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5 Of The Best Ways To Save For Retirement: The Pros & Cons Of Each Investment Option

All of us know we should be saving for retirement, but few of us actually apply the strategy that’s best for us.

In order to implement the best strategy, we must understand the pros and cons of our investment options and know how they fit in with our goals and values.

The following are some of my favorite investment options we can use to save for retirement.

#1: Your Company’s 401(k)

401(k) plans have been around since the 1980s and have become one of the most widely used vehicles investors use to save for retirement.

Investors who contribute to a 401(k) (or the similar 403(b) and 457(b) plans for nonprofits and governmental employees) are offered tax advantages, and oftentimes, employers match a percentage of what the employee contributes to the plan. The employer match may be the closest thing you can get to free money.

Normally, within your 401(k) plan you’ll have several different funds to select from. For example, you may have the option of picking an actively managed mutual fund, an index fund, or some type of annuity. Generally, these funds take your money as well as your employer’s match and invest in a combination of stocks, bonds, and cash equivalents.

Selecting the right fund is essential to your retirement plan since many funds generate subpar results for a premium price. You’re normally best off picking several different index funds if possible.

The benefits and drawbacks of 401(k)s are unique to the particular plan. As such, each plan needs to be individually evaluated.

With that said, here are some of the general pros and cons of 401(k) plans:

Pros of 401k Plans:

  • Employer Contribution. Many employers will match a percentage of what you invest up to a certain threshold. For instance, the company might match 50% of what you contribute up to 5% of your income.
  • High Contribution Limit. You can invest $18,000 into your 401(k) or $24,000 if you’re ever 50. This is 3 times more than you can invest in an IRA.
  • Not Limited By Your Income. Generally, with a 401(k) you’re not limited by your income. You can contribute $18,000 and reduce your taxable income even if you make over $200,000 a year. This isn’t the case with an IRA.
  • Tax Advantaged. Your contributions into your 401(k) are tax advantaged. If you use a Roth, you pay taxes on the money you contribute up front, but all the compound growth is tax free. With the traditional, you don’t pay taxes on the money you contribute today, but you’ll have to pay taxes on it and all the compound growth later when you withdraw the funds.
  • Pay Yourself First. Since your retirement contributions are directly deducted from your check, you make saving for your future your first priority. It comes before you can spend a dime, which is key to accumulating wealth.
  • Automated Savings. One of the biggest advantages to 401(k)s is how easily automated everything is. You don’t have to cut a check every month. Nor do you really have to think much about investing at all. It’s all done for you as soon as you sign up, select your investment funds, and get paid.

Cons of 401k Plans:

  • Limited Investment Options. Generally, the investment options within a 401(k) are much more limited than other retirement accounts such as an IRA or a taxable brokerage account. Too often the best investment options aren’t even on the table.
  • Account Fees. 401(k) plans require more administrative work and can be expensive to run. Fees vary wildly from plan to plan, but to keep your costs as low as possible, choose low-cost index funds or exchange-traded funds (ETFs) whenever they’re an option.
  • Early Withdrawal Fees. One of the inherent disadvantages of putting money in a retirement account is that you’re typically penalized for taking withdrawing funds before reaching age 59½.

To know exactly what to do with your 401(k), check out The Ultimate Step-By-Step Guide To Making the Most of Your 401(k). It provides a step-by-step guide to help ensure you apply the best strategy.

#2: Individual Retirement Accounts (IRA)

IRAs are another great tool to save for retirement.

There are primarily two types of IRAs—a traditional IRA and a Roth IRA. With a traditional account, you are generally allowed to defer paying taxes on the money you contribute today (the deduction is phased out after you pass a particular income threshold), but you’ll have to pay taxes on it and all the growth when you withdraw the funds. A traditional IRA is one way to reduce your tax liability now while you save for retirement.

On the other hand, with a Roth IRA, you pay taxes on the money you contribute today, but you don’t have to pay taxes on all the interest you accrue over the life of the investment. Due to certain income limitations, not everyone is able to contribute to a Roth, but if you are, it can help enable you to accumulate tax-free wealth.

Here are some of the biggest pros and cons of IRAs:

Pros of IRAs:

  • Many Investment Options. Within an IRA you have a wide array of investment options including mutual funds, index funds, exchange traded funds, stocks, bonds, cash equivalents, real estate, and others. The great thing about the IRA is that you have the power to decide where your money is invested. You can select the funds that match your goals and values.
  • Tax Advantaged. As discussed above, your contributions into IRAs are generally tax advantaged. With a Roth, you pay taxes today but nothing on the compound growth. With a Traditional, you get a tax break today but you’ll have to pay on the money you contribute and the interest you accrue when you withdraw the funds.
  • More Control Over Fees. You’re able to control your fees since you select the brokerage and the funds you invest in. Generally, low-cost index funds with Vanguard or Fidelity are great options.
  • Automated Savings. IRAs can easily be automated to ensure you consistently contribute to your retirement savings. Each month, your brokerage can automatically draw from your checking account and contribute the money to the investments you select. It’s simple, easy, and takes almost no time to set up.

