A 401(K) is a valuable vehicle for workers to build up a nest egg for retirement.
But Americans should not put all their savings in their workplace plan, financial planner Georgia Lord has warned.
Tax laws change constantly so it is crucial to diversify your retirement accounts to give you flexibility when it comes to accessing your savings later in life, she said, and avoid being caught out with a higher tax bill.
The bulk of retirement accounts contain either tax-advantaged, tax-free or taxable funds.
‘It is important to hold your funds across those different types of accounts based on their tax treatment so that when the time comes to draw down from those assets, you can make sure you are covered,’ she told DailyMail.com.
Americans should not put all their savings in their workplace plan, financial planner Georgia Lord has warned
In the same way that experts recommend diversifying any investment portfolio you might 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, as workers make pre-tax contributions.
This allows you to delay paying taxes on your earnings while you are working and gradually build up a nest egg.
When you retire, you will pay taxes on this money – but it is possible that your taxable income will be lower at this point than during your working years.
Roth IRA and Roth 401(K) accounts are classified as ‘tax-free’ as they are made up of after-tax contributions to help reduce your tax liability in retirement.
If tax rates continue to go up, said Lord, ‘why not have some of your assets, at least, be tax free in retirement.’
‘Taxable’ funds include brokerage accounts which allow you to buy or sell a variety of investments, and are often after-tax contributions.
‘We can’t make decisions based on tax legislation today, because there’s a very high chance that will change in the future – especially when we’re talking about retirement for younger folk who have so many years ahead,’ she said.
For example, Trump-era tax legislation introduced in 2017 is currently due to expire on January 1, 2026 – sparking major changes for millions of taxpayers across the US.
It is difficult to know what tax rates will look like when you retire, how much you will be earning in retirement, how much you will have saved and what your lifestyle may look like, she added.
‘By arranging to have a mix of tax-advantaged, tax-free and taxable funds, you give yourself more flexibility to minimize your overall tax liability and stay under certain annual income thresholds,’ Lord said.
Tax laws change constantly so it is 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 you have to take withdrawals, known as required minimum contributions (RMDs) in retirement, she said.
By planning ahead, you lower the risk of paying more in Medicare premiums or a higher percentage of your Social Security benefit becoming taxable if you earn too much or are pulling too much from your retirement accounts, she added.
Not all workers will be able to invest in their 401(K) and then have funds left over to contribute elsewhere, Lord acknowledged.
‘First and foremost, I would be doing at minimum the match in a 401(K),’ she said.
‘Then it comes down to if you can afford to save more, and in what vehicle should you do that.’
For those who may not have a large amount to contribute, Lord recommends looking to see if your 401(K) plan allows you to establish a Roth account within it.
This would help you diversify without having to open a separate account.
‘Almost all 401(K)s have the option to have Roth dollars within it,’ she said.