A 401(k) plan can be a great way to invest, giving employees a way to grow their savings tax-deferred until retirement. Many employers offer a cash match on contributions, giving you a quick return on investment, depending on vesting schedules. Unfortunately, some companies don’t have a 401(k) plan at all or their investment options are so poor that it makes more sense to save for retirement on your own.
There are other types of employees, such as government workers, who likely do not have access to 401(k) plans. Some of the people that work in the public sector may feel that their thrift savings plan, 403(b) or 457 retirement plans aren’t satisfactory for their retirement needs either.
If your employer’s retirement plan doesn’t cut it for you, here are six investing alternatives to consider.
6 alternatives to your company’s 401(k)
1. Traditional IRA
A traditional IRA is one of the most popular ways a person can save for retirement, regardless of what other retirement plans they have. The traditional IRA allows a wage earner to put away money in an account that allows the money to grow tax-free. You’ll pay taxes only when you withdraw the money at retirement. Plus, contributions to the account can be deducted from your taxable income, so you avoid taxes on that income today.
Key benefits: Tax-deferred growth, a tax break today on contributions and complete flexibility in investment choices.
Drawbacks: Contributions have an annual maximum: $6,000 for those under age 50 in 2020, ($7,000 for those 50 and older), though this amount has typically increased over time. There are required minimum distributions (RMDs) that need to be taken while in retirement. The entire contribution may not be tax-deductible based on your income. Here’s everything you need to know about an IRA.
2. Roth IRA
A Roth IRA is another way that workers can stash some cash for retirement, and it has two key differences from the traditional IRA:
- The Roth IRA allows you to grow your money tax-free, but you’ll be able to withdraw any of the money at retirement completely tax-free.
- In exchange for this benefit, you’ll contribute money on an after-tax basis. In other words, you don’t get any tax savings today from the Roth IRA.
Because of other legal and tax benefits, many financial planners think the Roth IRA is the best retirement plan available.
Key benefits: Tax-free growth and withdrawals at retirement, flexibility to use the contributions for some qualified expenses (such as college expenses) without a penalty, the account can be passed to heirs, complete flexibility in investment choices and no capital gains on asset sales.
Drawbacks: You’re giving up a tax benefit today for the promise of tax-free withdrawals at retirement. Contributions have an annual maximum, $6,000 in 2020 ($7,000 for those 50 and older), though this amount will likely increase over time. Here’s how to open a Roth IRA.
3. SEP IRA
A Simplified Employee Pension IRA, or SEP, is an IRA for those who have their own business, and it functions much like a traditional IRA but with a few differences. The SEP IRA has the same investment, distribution and rollover rules as a traditional IRA, and it allows you to grow money tax-deferred until you withdraw it at retirement. A key difference is that instead of the traditional IRA’s $6,000 limit (for those under age 50) on contributions, participants can contribute up to $57,000 in 2020 or 25 percent of their income, whichever is less.
Key benefits: Higher contribution limit than traditional IRAs, complete flexibility in investment choices, tax-deferred growth on any contributions, larger maximum contributions are some of the perks for entrepreneurs and business owners.
Drawbacks: Contributions are limited to 25 percent of business earnings. Any employees working for the business must receive the same contribution. There are required minimum distributions that must be taken when in retirement. Get all the details in this complete guide to SEP IRAs.
4. Solo 401(k)
You’ll need your own business to take advantage of the solo 401(k), but it’s a powerful savings vehicle, especially if you have a side gig. The plan simplifies the 401(k) process and is designed for businesses that have no employees besides a spouse. You’re allowed to contribute as much as $57,000 for 2020, though that amount is divided into components for yourself as the employee ($19,500 for 2020) and yourself as the employer ($37,500). If you’re age 50 or over, your employee limit is $26,000 for 2020, making your potential total contribution as high as $63,500.
One of the best perks of the program, especially if you’re earning enough money in your main job, is the ability to save 100 percent of your income up to the annual maximum contribution limit. In other words, you could sock away your first $19,500 in income as your solo 401(k) contribution. That’s a huge improvement over SEP IRAs, for example, where your contribution is limited to 25 percent of your income, slowing your ability to put away money.
Key benefits: Can contribute substantial amounts to the plan, complete flexibility in investment choices and an ability to contribute 100 percent of income up to contribution limit make the solo 401(k) an attractive option for those who are eligible to participate in the plan.
Drawbacks: There are extra legal rules and paperwork with this program. You need to have your own business to participate. Not all brokers offer the program at a reasonable cost. It can become complicated if you have multiple employees. Here’s why the solo 401(k) is a great tool for the self-employed.
5. Health savings accounts
Health savings accounts (HSAs) aren’t just for health care, though they were created to help Americans with high-deductible health plans pay for their care.
HSAs offer a huge benefit for those who are able to hold on to some money in their account until they hit retirement age. You’re eligible for one if you have a minimum deductible of $1,400 and a maximum deductible and out-of-pocket cost of $6,900 (different amounts apply to family coverage). For 2020, the plan allows individuals to contribute up to $3,550 toward an HSA and families up to $7,100.
In exchange for making a contribution to your HSA, you’ll get a tax deduction today, and the interest or other earnings on the account are tax-free. And distributions from the account are tax-free if you use the account to pay for qualified medical expenses. But the real benefit for retirees occurs once you hit age 65. That’s when you can avoid the 20 percent penalty for non-medical uses of the plan, and the plan otherwise functions much like a traditional IRA. One important difference: Unlike a traditional IRA, the HSA has no minimum required distribution.
Key benefits: HSAs allow for flexible use of contributions, employers can contribute to the plan, functions much like an IRA after you turn 65 and the entire HSA contribution is tax-deductible.
Drawbacks: May be expensive to set up, and the investment options may be limited. You may not want to invest vital health care funds in risky investments, and there are typically lower returns on safe investments. Here are some other concerns with health savings accounts.
6. Taxable brokerage account
And finally, if you’ve exhausted the other retirement savings options or they don’t apply, you can always save money in a taxable brokerage account. You won’t get any help from your employer here – no cash match, for example – but you can invest in what you want and you can choose the broker that works best for you. So if you’re searching for low-cost brokers or you need to trade specific funds for free, you can do that.
Key benefits: No limit on contributions, complete flexibility in investment choices, potential to access low-cost options compared to a 401(k) are some major perks that come with this type of account.
Drawbacks: Realized capital gains are taxable, and that can make a big dent in your earnings.
While having a company-sponsored 401(k) plan is great, workers have other options if their employer doesn’t offer this type of retirement plan. IRAs are a natural replacement for 401(k) plans, though savers won’t benefit from the employer match. For the self-employed, the solo 401(k) is a fantastic option, given its ability to protect so much income and grow it tax-free.