Retirement And Beyond: Exploring The World Of Alternative Investments

Investing outside of retirement accounts is a great way to build wealth and make the most of your income. While retirement accounts are where most people do the bulk of their investing, there are other options to consider if you have extra income to invest. These include brokerage accounts, health savings accounts (HSAs), real estate, and small businesses. Each of these options has its own advantages and disadvantages, so it's important to understand the risks and rewards before making any decisions. By diversifying your investment portfolio and seeking expert advice, you can work towards achieving your financial goals and building a secure future.

Invest in a Traditional or Roth IRA

A traditional IRA and a Roth IRA are both types of individual retirement accounts (IRAs). IRAs are one of the most common ways to save for retirement.

The main difference between a Roth IRA and a traditional IRA is how and when you get a tax break. Contributions to traditional IRAs are tax-deductible, but withdrawals in retirement are taxable as income. In comparison, contributions to Roth IRAs are not tax-deductible, but the withdrawals in retirement are tax-free.

The most common advice when it comes to choosing between a Roth IRA and a traditional IRA is to consider your future income and tax rates. If you expect to be in a higher tax bracket in retirement, a Roth IRA is a good option as it offers a delayed tax benefit. On the other hand, if you expect to be in a lower tax bracket in retirement, a traditional IRA is preferable as it provides an upfront tax advantage.

However, it can be challenging to predict future income and tax rates, especially if retirement is decades away. In such cases, it is recommended to maintain tax diversification in your retirement savings. This means having accounts that will be both taxable and tax-free upon withdrawal in retirement. For instance, if you already have a tax-deferred 401(k) plan through your employer, investing in a Roth IRA can provide a good balance.

Other factors to consider

Early withdrawals

Early withdrawal rules are more flexible with a Roth IRA. While early withdrawals from retirement accounts are generally not advised, Roth IRAs allow you to withdraw contributions without paying income taxes. In contrast, withdrawing from a traditional IRA before the age of 59 1/2 will likely result in a 10% early withdrawal penalty, and you will have to pay taxes at your current income tax rate.

Required minimum distributions

Traditional IRAs require you to start taking required minimum distributions (RMDs) at certain ages. This age was 72 previously, but it has increased to 73 in 2023 and will increase again to 75 in 2033. On the other hand, Roth IRAs do not have any required minimum distributions, giving you more flexibility in retirement.

Discipline in saving

With a traditional IRA, you receive the tax benefit annually when you file your taxes. This means that the money saved on taxes can be easily spent on other things. In contrast, with a Roth IRA, the tax benefit is realised in retirement when withdrawals are tax-free. This makes it more likely that you will end up with more after-tax money in a Roth IRA, provided you have the discipline to save the money received from tax savings every year.

Tax diversification in retirement

If you only have a traditional IRA or a similar tax-deferred vehicle like a 401(k), you may have fewer tax planning options in retirement. However, if you also have a Roth IRA or a brokerage account, you can consider other planning opportunities. For example, you can blend withdrawals from both types of accounts or tap into tax-deferred assets in years when you are in a lower marginal tax bracket.

Estate planning

Roth IRAs can be used for estate planning as any unused money can be passed on to your beneficiaries tax-free.

Income limits

It is important to note that income limits apply to both types of IRAs. For 2023, individuals earning $153,000 or more per year cannot contribute to a Roth IRA. This limit increases to $161,000 in 2024. Traditional IRAs also have income limits, but they are higher than those for Roth IRAs.

Contributing to both accounts

If you are unsure about your future income and tax rates, you can contribute to both a traditional and a Roth IRA in the same year. This allows you to hedge your bets and maintain tax diversification. However, it is important to stay within the combined contribution limits for these accounts. For 2024, the maximum contribution amount is $7,000, or $8,000 for individuals aged 50 and above.

Open a brokerage account

Opening a brokerage account is a straightforward process that can be done online. It is the first step to buying stocks, bonds, mutual funds, and other investments. Brokerage accounts are non-qualified, taxable investment accounts that can include vehicles like stocks, bonds, mutual funds, and exchange-traded funds (ETFs).

• Pick a brokerage firm: Compare the costs, fees, and services offered by different brokerage firms before deciding. You may also want to consider the investment options available at each institution.
• Choose the type of brokerage account: There are two main types of brokerage accounts: full-service brokerage accounts and online brokerage accounts. Full-service accounts come with financial guidance, usually from a human advisor, while online accounts are typically managed by the investor themselves or with the help of a robo-advisor.
• Fill out an application: You will need to provide some personal information, such as your Social Security number, employment status, and net worth.
• Fund the account and start investing: After setting up your account, you can make an initial deposit or set up automatic withdrawals from your bank account. Once your account is funded, you can begin investing in the options available through your chosen brokerage firm.

It is important to note that brokerage accounts are subject to capital gains taxes, and there are no tax benefits associated with these accounts. However, they offer flexibility in terms of contribution limits, income limits, and early withdrawals.

Invest in real estate

Investing in real estate can be a great way to earn passive income during retirement. Here are some things to keep in mind if you're considering investing in real estate:

Rental Properties

One of the most common ways to invest in real estate is to purchase a property and rent it out. This can provide a steady stream of income, but it's important to consider the location and market demand to ensure you can find tenants. You'll also need to be prepared for the responsibilities of being a landlord, including maintenance and repairs.

Location

When investing in real estate, location is crucial. Look for properties in high-demand areas with good job opportunities, schools, and amenities. This will not only increase the value of your investment but also make it easier to find renters.

