Yes, You Can Save for Retirement Without a 401(k)
The 401(k) is arguably the favorite retirement savings vehicle. Once the contribution amount is set, savers don't have to actively make contributions as they automatically come out of each paycheck. Better still, employers often match some of these contributions, resulting in free money that grows over time. But what if your employer doesn't offer a 401(k)? Or you don't have an employer at all?
You're probably feeling left behind in the 401(k) craze, but fear not. Fortunately, there are other retirement savings accounts to consider, including traditional and Roth IRAs, SEP IRAs, and SIMPLE IRAs. I discuss each of these in detail below.
Traditional and Roth IRAs
Traditional and Roth IRAs are a good place to begin if you work for a company that doesn't offer a 401(k). You open these accounts on your own and can contribute up to $6,000 to them in 2019, or $7,000 if you're 50 or older. You won't receive any matching contributions from anyone, but you will have a larger number of investment options to choose from than you would with a 401(k). Plus, the administrative fees are usually lower than that of a 401(k).
The difference between traditional and Roth IRAs comes down to taxation. Traditional IRAs are tax-deferred, which means that any contributions you make will come off your taxable income for the year, but you'll pay taxes on the money when you withdraw it from the account. Contributions to Roth IRAs do not come off your taxable income for the year, but you won't pay any taxes when you make withdrawals in retirement as long as the money has been in the account for at least five years.
As a general rule, Roth IRAs are a better move if you believe you're in a lower income tax bracket now than you will be in retirement. Otherwise, a traditional IRA will be a better fit.
Traditional and Roth IRAs, like 401(k)s and the other retirement accounts discussed below, have a 10% early withdrawal penalty if you take distributions before you reach 59 1/2. It's usually best to leave the money alone so it can continue to grow, unless you absolutely have to withdraw it.
Simplified employee pension (SEP) IRA
The SEP IRA was designed with self-employed individuals and small business owners in mind. This account is similar to a traditional IRA except that the contribution limits are much higher. You can contribute up to the lesser of 25% of your annual income or $56,000 in 2019. There isn't a catch-up contribution option for individuals over 50, but the high contribution limits should render this a nonissue for most.
But SEP IRAs get a little trickier if you have employees. To make a contribution to your own SEP IRA, you must also make equal contributions to the IRAs of all eligible employees. So if you contribute 10% of your income to your plan, you must also contribute 10% of your employees' incomes to their plans. An eligible employee is anyone who is 21 or older, has worked for you for three of the past five years, and has made you at least $600 in the past year.
This rule can limit your own ability to save for retirement. And for this reason, SEP IRAs are usually favored by individuals with few or no employees. But if you do choose this route, you can also deduct the amount that you contribute to employee IRAs up to $270,000 this year.
Savings incentive match plan for employees (SIMPLE) IRA
A SIMPLE IRA may be a better choice for owners of small businesses with fewer than 100 employees. You can also use it if you're self-employed and have no employees and you want to contribute more than a traditional IRA would allow. The total amount that an employeecan contribute to a SIMPLE IRA in 2019 is $13,000. Adults 50 and older can also make $3,000 in catch-up contributions. This amount does not include employer-contributed funds.
It's similar to the SEP IRA in that employers are required to make contributions to eligible employee accounts, but the rules are a little different. Employees are considered qualified if they have received at least $5,000 in compensation from you in the last two years and can be reasonably expected to receive at least that much this year as well.
Employers have the choice of making elective matching contributions or nonelective contributions, as with the SEP IRA. You must either contribute up to 2% of the employees' contributions regardless of whether they make any contributions themselves, or you can do dollar-for-dollar matching. You're usually required to do this on up to 3% of an employee's compensation, but you can reduce this amount to as low as 1% for two out of every five years. You are allowed to match your own contributions as well, so you can contribute up to the maximum $13,000 (or $16,000 if you're 50 or older) as an employee and then an additional 3% of that as your employer contribution.
It's also worth noting that, unlike 401(k)s, any employer-matched funds are vested immediately, so employees get to keep them even if they quit the next day. Employers, however, are able to deduct these matching funds from their own taxable income.
One of these options should suit a person whose employer doesn't offer a 401(k) or someone without an employer at all like a self-employed person or a contractor. Remember, contribution limits change every year, so it's important to stay on top of them if you plan to contribute the maximum amount.
The sooner you begin saving, the better -- your money will have more time to grow and you'll be able to take advantage of the nice tax breaks these accounts offer.
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