You've probably heard of arguments in favor of every retirement account, including traditional and Roth IRAs as well as 401(k)s. Even some less conventional accounts, like health savings accounts (HSAs) and taxable brokerage accounts, can make great homes for retirement funds.
But it might surprise you to know that the most popular retirement account isn't any of these. The average worker's favorite home for retirement savings is something most people use every week. But just because it's popular doesn't mean it's the right choice for you. Here's what you need to know.
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The most popular retirement account isn't a retirement account at all
When we think of retirement accounts, we usually think of accounts that enable us to invest our money in the stock market to grow its value over time. But the most popular retirement account, according to a recent Transamerica survey, doesn't fit this bill.
Approximately 6 in 10 workers surveyed say they keep retirement savings in an ordinary bank account, like a checking account, savings account, money market account, or certificate of deposit (CD). That's 11% more than the second most popular retirement plan, the 401(k).
On one level, saving for retirement in a bank account is appealing because it enables you to avoid common inconveniences of most other retirement plans. You can contribute money to a bank account as often as you'd like and withdraw it at any age. There are no annual contribution limits, and you may not even pay a fee to it.
But bank accounts lose a lot of the appeal when you compare their returns to traditional retirement account returns over the long term. The best high-yield savings accounts right now have an annual percentage yield (APY) of about 4%, and even this is pretty high compared to what we've seen over the past few years. By contrast, the stock market has about a 10% average annual return over the long term.
To put this into perspective, let's say you have $10,000 in retirement savings. If you invested it in a savings account and earned an average 4% APY over 30 years, you'd have a final balance of $32,434. That's over three times your starting balance, but you could probably do better by investing your money instead. A 10% average annual rate of return on your $10,000 investment would give you nearly $175,000 after 30 years, more than five times your final savings account balance.
To be fair, not every dollar you earn through investing is profit. You will have to pay investment fees, though these vary depending on what you invest in. And there's also the chance that you could lose money over the long term.
But what many don't realize is that you could still lose buying power with a bank account. Inflation will continue to drive up costs over time, and it's possible the inflation rate could exceed what you earn in interest each year. If this happens, your balance will still grow, but your money won't go as far.
Which retirement account should you use?
It may not hurt to keep some of your retirement savings in a bank account, especially if you're nearing retirement and plan to spend the money within the next couple of years. But if you don't need the money in the near future, a retirement account is probably a better home for your savings.
A lot of people choose to begin with a workplace retirement plan, like a 401(k), if they have access to one. These plans enable you to defer a portion of each paycheck so you don't have to remember to make contributions on your own. Some companies also give their employees a matching contribution if they put money in their 401(k)s.
An IRA can be a great alternative if you don't have access to a 401(k) or you don't like the investments the plan offers. You can choose between a traditional IRA, which gives you a tax break upfront in exchange for paying taxes on your contributions and earnings when you make a withdrawal, or a Roth IRA, which gives you tax-free withdrawals for paying taxes on your contributions when you make them. IRAs also give you complete control over what you invest in, which can help you keep your fees down.
You're the only one who can decide which account is right for you -- and you may want more than one. Review all the options available to you and decide where you'd like to put your savings. Be sure to double-check the annual contribution limits for each account you're using as well, to ensure you don't set aside too much and incur government penalties.