Financing

If you don't have the cash to buy a property outright, you'll need to secure financing. For investment properties, a down payment of around 20% to 30% is typically required. You'll also need to cover closing costs, which can range from 2% to 5% of the property's price.

Taxes and Expenses

Real estate investments come with a variety of expenses, including property taxes, insurance, maintenance, and management fees. It's important to factor these costs into your budget and have a contingency fund for unexpected expenses. Additionally, be sure to take advantage of any tax benefits, such as deductions for mortgage interest, property taxes, and depreciation.

Real Estate Investment Trusts (REITs)

REITs are publicly traded companies that invest in a diversified portfolio of income-producing properties. They offer an easy way to get started in real estate investing, as they are similar to buying stocks or funds. REITs provide diversification and allow you to invest in multiple properties, reducing risk. They also offer the benefit of liquidity, as you can sell your investment quickly. However, keep in mind that taxes on REIT dividends can be burdensome, and there may be limited principal growth due to high payout ratios.

Fix-and-Flip Properties

If you have the skills and capital, buying distressed properties, renovating them, and selling them for a profit can be lucrative. This approach requires a good understanding of the real estate market and home improvement skills.

Short-Term Rentals

Platforms like Airbnb or VRBO allow you to rent out your property for shorter periods, which can bring in higher rental income compared to traditional long-term leases. However, this approach may require more active management and compliance with local regulations.

Real Estate Crowdfunding

Online crowdfunding platforms enable you to invest in real estate projects alongside other investors. This diversifies your portfolio, and you don't have to deal with the responsibilities of property management.

Other Considerations

• Time Horizon: The longer you invest in real estate, the more time your property has to appreciate in value and provide consistent rental income.
• Market Volatility: Real estate markets can fluctuate due to economic factors, interest rates, and local demand. It's important to be prepared for potential downturns and their impact on property values and rental income.
• Reliable Tenants: Finding reliable tenants can be challenging. Vacancies can lead to income loss, especially if you have mortgage payments to cover.
• Upkeep and Repairs: Properties require maintenance and unexpected repairs, which can eat into your profits.
• Illiquidity: Real estate investments are illiquid, meaning it can take time to sell a property, and there may be transaction costs involved.

Remember, investing in real estate during retirement can provide a stable income stream, but it's important to carefully plan, research, and consider your personal financial situation and goals.

Take advantage of your HSA

A health savings account (HSA) is a great tool to help you prepare for future health care costs and retirement. It can also help you save on taxes. HSAs are triple tax-advantaged, making them an effective savings and investment account:

• Withdrawals for qualified medical expenses are income tax-free.
• All contributions to an HSA are income tax-free.
• Any interest earnings and investment growth from deposits are income tax-free.

Unlike other accounts, an HSA is one of the only savings vehicles that allows you to put money in on a before-tax basis through payroll contribution, grow your savings tax-free (interest and investment earnings are not taxed), and take the money out income tax-free for qualified medical expenses. With a 401(k), you’ll always pay taxes when you withdraw funds but, if you use HSA funds for qualified medical expenses, it’s generally 100% income tax-free.

Plus, after turning 65, you can use your HSA funds for non-qualified expenses. You’ll pay ordinary income tax on those funds, but the 20% tax penalty no longer applies.

Many HSA administrators require a minimum balance in your account before allowing you to invest. Check with your HSA administrator to find out if there's a minimum balance required for your HSA before you can invest.

Investing HSA dollars has many potential tax benefits and can be an additional way to save for long-term health care expenses and financial goals. Once your HSA reaches a certain designated balance, typically $2,000, you may choose to invest a portion of your HSA dollars.

You can invest HSA dollars the same way you would an individual retirement account (or other investment account).

Make HSA contributions by the tax-filing deadline to lower your taxable income.

If you're interested in using an HSA to fund retirement expenses, there are a few tax rules to know.

If you withdraw HSA money before you turn 65 for reasons other than qualifying medical expenses, you'll be taxed at your ordinary income tax rate. You could also incur an additional 20% tax penalty on HSA distributions for non-qualified reasons.

However, if you can wait until you're at least 65 to make non-qualified withdrawals, you can avoid the 20% tax penalty. However, you'll still owe income tax on any funds you withdraw, which negates some of the benefits of saving in an HSA in the first place.

The best use for HSA funds in retirement is health care expenses, since qualified withdrawals are tax-free.

Invest in a small business

Investing in small businesses is a great way to generate passive income and diversify your portfolio outside of the stock market and real estate. It also offers the potential for high returns and an opportunity to participate in the success of the American economy.

There are two main ways to invest in a small business: equity investments and debt investments. Equity investments involve offering money in exchange for a share of the business, which makes you an owner of the company, sharing its profits or losses and possibly participating in business decisions. Debt investments, on the other hand, are loans given to small business owners in exchange for interest payments over a predetermined period. The business owner maintains full ownership of the company in this case.

When considering investing in a small business, it is important to exercise due diligence and ask the right questions. Some key questions to ask include:

• What is the business plan and strategy?
• What is the current state and future potential of that industry?
• What does the competitive landscape look like, and what are the top barriers to entry?
• How much money does the business need to raise?
• How much equity, debt, and liabilities does the business hold?
• When can you expect to see a return on your investment?

It is also important to remember that all investments carry varying levels of risk, and investing in small businesses is inherently risky. Many small businesses fail within five years, so it is recommended that you only invest what you can afford to lose.

If you are considering investing outside of retirement, small businesses offer a great opportunity to generate returns and support local businesses. By investing in small businesses, you can add value to your community and participate in their success while also growing your wealth.

Frequently asked questions