Saving for retirement is one of the most important financial goals for many people. With so many investment options available, it can be challenging to determine the best approach to building your nest egg. Two popular choices are 401(k) plans and brokerage accounts.
A 401(k) is an employer-sponsored retirement savings plan that allows employees to save and invest a portion of their paycheck before taxes are taken out. Employers may match a percentage of the employee's contribution, providing an additional boost to retirement savings.
On the other hand, a brokerage account is an investment account that allows individuals to buy and sell a variety of securities, such as stocks, bonds, mutual funds, and ETFs. Brokerage accounts offer more flexibility and control over investments but do not provide the same tax advantages as 401(k)s.
In this comprehensive guide, we'll dive into the pros and cons of 401(k)s and brokerage accounts, helping you determine which option is better suited for your unique financial situation and retirement goals. We'll explore the key features of each account type, discuss factors to consider when making your decision, and provide actionable tips for maximizing your retirement savings.
Whether you're just starting your career or nearing retirement age, understanding the differences between 401(k)s and brokerage accounts is crucial for creating a solid financial foundation. Let's get started!
401k vs. Brokerage Account: Which Should I Choose?
Plenty of investors maintain multiple accounts, including a 401(k), brokerage account, and others like an individual retirement account (IRA), savings account, and checking account. Combining brokerage and 401(k) accounts can be beneficial in pursuing your retirement goals. According to studies by Vanguard and Schwab, investors who held both a 401(k) and a brokerage account had an average balance of $310,400, compared to $112,572 for those with only a 401(k).
That said, if you need to choose one, the following information will help you make the right decision based on your situation. Deciding between a 401(k) and a brokerage account depends on factors such as your age, income, investment goals, and risk tolerance. Let's dive deeper into the basics of each account type and explore scenarios where one might be more advantageous than the other.
401(k) Basics
A 401(k) plan is probably the most common employer-sponsored retirement saving program. As of 2023, the number of active 401(k) participants had surged to over 71.5 million, with total assets in 401(k) plans reaching approximately $7.4 trillion. This tax-advantaged account allows employees to save for retirement using pre-tax dollars deducted from their paychecks.
The funds within a 401(k) are typically invested, often in mutual funds, to increase their value over time. Taxes on annual contributions and investment gains are deferred until withdrawal during retirement. This tax deferral can result in significant savings, especially for those in higher tax brackets.
Some employers offer a matching contribution to their employees' 401(k) accounts as an added pre-tax benefit. The average employer match is around 4.7% of an employee's salary [^3^]. This means that if you contribute 4.7% of your salary to your 401(k), your employer will match that amount, essentially doubling your contribution.
Some of the key 401k benefits include tax-deferred growth, potential employer matching contributions, and automatic payroll deductions, making it easier to save consistently for retirement. For strategies on maximizing these benefits, you can learn more about the safest 401(k) investments during a recession.
Ins and Outs of Brokerage Accounts
A brokerage account enables investors to purchase stocks and various securities through a brokerage firm. These accounts are also known as taxable investment accounts or asset management accounts. Unlike 401(k)s, there are no contribution limits or income restrictions for brokerage accounts.
In addition to stocks, brokerage accounts can hold a range of assets such as cash, mutual funds, exchange-traded funds (ETFs), money market funds, bonds, and commodities. This flexibility allows investors to diversify their portfolios and potentially earn higher returns than they would with a 401(k) alone.
One of the main advantages of brokerage accounts is the wide range of brokerage account investment options available, such as stocks, bonds, mutual funds, ETFs, and more, allowing investors to create diversified portfolios tailored to their goals and risk tolerance.
Brokerage accounts offer features like margin trading and trading in options and other types of securities. However, these advanced features come with additional risks and may not be suitable for all investors. It's essential to understand the risks and rewards before engaging in these types of trades.
To contribute to a brokerage account, you can link it to a bank account or use alternative methods like check, cash, or wire. You can hire professional investment management services, or you can opt to manage your investments independently.
A 401(k) May Work Best For You If…
Ease of Use is Important to You
Saving early and consistently is crucial for retirement readiness. According to a study by the National Institute on Retirement Security, 95% of millennials are not saving adequately for retirement. Utilizing a 401(k) allows for automatic contributions directly from your paycheck, streamlining the saving process effortlessly.
Because the deduction occurs before your pay is received, you're less likely to notice the money being set aside. This "set it and forget it" approach can help you stay on track with your retirement savings goals without having to think about it every month.
Your Employer Contributes
A 401(k) employer match assists employees in saving for retirement. This additional company match can significantly enhance your savings, and financial advisors often advise contributing at least up to the maximum match amount. For example, if your employer matches 50% of your contributions up to 6% of your salary, you should aim to contribute at least 6% to take full advantage of the match.
This is one of the biggest benefits of 401(k)s. Don't leave cash on the table. According to a report by Financial Engines, 1 in 4 employees misses out on an average of $1,336 per year in employer matching contributions.
You Want to Save on Taxes Today
Pre-tax contributions to a 401(k) will immediately lower your taxable income. For example, if your annual salary is $50,000 and you contribute $5,000 to your 401(k), your taxable income for that year will be $45,000. This pre-tax benefit is particularly advantageous for higher-income investors seeking to reduce their taxable income today.
Additionally, the investment gains in your 401(k) grow tax-deferred, meaning you won't pay taxes on them until you withdraw the money in retirement. This can lead to significant tax savings over the long term.
