You don’t have a 401(k)?
About 55 million people are currently contributing to a 401(k). This adds up to over $5 trillion (which is 59% of all private retirement savings) that is earmarked to pay for a portion of retirement.[1]
401(k)s are terrific. They offer:
- Forced, pre-tax savings
- High(ish) contribution limits
- Employer contribution matching
- Tax-deferred growth
But while 55 million is a massive number, it still leaves tens of millions of hard-working folks searching for viable,tax-efficient ways to save for the future.
I won’t sugarcoat it: If you won’t be receiving a pension, and you don’t have access to a defined contribution plan (401(k), 457, 403(b)), you’ve got a much more difficult road to hoe than those people who have access to either of those two retirement vehicles.
You’ll simply have to be that much more proactive. Depending on your unique situation, here are 3 options to help you prepare.
You’re employed, but don’t have access to a defined contribution plan.
Aside from the important decisions to consistently save and invest, to own your own home, and to work with a fiduciary advisor, you should probably be funding either a Traditional or a Roth IRA.
While deposits into both grow tax-free, there are some important distinctions, which will influence which option is best for you.
Traditional IRAs:
- $5,500 yearly contribution limits ($6,500 if over age 50)
- No income limits
- Funded with “pre-tax” money
- Taxes applied to distributions
- No contributions after age 70½
- Penalties if money is withdrawn before age 59½
Roth IRAs:
- $5,500 yearly limit ($6,500 limit if you are over age 50)
- Contribution limits kick-in when income exceeds $120,000 (2018)
- Funded with “after-tax” money
- You pay no taxes on distributions
- No contribution age limits
- Money can be withdrawn at any time without penalty
Traditional or Roth: which should you choose?
First, with their extremely low contribution limits (by comparison, 401(k) plan participants can contribute 3X as much), IRAs should be seen as just a single part of your overall approach to saving for retirement.
Generally, if you’re going to be in a lower income bracket once you retire (which is, obviously, difficult to predict), you’re better off with a Traditional IRA.
Younger savers who are worried about having access to their money might prefer a Roth, but, emergencies aside, my experience has been that easy “access” to money that is earmarked for retirement is typically not in your best interests.
Simply, if at all possible, try and keep your retirement savings out of sight and out of reach.
If you’re self-employed, but don’t have full-time employees.
Some sole proprietors, consultants, freelancers, independent contractors, and people who own their own businesses/companies (but don’t have full-time employees), have a terrific option when it comes to saving for retirement.
Fund a Solo 401(k).
Also known as an “Individual K,” or an “Owner-Only 401(k),” while the amount of money you can invest in an IRA is inexplicably low, with their flexibility and extremely high contribution limits, Solo 401(k)s are a great tool for eligible savers.
Basic facts about Solo 401(k)s:
- There are no age or income restrictions
- Contributions must come from self-employment income
- You can still earn income from a regular job
- You can even still have a 401(k) from an employer
- You can’t have any full-time employees
- The maximum contribution amount is $55,000
- Contributions can be either pre-or-post tax
One issue I have with Solo 401(k)s is, at least when it comes to your investment options, there’s almost too much flexibility for the average person. In fact, the IRS doesn’t stipulate what a Solo 401(k) plan participant can invest in, only what he or she can’t.
Business owners with employees.
Somewhat like employees of companies that do not offer a 401(k) [or pension], saving for retirement when you’re a business owner (with employees)surely means meeting that challenge by using a variety of approaches and vehicles.
One good way to begin is to open a SIMPLE IRA.
While you can open one for your employees, for our purposes, let’s briefly focus on how a SIMPLE IRA helps you save for retirement.
SIMPLE IRAs offer you:
- Tax-deferred contributions
- Distributions taxed as ordinary income
- Significantly higher contribution limits ($12,500/$15,500 over age 50) than IRAs
While a SIMPLE IRA is a good option for business owners with employees, remember, all investments carry some risk. If you aren’t absolutely certain about your risk tolerance, and you have limited experience when it comes to selecting investments.
Conclusion
One final note about IRAs: I have long believed it patently unfair that those people who are fortunate enough to have access to a defined contribution plan (401(k), 403(b), 457) get to sock away substantially more tax-deferred money (as of 2018, $18,500 to $24,500 [if you’re over 50]) than those who don’t.
But the government seems unwilling to up the IRA contribution limits to address this disparity.
Retirement, and the tax laws surrounding things like IRAs and Social Security, are becoming increasingly complex, and I don’t anticipate them changing for the better in the future.