mix and enjoy more tax-efficient gains. This strategy is known as “asset location” and can help reduce your overall tax burden over the years by strategically directing investments between your taxable brokerage account and your tax-advantaged retirement accounts.

For example, high-turnover bond funds and individual stocks that you are planning to hold for the long term might be better held in your taxable brokerage account, where taxes on dividends and capital gains can be more favorable than in a tax-deferred account like a 401(k) or IRA. In this way, you can use your taxable brokerage account in conjunction with savings in tax-advantaged accounts to maximize the benefits of compound interest over time.

Another consideration is whether or not your employer offers a 401(k) plan with a low investment fee. If you find that your 401(k) is overpriced, it might be worthwhile to move your assets into an IRA or other taxable brokerage account where the fees are more reasonable.

Finally, the ability to withdraw funds from a taxable brokerage account is an important consideration. Depending on your goals and financial situation, you may need access to the funds in your taxable brokerage account to fund expenses or for other purposes. If your taxable brokerage account is well-diversified and enables you to avoid withdrawal penalties, it could be an ideal investment vehicle for you.

Bankrate principal writer and editor James F. Royal covers investing, wealth management and personal finance. His work has been cited by CNBC, the Washington Post and the New York Times, among others.

How much should you save?

The best strategy for most investors is to contribute the maximum amount allowed to your employer-sponsored retirement plan and a traditional IRA or Roth IRA. But for those with significant income, a taxable brokerage account is a good option for building wealth without the handcuffs of a 401(k).

To determine whether or not an IRA or other taxable brokerage account is a smart investment for you, consider your needs, the options available in your 401(k), and the current tax rates on qualified dividends and long-term capital gains.