As more Americans find themselves without an employer-sponsored 401(k) plan, it becomes even more important for investors to understand their options for retirement planning. Although it may take a bit more effort to save for retirement without a 401(k), it is even more imperative for those without an employer-sponsored plan to save diligently.
Saving for retirement without a 401(k)
There are a couple of options for employees to save for retirement when they don’t have a 401(k).
If you aren’t covered by a retirement plan at work, your ability to deduct contributions to a traditional IRA will be different than if you were covered by an employer’s plan. In 2016, single filers under age 50 can make fully deductible yearly contributions of up to $5,500 if they’re not covered by a retirement plan at work, regardless of their annual adjusted gross income (AGI).
For married filers, the deductibility of contributions will depend on whether your spouse is covered by a plan at work; and if so, your combined AGI. Work with your financial advisor and CPA to better understand how these guidelines apply to your personal situation.
How does a traditional IRA differ from a 401(k)?
Although the impact will ultimately depend on your personal situation, there are broad ways in which an IRA differs from a 401(k):
- Contribution limits: Individuals under age 50 may make a maximum contribution of $5,500 into a traditional IRA, while the limit is $18,000 for a 401(k). Further, those covered by a 401(k) plan at work may also receive employer contributions, often in the form of matching. The combined limit for employee and employer annual additions is $53,000 in 2016. (Note: catch-up contributions are available for both IRAs and 401(k) after age 50.)
- Deductibility: As discussed above, your ability to deduct your IRA contribution in full will depend on your tax filing status and possibly adjusted gross income as well. In contrast, 401(k) plan participants can make pre-tax contributions up to the $18,000 annual limit.
- Investment options: An individual IRA account will allow greater access to a diverse base of investments than a 401(k) plan will. Although there are guidelines to ensure a certain level of diversity offered in an employer-sponsored 401(k), your options will quite often be much more limited.
Even if you don’t have a 401(k) at work, your ability to contribute to a Roth IRA will still be subject to income limitations. The maximum contribution in 2016 is the same as a traditional IRA for those under age 50, however depending on where your AGI falls in the IRS table, your contribution amount may be reduced or phased out entirely.
How does a Roth IRA differ from a traditional IRA and a 401(k)?
Assuming a Roth IRA is an option, here’s a quick summary of how this type of retirement account will differ from a 401(k) or an IRA:
- Deductibility: Contributions to a Roth IRA are made with after-tax dollars. Unlike an IRA or 401(k) which can be (but doesn’t have to be) made with pre-tax contributions, a Roth account is solely funded with after-tax dollars and there is no tax deduction in the current year.
- Tax-free withdrawals: Since your Roth account is funded with after-tax dollars your withdrawals will be fully tax-free in retirement, assuming at least five years has passed since your initial contribution. A Roth strategy is generally best for an investor who is currently in a lower tax bracket than they expect to be in retirement.
- No required minimum distributions: Unlike an IRA or 401(k) account, Roth IRAs do not have RMDs upon reaching age 70 1/2. This can leave greater flexibility for individuals who have built considerable wealth as they will not be required to draw down all of their retirement assets.
Deciding on a retirement planning strategy
Saving for retirement without a 401(k) can be stressful. Although it isn’t advantageous, it is important to make the best of your situation and start planning today. If you exceed the income limitations for a Roth you can still convert a traditional IRA to a Roth IRA once a year. Before making any decisions regarding your retirement planning however, consider which strategy will maximize your overall wealth in the long term. Taking the time to develop a comprehensive retirement planning strategy early on is sure to pay off later in life.
The material contained in this article is for general information only and should not be construed as the rendering of personalized investment, legal, accounting, or tax advice.
To learn more about Thomas McFarland, view his Paladin Registry research report.
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