I'd Tell Anyone in This Situation to Stop Funding an IRA or 401(k)

You'll often hear that if you're trying to save for retirement, your best bet is to make contributions to an IRA or 401(k). That's because these accounts are loaded with tax breaks.

With a traditional IRA or 401(k), your money goes in on a pretax basis, allowing you to legally shield some of your income from the IRS. Investment gains in an IRA or 401(k) are also tax-deferred, which means you don't pay the IRS on those gains until you take withdrawals.

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That's important, because many people end up in a lower tax bracket in retirement than during their working years. So it's better to pay taxes on gains at that stage of life than when you're earning a large paycheck and are in a higher tax bracket.

But as much as it often pays to fund an IRA or 401(k), there's one specific scenario where it makes sense to stop. It's important to know how to redirect your money if that situation applies to you.

When early retirement is on your radar

A lot of people hope to retire early, but acknowledge that it may be a pipe dream. However, if you're well into your career and have been saving consistently, you may have enough money that early retirement is more than feasible.

If that's the case, though, then you may want to halt contributions to your IRA or 401(k) plan. The reason is that you don't want to end up in a situation where you've saved enough to retire early but don't have penalty-free access to your money.

While the IRS offers a generous tax break on IRA and 401(k) contributions, it imposes a steep 10% penalty for people who take withdrawals prior to age 59 1/2 (aside from a few exceptions). If you don't build savings outside of an IRA or 401(k), you risk getting to the point where you have the money to retire early, but it's all locked up in an account you can't access yet without taking a huge financial hit.

For example, let's say you're 45 years old with $2 million in your 401(k). Even if you don't contribute another dime, if your balance grows a modest 6% over the next seven years, which is several percentage points below the stock market's average, you should have $3 million by age 52.

You may decide that $3 million is more than enough to retire on, especially if you intend to live modestly. But there's a problem.

If that entire $3 million is in your 401(k) and you want to withdraw $100,000 a year to cover expenses, you'll lose $10,000 of that to a penalty until you turn 59 1/2. So, in that situation, it could pay to stop funding your 401(k) for the most part and direct all future retirement contributions to a taxable brokerage.

With a taxable brokerage account, you won't shield income from taxes, and any gains in that account will incur a same-year tax bill.

However, you won't have any restrictions. If you want to retire in your early 50s, you can. You can also contribute to a taxable brokerage account and take the money out three months later if you decide that you're burned out at work and need to self-fund a six-month sabbatical to refresh and continue working afterward.

Don't assume an IRA or 401(k) is always your best bet

It certainly pays to contribute to an IRA or 401(k) early on in your retirement savings journey. If your 401(k) plan comes with a workplace match, it's generally wise to contribute enough each year to claim that free money in full -- even if you're set on an early retirement and have a large 401(k) balance already.

But if you've run the numbers and are confident that you'll be able to stop working well ahead of age 59 1/2, then keeping all of your retirement savings in an IRA or 401(k) could become a dangerous thing. It pays to look outside these tax-advantaged accounts, so you have the option to withdraw your money penalty-free when the time is right for you.

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