Here’s a pop quiz for you. When you hear the word retirement, what immediately comes to mind? Some of you might have visions of traveling the world, playing golf, or hanging out with your grandkids. But, for most of you, you’re probably thinking about your 401(k).
Since first introduced in the early 1980s, defined contribution plans, such as a 401(k), have become the go-to-retirement plan. In fact, according to a study from insurance broker Willis Towers Watson, around 86 percent of Fortune 500 companies offer these plans instead of traditional pensions.
What is a 401(k)?
For those unaware, a 401(k) is an employer-sponsored retirement. Employers prefer defined contribution plans over pensions because they fluctuate with the market. So, if the fund isn’t performing well, payouts won’t be as much. With pensions, payments will always remain the same regardless of the market.
As for employees, a 401(k) is a tax-advantaged retirement plan. “Depending on the type of 401(k) you’re using, you’ll either pay your taxes before investing in the 401(k) but not have to pay tax when you withdraw the funds,” we explained in Due’s 401(k) Guide. “Or you’ll put money in the 401(k) before paying tax, but you’ll have to pay taxes when you retire and make withdrawals.”
“Because employers deduct 401(k) payments directly from salaries, you won’t notice the money coming out of your payslip and moving into your 401(k),” the guide adds. Moreover, contributions can be automatically withdrawn from your salary.
What are the disadvantages of 401(k) plans?
Despite these benefits, only 32% of Americans are investing in a 401(k). That’s mind-boggling since 59% of Americans have access to them. If an employer is matching your contributions, then you’re leaving money on the table.
There are, however, some drawbacks to a 401(k). These include;
- You can only get them through an employer.
- You’ll be penalized if you make an early withdrawal, like if you need the money to pay for an emergency.
- There are contribution limits. As of 2021, you’re allowed to contribute up to $19,500 a year. If you’re over the age of 50, you’re allowed to add $6,500 for a total of $26,000. Some employees also have their self-imposed contribution limits.
- Investment options are usually limited to basic mutual funds and target-date retirement funds.
- When you reach the age of 70 ½, you’re required to begin taking required minimum distributions (RMDs) by April 1 of the year after you reach this age.
With all that being said, are you still able to save for retirement without a 401(k)? Yes. There absolutely alternatives to a 401(k) if, for some reason, you don’t have one, like if your employer does not offer it or you’re self-employed.
Without further ado, are seven ways that you can save for your retirement sans 401(k).
Traditional or Roth IRA
Outside of a 401(k), individual retirement accounts are typically your best retirement vehicle. But, there are some requirements to know upfront.
Most notably, you must have an earned income. You’re also required to have a modified adjusted gross income. In a nutshell, this is your total gross income minus the deductions you’ve claimed. The IRS states that this must be less than $125,000 (if you’re single) or $198,000 for married couples filing jointly.
There are two main types of IRAs; traditional and Roth. The main difference between them is when you’ll have to pay taxes.
- With a traditional IRA, you get a tax break up front. And, when you file your tax return, you can deduct your contributions. Your money grows tax-free, but you’ll be taxed when you withdraw.
- A Roth IRA also allows your money to grow tax-free. You can also withdraw money in retirement without getting taxed. But, you’ll contribute money on an after-tax basis.
With both types, you’re only permitted to contribute $6,000 annually if you’re under 50. If you’re over the age of 50, you can “catch up” by being allowed to contribute up to $7,000.
In addition to a traditional and Roth IRA, there’s also the SEP-IRA. Short for Simplified Employee Pensions, this is available to sole proprietors, partnerships, C-corporations, and S-corporations. As such, it’s a solid retirement savings option for freelancers and small business owners.
A SEP IRA functions similarly to a traditional IRA. The key difference is that in lieu of the $6,000 contribution limit, it’s based on your income. In this case, participants can contribute up to 25% of their income or up to $57,000 in 2020 (it will increase to $58,000 for 2021). It just depends on whichever is less.
Self-employed Solo 401(k)
“As you might have surmised, a solo 401(k) is a retirement plan designed, well, for individuals,” writes Due Founder and CEO John Rampton in a previous Due article. “Specifically, business owners who only employee me, myself, and I.
“Sole proprietors, independent contractors, and freelancers all quality — just as long as they don’t employ anyone else,” adds Rampton. “And, don’t try to pull a quick one on the IRS as they are very strict about this requirement.”
There are, however, several caveats to take note of. “One is that if you’re married. If so, your spouse is also covered,” he adds.
