A 401(k) is a great way to save for retirement, but not all employers offer them. Only about 60% of American workers have the option to invest in a 401(k). Despite this discrepancy in access, the importance of saving for retirement using a tax-advantaged account remains. If you are someone without 401(k), it is important to explore alternatives.
An individual retirement account (IRA) is held by a person, not their employer. If you are working, you can open an IRA to save for retirement. Like a 401(k), IRAs have tax benefits. A Traditional IRA is funded with tax-deductible money, and you pay taxes on the money when you start making withdrawals after age 59 ½. A Roth IRA is the opposite; you fund it with post-tax money, it grows tax-free, and your withdrawals (after age 59 ½) are tax-free.
IRAs give you more flexibility than a 401(k). The investment choices for a 401(k) are limited to those that your employer offers. However, you can invest in a wide variety of investments with IRA funds. This may save a significant amount of money on fees, depending on the investments you choose. Currently, the maximum you can contribute to an IRA is $6,000 a year. If you are age 50 or older, you can add an extra $1,000.
The current maximum contribution for a 401(k) is $19,500 (with an additional $6,500 for those age 50 and over). The maximum contribution for an IRA is woefully short of that. You may invest as much as you desire into a taxable investment account, but you will not enjoy the tax advantages that retirement accounts offer.
An HSA (Health Savings Account) can help you bridge the gap. These accounts were intended to help those with high deductible health insurance plans save money on out-of-pocket medical expenses (like co-pays and co-insurance). Some employers that offer high deductible plans offer HSAs alongside. If your workplace does not, you can open your own HSA account assuming you have a qualifying plan.
An HSA works similarly to an IRA. Currently, the maximum contribution is $3,550 for single accounts and $7,100 for families. Like IRAs, they allow an extra $1,000 contribution for those age 55 and older. You can take advantage of three tax benefits through these plans. First, HSA contributions are pre-tax if the plan is through your employer. If you opened your own account, you do not pay taxes on the growth within the account. You also do not pay taxes on withdrawals when they are used for qualifying medical expenses.
Once you reach age 65, there is no penalty for taking non-healthcare related withdrawals. You would only pay income tax on the amount taken (similar to withdrawals from Traditional IRAs after age 59 ½). This allows you to essentially double your yearly IRA contributions if you leave the money to grow in the account and pay your medical expenses out of pocket.
Get a Side Hustle
Any employer can open and contribute to a SEP IRA (including unincorporated businesses, sole proprietorships, and partnerships). Even if they are employed elsewhere and have an employer-sponsored 401(k), they can still participate. Therefore, generating freelance income and contributing these funds to a SEP IRA makes a great deal of sense.
Current SEP IRA contribution limits are 25% of your net earnings (from self-employment) up to $57,000. Contributions are tax-deductible, but the withdrawals after age 59 ½ subject to taxes.
If you max out your IRA and HSA (assuming for a family), you have contributed $13,100. To reach the 401(k) limit of $19,500, you would need to contribute $6,400 to your SEP IRA. In total, you would have put $25,600 into tax-advantaged accounts for the year.
This may not be possible for everyone, but it would be life-altering for those that can. In today’s world, building another income stream certainly is not the worst use of your time.
Consider Moving On
When reviewing your options above, you may tend to ignore the lack of a 401(k) at your employer. With an IRA and an HSA, you can nearly reach the contribution limit for a 401(k). Not so fast. You are missing out on 401(k) matched funds from your company. This is free money that could compound over time if invested.
Employer-matched contributions are funds that a company contributes to your 401(k). There are generally two ways that the contributions are made. Commonly, your employer will match a percentage of your contribution, up to a specific portion of your total salary. The less common method is to match your contribution up to a certain dollar amount (regardless of compensation).
Currently, the total contribution limit to your 401(k) account is $57,000 or 100% of compensation, whichever amount is less. You can contribute $19,500 per year and your employer can contribute up to $57,000 each year.
Shifting jobs is no trivial task, but the amount of money you are leaving on the table you’re your employer does not match should not be ignored. Moving to a company that does offer 401(k) matching is certainly something to consider.
Planning is the Key
Maxing out accounts and receiving matched funds is admirable, but it is only a small part of retirement planning. The real key is putting your goals on paper and looking at your whole situation. When you fail to have a retirement plan in place, having a pile of money saved is not sufficient. Retirement planning can help you insulate your money from the risks we all face in retirement.
Paradigm Wealth Partners can help you understand and insulate yourself from the risks you face when planning for retirement.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. No strategy assures success or protects against loss. Investing involves risk including loss of principal.