“Hey Dad, how do I save for retirement if my employer doesn’t offer a 401k?”
That’s a very good question, kids:
Not all employers offer a 401k plan for their employees, nor are they legally required to do so. Additionally, not all employers who do offer a 401k plan offer an employee match, nor are they legally required to do so.
In my opinion, the biggest benefit of employer sponsored 401k plans is the employee match (BOGO). The second biggest benefit is the annual amount you can contribute to a 401k. For 2023, the 401k contribution limit for employees is $22,500, or $30,000 if you are age 50 or older. “That’s a sizable chunk of change to save in 1 year”. However, 401k plan options are limited to the funds that are included in the employers’ plan, which can vary widely. The third biggest benefit is your contributions are invested with pretax dollars. Basically, that money comes out of your paycheck before “Uncle Sam” has the opportunity to tax it. “He will get his unfair share eventually, just not right now”.
Without having the option of an employer sponsored retirement plan, you can contribute to a Traditional Individual Retirement Account (IRA) and/or a Roth Individual Retirement Account (Roth IRA), which are both “similar” in nature to the 401k. The IRA and Roth IRA can be opened at most banks or at a brokerage firm like Fidelity Investments. For 2024, the annual contribution limit for all your traditional IRAs and Roth IRAs cannot be more than $7,000, or $8,000 if you are age 50 or older. Like with the 401k there are some tax implications that you need to be aware of. Additionally, you must have earned taxable income to contribute to an IRA. “Consult with a tax accountant or certified financial planner for specifics”. IRAs have a vast number of options available, including stocks, bonds, mutual funds, annuities, unit investment trusts, exchange-traded funds, and even real estate. There are some restrictions like artwork, stamps, rugs, automobiles, alcohol, certain metals, and other similar items. “That’s still a tremendous amount of investment options”. Unfortunately, with these accounts there is no match.
With a traditional IRA you make contributions with money that you already have in your savings, checking, and/or brokerage accounts. You are able to deduct your contributions to a traditional IRA on your tax return. Again, “Consult with a tax accountant or certified financial planner for specifics”.
With the Roth IRA your contributions are invested with after-tax dollars also, however the growth on your investments never gets taxed. This, my friend, is “the move”. “Uncle Sam is now out of the picture”. There are salary restrictions associated with the Roth IRA. Be sure to consult with a financial advisor to understand how to implement a Roth IRA strategy in your retirement plan.
There is another option that very few people talk about. It’s a “Brokerage Account”. There is no limit on how much money you can invest in a brokerage account. “Feel free to stack up the chips!” The investment options are unlimited. And as with the IRA, you are using after-tax dollars to invest in your brokerage account. There is a tax benefit using a brokerage account if the stocks you purchase are held for at least 365 days. The capital gain (profit made from the sale of your stock) on your stock portfolio is taxed at capital gains rates (0%, 15% or 20%), while the gains on 401k and IRA investments are taxed as ordinary income, based on your tax bracket (10%, 12%, 22%, 24%, 32%, 35% or 37%). In my opinion, the biggest benefit of the brokerage account is your money is always available to you, regardless of age. Frankly, if your tax bracket is higher than 20%, the brokerage account is not a bad retirement strategy .
Another big benefit of the brokerage account is if you plan to leave a stock portfolio to your heirs, they will receive the benefit of a “step-up provision”. The step-up provision adjusts the value, or “cost basis” of an inherited asset (stocks, bonds, real estate, etc.) when it is passed on, after death. For example, if you bought Amazon stock for $100 per share (that’s your cost basis) and it grew to $300 per share when you passed, the cost basis for your heirs is not $100, where they would have to pay capital gains tax on the $200 per share gain, their cost basis is $300 per share (that’s the step-up provision). They would only have to pay taxes on the growth of the Amazon stock above $300 per share. Frankly, they could sell the stock at $300 per share and not pay any taxes at all on the sale.
And for those fortunate people who have a $1,000,000 account balance in a 401k and/or Traditional IRA, Congratulations! You’re a millionaire today, on paper. Unfortunately, there’s a very good chance that your least favorite uncle, “Uncle Sam”, is going to be looking for his $200,000+ unfair share of that, when you start taking money out in retirement. “He’s been waiting for this moment”.
Take the time to evaluate your options and understand the tax implications. If your employer does not offer a 401k, or does not offer an employee match, consider implementing a strategy to take advantage of a combined cash (minimum of 12 months of living expenses), Roth IRA, and brokerage accounts. Frankly, even if you do have a 401k with an employee match, you should consider this combined strategy for diversification purposes. You are going to need money outside of your retirement accounts to avoid having to withdraw money from your retirement portfolio during a downturn in the stock market (bear market). Yes you have options. “Use them”.