“The second is that if you’re earning money from a side hustle, but just so happen to have a full-time job as well,” Rampton states. “You may be able to contribute to both.” To play it safe, though, double-check this with a tax professional.
“And, in case you’re curious, there are no age or income restrictions when it comes to a solo 401(k). And, you can also pick your tax advantage.
If you made contributions from your salary, you’re allowed up to $19,500 or 100% of compensation (whichever is less) in salary deferrals for tax years 2020 and 2021. As an employer, you’re permitted a profit-sharing contribution of up to 25% of your compensation or $57,000 for 2020 — this will rise to $58,000 for the tax year 2021.
What about catch-up contributions? There’s the standard $6,500. Or, business owners over 50 are eligible for a $63,500 total annual 401(k) contribution limit.
Taxable Brokerage Account
“To secure a comfortable retirement solely with IRA contributions, you likely have to start saving in your early 20s because of those low contribution limits,” writes Catherine Brock for The Motley Fool. “If you’ve already seen your 25th birthday come and go, that’s obviously not an option.”
“Instead, you can supplement your IRA savings with deposits to a taxable brokerage account,” adds Brock. “Look to save 15% of your income across the two accounts.”
“You will have to manage your tax burden as your brokerage account grows,” she warns. “Dividends, interest, realized gains, and capital gains distributions from mutual funds are taxable annually. You can manage your tax bill proactively by investing in tax-efficient mutual funds and buy-and-hold stocks that do not pay dividends.”
“Your non-dividend-paying stock positions only incur taxes when you sell them and realize profits — that’s one of several good reasons to avoid impulsive trading,” Brock advises. “Invest in quality stocks that you can hold for long periods of time.”
What’s more, there are no requirements, contribution limits, or penalties for early withdrawals. Additionally, there are unlimited investment options or mandatory distributions.
High-Yield Savings Account
“High-yield savings accounts are a type of deposit account that can be found at both online and brick-and-mortar institutions,” explains Bankrate. “These financial tools typically pay a higher interest rate than traditional savings accounts and almost always offer better returns than traditional checking accounts.”
Furthermore, they tend to have higher annual percentage yields (APYs) and either no or low fees. They’re also risk-free as they’re FDIC insured.
However, I would bank solely on these accounts for your retirement. Currently, the highest-yielding savings accounts are well under 1% of the dollars saved. As such, these are better suited for a down payment on your home, saving for a vacation, or emergency fund.
Still, it’s better than not having a retirement saving account at all.
Health Savings Account
With a qualified health saving account (HSA), you’re setting aside pre-taxed money for future medical expenses. You’ll be able to lower your overall healthcare costs as these accounts pay for expenses like deductibles, copayments, and coinsurance.
What really makes an HSA so appealing is that you can make pre-tax contributions, grow tax-free earnings, and enjoy tax-free withdrawals. After the age of 65, you can take money out of the account without getting penalized. In fact, at that point, it functions more like an IRA.
For 2020, individuals can contribute up to $3,550 toward an HSA ($3,600 for 2021) and families up to $7,100 ($7,200 for 2021).
Non-Traditional Ways to Fund Your Retirement
Finally, you can also consider the following out-of-the-box ways to save for retirement;
- Switch jobs. If you’re really sweating your retirement, as you should, you might want to work for a company that provides a 401(k) or profit-sharing plan. Also, consider non-profit or government jobs that provide 403 (b) or 457 plans offered by state and local public employers.
- Get into real estate. Either purchase a rental home or rent out a spare room on Airbnb. You could also rent out your garage or even put a billboard on the exterior of a building that you own.
- If you’re over the age of 62, consider a reverse mortgage.
- Consider downsizing your home or relocating to a more affordable area.
- Sell assets that you no longer need, such as a boat or motorcycle.
- Resell your used items on eBay, Craigslist, or Facebook Marketplace.
- Monetize a hobby, such as cooking, gardening, or woodworking.
- Have an encore career like consulting or freelancing.
- Participate in the gig economy. For example, when you have free time, you could drive for Lyft or Uber.
The Bottom Line
Having a 401(k) would give you some peace of mind when it comes to retirement. But, it’s not the only way that you can save for your Golden Years. This is especially true if you don’t have an employer-sponsored plan. If not, you can turn to IRAs.
Business owners have options like a SEP IRA or Solo 401(k). But don’t rule out overlooked options like an HSA.
Though, it wouldn’t hurt to have a combination of all of the above. It’s an effective way to keep your retirement investments diversified. And, it will ensure that you’ll have enough money to enjoy for years to come.