Cons of IRAs:

  • Lower Contribution Limit. Unlike 401(k)s, with both Roth and Traditional IRAs, you and your spouse can each contribute a maximum of $5,500 ($6,500 if you’re over 50) per year. In other words, between you and your spouse, you can stock away $11,000 per year for retirement in IRAs.
  • Limited By Your Income. IRAs are also limited by your income. The amount you can contribute to a Roth IRA phases out after your income reaches a certain point. In addition, the tax deductions from a Traditional IRA phase out after you pass a certain income threshold.  
  • Early Withdrawal Fees. One of the disadvantages of putting money into an IRA is that you’re typically penalized for pulling the money out before reaching age 59½. However, with a Roth IRA you can withdraw your contributions before you’re 59½.

Check out How To Set Up Your Own IRA: 6 Simple Steps To Start Saving For Your Retirement Today for more information about making the most of your IRA.

#3: Real Estate

Real estate is one of my favorite asset classes as it offers benefits that most other assets don’t.

Essentially, real estate can generate income now, diversify your asset base and your income, create tax advantages, capture equity, and appreciate over time giving you more wealth for retirement. If used correctly, it can help generate massive wealth.

Here are the primary pros and cons I see.

Pros of Investing In Real Estate:

  • Income Now & In the Future. If you buy real estate at the right price, it will boost your income even after the mortgage, insurance, utilities, property management, vacancies, big repairs, and capital expenditures are accounted for.
  • Tax Advantaged. Investing in real estate creates tax advantages you normally wouldn’t be able to get. For example, you’re able to depreciate your properties creating a paper loss even though you didn’t spend actual money. In addition, you may be able to deduct interest, a home office, mileage, repairs, and any other business expense related to your properties.
  • Equity Capture & Buildup. Unlike most other asset classes, you can buy real estate at a discount, because it’s a less efficient market. Buying at a discount enables you to capture equity immediately and then it will build as you pay down your loan over time. This is a huge reason real estate generates so many millionaires.
  • Appreciation. Historically, real estate has appreciated about 2% per year. If you bought a house for $200,000 it could be worth more than $350,000 in 30 years. By that time you could have paid off the mortgage and own a $350,000 asset free and clear.
  • Ability To Use Leverage. Leverage can boost your investment returns, but most other asset classes don’t allow you to use it. It also increases your risk so be careful.
  • Not Limited By Your Income. No matter how high your income is, you can invest in real estate. You’re not disqualified even if you make hundreds of thousands a year.
  • No Contribution Limit. You are free to invest as much money into real estate as you’d like every year. You’re not bound by any arbitrary rule the IRS has established.
  • You’re In Control. The ability to control the asset is another one of the major advantages of investing in real estate. You can “force” appreciation by remodeling or updating your property. I can’t buy enough iPads to push Apple’s stock price up, nor can I control the decisions management makes—I’m at their mercy, but with real estate, I’m in total control.

Cons of Investing In Real Estate:

  • Requires More Work & Time. Real estate requires more work and time than most other investments. It takes time and resources to find discounted properties. It takes time to make repairs, hire contractors, or work with property managers. I can buy an index fund and let it grow on autopilot, but the same isn’t necessarily true with real estate.
  • Potentially More Risk. Depending on your strategy, real estate may also be more risky. For example, if you leverage your investments you’ll have a mortgage bill even if you don’t have a paying tenant. In addition, it’s generally more difficult to diversify your real estate investments since the deals are so much bigger than the purchase price of a simple index fund.
  • Slower Appreciation Rate. Residential real estate has historically appreciated 2% per year, which is about ⅕ of what the stock market has averaged. Remember, appreciation is just one of the ways you build wealth with real estate though.

For more details, check out The Top 5 Reasons Why I Invest In Real Estate.

#4: Health Savings Account (HSA)

A Health Savings Account (HSA) is like a personal savings account, but the money is used only for qualified health care expenses.

HSAs allow people with high-deductible health plans to pay for current healthcare expenses and save for future expenses on a tax-favored basis. If used properly, HSAs can enable us to accumulate tax free wealth.

Here are the major pros and cons.

Pros of HSAs:

  • Contributions Reduce Your Taxes. You may be able to make either pre-tax or tax deductible contributions into an HSA. If you make contributions through payroll deductions, then you can avoid federal income tax. Contributions made with after tax dollars can be deducted from your gross income on your tax return. Either way, you can reduce your tax burden.
  • Interest Earned Is Tax Free. Any interest you earn on your investments in the account is tax free.
  • Tax Free Withdrawals. Withdrawals from your HSA are not subject to federal (or in most cases, state) income taxes if they are used for qualified medical expenses.
  • Funds Roll Over. If you have funds left over in your account at the end of the year, they do not expire like they do with a Flexible Spending Account.
  • No Income Limitations. You contributions are not limited to your income. You can contribute, even if you’re a high income earner. 
  • No Time Frame For Withdrawals. This is huge! You do not need to withdraw the money within a given time frame from of when you incur the medical expense. In fact, you could incur a medical expense when you’re 30 and not withdraw the funds from your HSA until you’re 65. And as long as you keep your receipt, the 35 years worth of investment growth will be completely tax free. Awesome, huh?

