While investing in a 401(k) retirement plan is a viable option for some people, there are several alternatives for building a nest egg that will provide you with more flexibility. Your employer may not offer a 401(k) plan, or even if they do, you may be seeking a backup plan. Here are four options for saving for retirement outside of a 401(k).
Traditional IRA
An Individual Retirement Account, commonly called an IRA, is designed purposely as a retirement-savings plan. The traditional IRA, like a 401(k), provides attractive tax breaks that allow you to put away money before it is taxed. Additionally, all contributions then earn tax-deferred interest until money is withdrawn.
With the traditional IRA you can begin withdrawing money when you reach 59 1/2 years of age. However, if you withdraw money from a traditional IRA beforehand, you will be responsible for paying taxes, interest, and penalties that can amount to over 50 percent of the amount withdrawn. The current contribution limit for a traditional IRA is $5,500 annually or $6,500 annually if you are at least 50 years old.
Roth IRA
For many people, a Roth IRA is a better option than a traditional IRA because you can withdraw your money at any time free of taxes, interest, and penalties up to your contribution limit. However, the catch with this plan is that deposits are made with post-tax dollars, meaning money that has already been taxed. Once you reach 59 1/2, you can withdraw the earnings tax-free.
The annual-contribution limits for a Roth are the same as a traditional IRA. However, there is an income cap on Roth contributions, based on your modified adjusted-gross income, or MAGI. The MAGI is currently set at an annual salary cap of $135K for a single person and $190K for a married couple. People making over these amounts may not contribute directly to a Roth IRA.
SEP IRA
An SEP, or simplified-employee pension IRA, is designed for self-employed individuals, including small-business owners and freelancers. The SEP IRA essentially is a way for self-employed workers to create a retirement account similar to a 401(k), but with a lot less red tape. Additionally, you can contribute more money to an SEP than to either a traditional or Roth IRA — up to $55K annually.
Like a traditional IRA, your SEP contributions and earnings aren’t taxed until the money is withdrawn. While an SEP is a great option if you have more than $5,500 a year to put away, a traditional or Roth IRA is the better choice because those accounts require less paperwork than an SEP. Similarly, if you have employees, an SEP will require that you make contributions to their retirement accounts.
Standard Investment Account
There is no law requiring you to use a specialized “retirement” account to save for retirement. While there are some attractive tax breaks with a specialized account, the contribution and withdrawal restrictions can be burdensome. However, a standard investment account offers you the freedom and flexibility to go wherever the wind blows you.
A standard investment account will allow to invest as much as you like, whenever you like, and withdraw as much as you want whenever you want without any penalties. This makes a standard investment account ideal for people who may be planning to retire early.
Choosing an Account
To decide what type of retirement account will make the most sense, you need to carefully consider your needs. Aside from offering major tax advantages, putting money into an IRA creates both a physical and mental firewall between your regular savings and your retirement savings. This makes it a lot less likely that you will blow your retirement money on a trip around the world. Conversely, if you are disciplined and can keep your hands out of the cookie jar, a standard investment account may be the way to go.