How to Save for Retirement Without a Traditional 401(k)
Tools to Help Creatives and Other Self-Employed Individuals Plan for a Sound Financial Future
Much of the retirement advice you hear is of the “start saving early” and “take advantage of your employer match” variety. However, those things may not be possible for everyone. Many small companies and startups don’t offer a 401(k) or similar retirement savings plan, and those who are self-employed or independent contractors are entirely responsible for their own benefits, retirement planning vehicles included.
If you’re in this boat, don’t despair. While the path toward a financially sound retirement may not be as obvious for you, your options might even be better. We’ll review several below.
Option #1: Traditional IRA
An IRA does not require employer sponsorship, so individuals can set up traditional IRA accounts with most brokerages and even at some banks. You can control the types of funds you want to invest in, or you can even use a robo-advisor to manage your portfolio automatically based upon preferences you provide upfront. Of course, your best bet is often to seek guidance from a financial advisor to help you determine the best options for your needs.
One thing to note is that, while most brokerages will have an initial investment amount required to open a traditional IRA, a good many are willing to waive it if you set up automatic monthly contributions instead.
IRAs do have contribution limits, though you aren’t required to meet those limits. So, you can start out saving what you’re able, then slowly increase your contribution amounts each year until it becomes possible to begin contributing the maximum. For 2020, the traditional IRA contribution limit is $6,000 (or $7,000 if you’re 50 or older). Your contributions may be pre-tax (and may be tax-deductible) and your money grows tax-free. When you take money out in retirement, you’ll pay taxes on it at that time.
Note that not everyone is eligible for a tax deduction. We recommend against making a non-deductible IRA contribution. Consult with your tax professional to find out how the rules apply to you.
Option #2: Roth IRA
Roth IRAs have the same contribution limits as traditional IRAs, and they are an excellent retirement savings vehicle for those without an employer-sponsored retirement plan. The difference between a traditional IRA and a Roth is that contributions to a Roth account are made with after-tax dollars. The funds grows tax-free, and you are not taxed on your money or your earnings when you take distributions in retirement. This is a solid option if you expect to be in a higher tax bracket in retirement than you are right now.
Note that not everyone is eligible to contribute to a Roth IRA. If you earn less than $139,000 as a single person or $206,000 if you’re married and filing jointly, you are eligible to contribute to a Roth. If your income exceeds these caps, however, you may still contribute to a traditional IRA.
Option #3: SEP IRA
While anyone can open a traditional or Roth IRA, self-employed individuals and independent contractors have an additional option: the SEP IRA. Like its counterparts mentioned above, it is a tax-advantaged retirement savings tool that allows you to invest pre-tax dollars and pay taxes later when you take distributions in retirement. The major benefit of an SEP IRA, however, is its higher contribution limits as compared to traditional and Roth IRAs. For 2020, the SEP-IRA contribution limit is $57,000.
Option #4: Solo 401(k)
The Solo 401(k) was designed for self-employed workers and business owners with no employees. Termed a “one-participant 401(k)” by the IRS, it offers many of the same benefits you’d find with an employer-sponsored 401(k), plus you can use it to cover both you and your spouse. There are no age or income restrictions, and the contribution limit for 2020 is $57,000 (plus an additional $6,500 if you’re over 50). The contribution formula is more flexible than a SEP. And you can make ROTH contributions. So, it definitely has advantages over the SEP. However, it may also require more paperwork. Like the SEP it enables the self-employed to save significant funds into a tax-advantaged plan.
Option #5: Set Up a Defined Benefit Plan
This option seems almost too good to be true. If you are a self-employed individual with a lot of excess cash flow, this enables you to fund your retirement plan with way more than you even pay yourself. Most retirement plans restrict you to 25% of your income, but not the Defined Benefit plan. You could put 200%, 300%, or more than your salary – untaxed – into your retirement plan. You can quickly build up several million dollars to take care of yourself in retirement, adding a little more predictability to your life.
These plans are somewhat complex, and you need an advisor experienced in setting them up. They have annual administrative needs and fees, and you need to have the ability to fund them and to do so relatively consistently.
Final Thoughts on Saving for Retirement Without a 401(k)
One of the many advantages of being self-employed is that you may be able to save significantly greater sums into a correctly designed retirement plan than a traditional employee. Utilizing one or more of the five options above and committing to a savings plan will allow you to properly plan for a financially secure retirement.
If you’re unsure where to begin, you may benefit from talking with a financial advisor. A financial professional is best suited to help you wade through the various options, and a tax professional can also help you make the most tax-efficient decisions with your investments.
At WellAcre, we welcome the opportunity to speak with you about your goals and help you build a foundation to achieve them. Please reach out to begin a conversation about your retirement plan today. After all, it’s never too soon to begin planning for your financial future.