Cons of HSAs:

  • High Deductible Requirement. In order to qualify to use an HSA, you must have a high-deductible health plan.
  • Potential Penalties. If you withdraw money for non-qualified expenses before you turn 65, you’ll owe taxes on it plus a 20% penalty. After age 65, you’ll have to pay taxes but not the penalty.
  • Record Keeping. You have to keep your receipts to prove that withdrawals were used for qualified health expenses. This could be a pain especially if you’re trying to maximize your tax free earnings by not withdrawing funds for years after incurring the expenses.

So here’s a quick example how an HSA can work for you. Let’s say you contribute $5,000 to an HSA today. Your account grows to $9,000, and then you pull $1,00 out for medical expenses. Not once did you ever have to pay taxes on any of that money. You got to deduct the $5,000 you contributed. Your HSA grew and you owed no tax, not even on what you withdrew since it was used for qualified medical expenses.

HSAs are one of the most tax advantaged accounts that, if used correctly, can enable you to accumulate a lot of tax free wealth.

#5: Taxable Brokerage Account

Another investment option to consider is using a taxable brokerage account.

You can buy securities (stocks, bonds, etc.) in a taxable brokerage account to save for retirement; however, you will not get the same tax advantages you get with an IRA, HSA, or your 401(k). Therefore, I generally recommend using this option after you’ve already maxed out your contributions with the other investment vehicles (IRA, HSA, 401k) available to you, or if you’ve decided you don’t want to invest in real estate directly.

Pros of Using Taxable Brokerage Accounts:

  • Many Investment Options. Investing within a taxable brokerage account gives you many investment options including mutual funds, index funds, exchange traded funds, stocks, bonds, and cash equivalents. You have complete control to decide what investments you think will provide the best for you.
  • More Control Over Fees. You’re able to control your fees since you select the brokerage and the funds you invest in. Generally, low-cost index funds with Vanguard or Fidelity are great options.
  • Automated Savings. With a brokerage account you can easily automate your investments to ensure you consistently contribute to your retirement savings. Each month, your brokerage can automatically draw from your checking account and contribute the money to the investments you select. It’s simple, easy, and takes almost no time to set up.
  • Not Limited By Your Income. You are free to invest as much as you’d like regardless of how much money you make.
  • No Early Withdrawal Penalty. Since this is not an advantaged retirement account, you can withdraw from a taxable brokerage account whenever you’d like. However, there will be tax implications and most of the time, you’re better off leaving your money there to compound and grow over time.

Cons of Using Taxable Brokerage Accounts:

  • Not As Tax Advantaged. You don’t not get a tax deduction on the money you invest in a taxable brokerage account, nor can you easily shelter investment growth when you withdraw. However, your gains are taxed at an advantaged rate compared to your earned income.

Bonus: Bitcoin?

If you’re like most people, you keep hearing about Bitcoin but have no idea what it is.

Essentially, it’s an electronic currency that can be instantly transferred world wide with a few clicks of a button. Bitcoin has increased in value over 2,000% over the last year, which is why there’s starting to be so much buzz around it.

Many smart people argue that it is going to revolutionize the world like the internet did. Many others argue that Bitcoin has created a value bubble that will soon pop leaving a lot of broken hearts and wallets.

The truth is that no one really knows what’s going to happen.

Because of the complete uncertainty around Bitcoin, I don’t recommend it as a “retirement” saving strategy, but I do think it’s probably a good idea to skip going out to eat a few times and use your saved money to buy at least $100 of Bitcoin. Consider it fun money.

If it tanks, no big deal. You lost a few meals. If it eventually changes the world, then congratulations! I’m sure you’ll think that $100 was well worth it.

Get $10 for free if you use this link to register with Coinbase. If you use the link, it helps me too 🙂 Thanks!

Conclusion – Best Retirement Savings Options

In order to implement the best strategy for your retirement savings, you must know the pros and cons of each of your options. For most folks, I generally recommend a combination of one of these five investment vehicles.

A person can accumulate a lot of wealth of they know how to make the most of their 401(k), IRA, HSA, real estate, and taxable investments.

Action Steps

Start investing and saving for your retirement today!

Any of these 5 investment vehicles will help you acquire more financial freedom.

If you’re interested in Bitcoin, then use this link to register with Coinbase and get $10 of Bitcoin for free when you open an account.

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