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Over the past 40 years, 401(k) plans have become the most common retirement plans offered by private employers. As of September 2021, 401(k) plans held $7.3 trillion in assets and nearly 60 million active participants, according to the Investment Company Institute.
Despite such progress, many Americans still do not have such an employer-sponsored retirement savings account. This does not mean that you should give up retirement savings completely. There are many other ways to set aside money to ensure you are prepared for the future.
Many Americans still do not have a 401(k) plan
About half of all American households have access to a work-based retirement plan, according to a report by the Stanford Center on Longevity. There are various reasons for this. Currently, there is no legal requirement for employers to offer retirement benefits such as 401(k) plans, and many Americans are self-employed or contract workers who do not have access to these plans.
If you are in this situation, the good news is that there are other options. While funding your own retirement can be challenging, it’s important to start saving for the future and start doing so as soon as possible, so that you have time on your side – and years of savings to add interest.
“Without an employer-sponsored plan for retirement savings, there are many savings vehicles available to individuals who want to save outside of a self-employed or traditional employer-sponsored 401(k),” he says. Sri Reddy, Senior Vice President of Principal Retirement and Income Solutions.
4 investment options to prepare for retirement
Some of the more popular account options include traditional or Roth Individual Retirement Accounts (IRAs), brokerage accounts, a SEP IRA, or a Solo 401(k). Each account type has different advantages and disadvantages depending on your specific financial situation and needs.
1. IRA accounts
As the name suggests, IRAs are not tied to an employer. Self-funded retirement investment accounts offer tax-advantaged status, which we describe below. The most common choices are a traditional or Roth IRA.
Traditional IRAs help you build a retirement nest egg by allowing account holders to make tax-deductible contributions. “You can deduct IRA contributions on your taxes in the year you open them, which lowers your taxable income,” Reddy explains.
Money in this type of account is allowed to grow tax-deferred and is not taxed until you withdraw money. When you start tapping your traditional IRA funds, the distributions are taxed based on your income bracket at that time. At age 59 ½, you can start withdrawing the money penalty-free.
With a Roth IRA, you pay taxes on contributions made now, which can provide some benefits. For example, since you paid tax on the money, the distribution is tax-free. But this is not the only advantage. “Contributions can be distributed at any time because you’ve paid tax on those dollars,” said Catherine Tierney, senior pension strategist at Edward Jones.
However, if you take distributions too early—before 59 ½—you may be subject to taxes and penalties. This is the same if you start withdrawing money from a Roth that has been open for less than five years.
But there are some distinct differences when using a Roth to prepare for retirement. After all, there are income restrictions on people who qualify to use a Roth. For 2023, your income must be less than $228,000 for married couples and less than $153,000 to use a Roth IRA.
Whether using a traditional or Roth IRA, it’s also important to understand one of the main drawbacks of this type of account: minimum annual contribution limits. The maximum annual contribution limit for 2023 is $6,500 for individuals under 50, or $7,500 if you’re 50 or older, according to the IRS.
2. Traditional taxable investment account
Often referred to as a brokerage account, a taxable investment account can be an option for saving money for retirement when you can’t afford a 401(k). Using a brokerage account allows you to build a portfolio of assets and grow money for retirement. This can include stocks, bonds and mutual funds.
There are many benefits to using a traditional investment account to save for retirement, including the ability to choose any type of assets you want. Plus, there are no income limits when you open a brokerage account—which means, unlike Roth IRAs, they’re available to anyone, regardless of your annual income.
“While brokerages have limited tax benefits, they have many advantages over vehicles like IRAs because they offer fewer restrictions and more flexibility,” says Reddy. “With a brokerage account, you can withdraw money at any time without tax or penalty. This liquidity is one of the best reasons an investor might want to keep their assets in a brokerage. Plus, if you’ve already made other tax-free contributions like an IRA, a taxable investment account like a brokerage lets you save even more with smaller limits.
3. SEP IRA
For business owners, sole proprietors, freelancers or contract workers, a Simplified Employee Pension (SEP) IRA plan is another option.
“SEP IRA plans offer many benefits,” says Tierney. “They are relatively simple and inexpensive, require no special IRS filing or administration, are tax deductible for the employer, and do not require annual contributions to the plan.”
SEP IRAs generally follow the same investment and distribution rules as traditional IRAs. This means that earnings are tax-deferred, and distributions are taxed as ordinary income. In addition, distributions can be taken at any time. But if you withdraw funds before 59 ½ and don’t qualify for any of the penalty exceptions, there will be a 10% penalty on pre-tax dollars.
“In general, individuals must begin taking required minimum distributions (RMDs) from their plans when they turn 72 and each subsequent year,” Tierney added. “For SEP IRAs, there are no exceptions to the RMD rules for non-retired individuals.”
4. Solo 401(k)
Finally, a solo 401(k), sometimes called a participating 401(k), may be considered if you run a business that does not include any employees or if another employee is your spouse.
“A solo 401(k) can be a great option if you don’t plan to hire other employees and only see the savings as yourself,” says Reddy. “With these types of plans, you can save up to $22,500 in 2023 as an employee deferral, plus an additional 25% as an employer contribution.”
The benefits of this account are that the contributions you make as an “employer” to your business are tax-deductible and tax-deferred as long as you earn income.
The taken
Investing for retirement is one of the most important steps you can take to build a healthy financial future. Even without an employer-sponsored 401(k), you should contribute as much as you personally can to retirement and start as soon as possible. There are options for all types of financial needs, and many of the options include tax benefits.
“If you look at life expectancy, your retirement could be 25 to 30 years longer, maybe longer,” Tierney says. “Social Security can help meet some of your retirement income needs, but it’s not designed to meet all of your income needs. On average, it replaces 30 percent to 40 percent of your pre-retirement income, so it’s important to focus on what you need to meet your retirement needs and make sure you invest.” it is.
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