You Want a Less-Risky Option
Although a taxable account can be an excellent avenue to invest your funds, it carries certain risks associated with the stock market. Investing in a 401(k) is the more conservative investment option. Most 401(k) plans offer a selection of mutual funds with varying levels of risk, allowing you to choose a fund that aligns with your risk tolerance.
Your level of comfort in taking financial risks should determine the extent of your investments in the stock market. If you're risk-averse or nearing retirement age, a 401(k) with a more conservative investment mix may be the better choice.
A Brokerage Account Could be Best If…
You Want to Invest Without Limits
The IRS imposes restrictions on the amount you can deposit into 401(k) accounts. In 2024, the contribution limit stands at $23,000 (individuals aged 50 and above can contribute up to $30,500). If you want to save more than these limits for retirement, a brokerage account can be a good option.
If you aim to pursue a more aggressive investment strategy for retirement and/or have already reached the maximum contribution limits for 401(k)s and other retirement accounts like IRAs, you may consider investing in a taxable brokerage account. This can help you save more for retirement and potentially earn higher returns.
You Want to Supplement Retirement Savings
Considering early retirement? A brokerage account can help fill the income gaps during the period between your retirement date, when you begin receiving social security benefits, and when you can withdraw from retirement accounts without penalty (typically age 59½).
Having a brokerage account can provide flexibility in your retirement planning. You can use the funds in your brokerage account to cover expenses in the early years of retirement, allowing your 401(k) and other retirement accounts to continue growing tax-deferred. Learn why brokerage accounts are more important than you may think and discover tips for retiring early.
You Need to Withdraw Before Retirement
If you're saving money for a pre-retirement purchase, such as a home, it's wise to invest it in an accessible account that doesn't incur withdrawal penalties. While you can withdraw funds from your 401(k) before retirement age, you'll typically face a 10% early withdrawal penalty in addition to income taxes on the amount withdrawn.
Although some retirement accounts offer tax-free withdrawals of some funds for qualified pre-retirement purchases like buying a first home or paying for education, penalties for withdrawals made early apply to most retirement savings accounts.
It's beneficial to contribute funds earmarked for major purchases to a taxable brokerage account for easy access in the near term. This way, you can invest the money and potentially earn returns without worrying about early withdrawal penalties.
You May Be in a Higher Income Tax Bracket at Withdrawal Time
Since taxes are not paid on 401(k) contributions, qualified withdrawals are subject to ordinary income tax rates. You may end up owing more taxes on withdrawals in retirement than expected, if you're paying higher income taxes than you were when you started working (which is likely).
However, taxable brokerage account withdrawals only incur capital gains taxes, which are often lower than ordinary income tax rates. As of 2024, the long-term capital gains tax rates are 0%, 15%, or 20%, depending on your income level.
If you're operating with income limitations or, on the other end of the spectrum, you have low income with a high net worth that puts you in a higher tax bracket in retirement, you may prefer the tax breaks of a brokerage account.
Save Better With Kubera
Whether you choose a 401(k) or brokerage account for your retirement or other savings, Kubera is designed to safeguard your financial health and help you achieve your financial objectives. Tracking your investments across multiple accounts can be challenging, but Kubera simplifies the process.
Kubera is a holistic wealth management platform that allows you to track all your financial assets and their performance, understand your net worth, and balance your portfolio in accordance with your goals. This ensures you are prepared for major withdrawals, retirement, and managing the associated taxes and other details.
With Kubera, you can:
- Securely link all your financial accounts, including 401(k)s, IRAs, brokerage accounts, bank accounts, and more.
- Get a big-picture view of your entire portfolio, including your 401(k), Roth IRA, and other retirement accounts, as well as other assets and liabilities like bank accounts, cryptocurrency accounts, real estate, loans, and more.
- Analyze your asset allocation and rebalance your portfolio according to your retirement goals and timeline, using built-in features that help you monitor and adjust your target asset allocation, performance, and returns.
- Model real-life financial scenarios to see how changes in income, expenses, savings, investments, taxes, inflation, and interest rates impact your future wealth.
- Track your finances in your preferred currency, view your net worth and asset ROI in real-time, and organize your financial documents all in one place.
- Collaborate with your spouse, attorneys, and financial advisors to ensure everyone is on the same page.
- Access your dashboard from any device, anywhere, anytime, with secure and encrypted data storage and backup.
By having a clear picture of your financial situation and using Kubera's powerful tools to plan for the future, you can make informed decisions about your investments, savings, and spending to ensure a successful retirement plan.
Sign up for a trial to start managing your 401(k), brokerage account, and all your other financial accounts in one place.
Conclusion
Choosing between a 401(k) and a brokerage account depends on your individual financial situation and goals. Both account types have their advantages and can play a role in your overall retirement savings strategies.
A 401(k) offers tax advantages, employer matching contributions, and a more conservative investment approach, making it an excellent choice for retirement savings, especially if your employer offers a match. On the other hand, a brokerage account provides flexibility, a wider range of investment options, and the ability to access funds before retirement age.
Many investors choose to contribute to both a 401(k) and a brokerage account to take advantage of the benefits of each. By diversifying your savings across different account types, you can maximize your returns, minimize taxes, and ensure a comfortable retirement.
As with any financial decision, it's essential to consider your unique circumstances and consult with a financial advisor to develop a personalized savings plan. With the right strategy and tools like Kubera, you can take control of your financial future and achieve your retirement dreams.
