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When saving for retirement, the 401(k) is often the first account that comes to mind. Many employers offer this retirement plan, allowing employees to save pre-tax income for retirement. However, a 401(k) isn't the only option to build your retirement nest egg. Several other retirement savings accounts offer distinct benefits, tax advantages, and flexibility.
Whether you're self-employed, a business owner, or simply seeking to diversify your savings strategy, exploring these alternatives can help ensure a robust retirement plan. Let's break down some popular retirement savings options beyond the traditional 401(k).
Individual Retirement Accounts (IRAs)
An Individual Retirement Account (IRA) is a popular and accessible retirement savings account for those who don't have access to a 401(k) or want to supplement their existing 401(k) contributions. IRAs have tax advantages that can help you grow your savings over time.
Traditional IRAs allow you to make tax-deductible contributions up to a specific limit, which lowers your taxable income for the year. The investments grow tax-deferred, and you won't pay taxes on the funds until you withdraw them in retirement.
The RMD rules require individuals to start withdrawing from their IRAs (including SIMPLE and SEP IRAs) annually once they turn 72 (or 73 if they turn 72 in 2023 or later), even if they are still working. These withdrawals are taxed as ordinary income. Traditional IRAs are an excellent option for people who want to reduce their taxable income in the short term and have a reliable source of retirement savings that will grow over time. They are best for those who expect to be in a lower tax bracket during retirement.
Roth IRAs
A Roth IRA is another version of the traditional IRA but with a twist. Unlike Traditional IRAs, contributions to a Roth IRA are made with after-tax money, meaning you don't get an immediate tax break when you contribute. However, the benefit comes in the form of tax-free growth. The money you contribute to a Roth IRA grows tax-free, and when you withdraw it in retirement (after age 59½), you don't owe any taxes on the money, including any gains from investments.
Roth IRAs have income limits, so higher earners may not be eligible to contribute directly to one. However, a strategy known as a "backdoor Roth IRA" can allow higher earners to contribute indirectly. Roth IRAs are best suited for those who believe their retirement tax rate will be higher than it is today and want to avoid future tax on withdrawals. They are also ideal for those who want the flexibility of tax-free withdrawals in retirement and no required minimum distributions.
SEP IRAs
A SEP (Simplified Employee Pension) IRA offers an excellent retirement savings option for self-employed individuals and small business owners. It functions similarly to a Traditional IRA but allows for much higher contribution limits.
For 2024, business owners can contribute up to 25% of their compensation or $69,000, whichever is less. This makes it a fantastic option for those with fluctuating incomes or wanting to make significant contributions in a single year.
Contributions to a SEP IRA are tax-deductible, which can lower your taxable income for the year, and the investments grow tax-deferred until retirement. However, similar to a Traditional IRA, you will be required to take RMDs beginning at age 73. A SEP IRA is ideal for self-employed individuals or small business owners who want to maximize their retirement savings while benefiting from the same tax advantages as a Traditional IRA.
Solo 401(k)
If you are a business owner with no employees (other than your spouse), a Solo 401(k) can be a great way to boost your retirement savings. This plan allows you to contribute both as an employer and an employee, giving you the potential to save more than with other retirement accounts.
A Solo 401(k) allows for both traditional (pre-tax) and Roth (after-tax) contributions, providing tax flexibility. The ability to make large contributions makes it an attractive option for business owners with higher incomes, allowing them to reduce their taxable income or benefit from tax-free growth, depending on the type of contribution. If you're self-employed with no full-time employees, a Solo 401(k) can be a powerful tool for securing your retirement.
Health Savings Accounts (HSAs) as Retirement Savings
While a Health Savings Account (HSA) is technically not a retirement account, it can be used strategically to save for retirement-related medical expenses. HSAs help individuals with high-deductible health plans (HDHPs) save on healthcare costs. Contributions to an HSA are tax-deductible, and withdrawals for qualified medical expenses are tax-free.
What makes an HSA particularly attractive as a retirement savings tool is that after age 65, you can withdraw the funds for any purpose, not just medical expenses, without paying a penalty. You'll still have to pay taxes on those withdrawals if they aren't used for medical expenses, but this can provide another source of retirement income.
Additionally, the HSA offers tax-free growth for healthcare expenses, making it a suitable supplementary option for those who expect significant healthcare costs in retirement.
Borrowing from Retirement Accounts: An Important Consideration
Sometimes, life circumstances require accessing funds for emergencies, and you might be tempted to dip into your retirement savings. While it's generally not advisable to borrow from your retirement accounts, there may be times when it's unavoidable, such as in the case of an unexpected medical emergency or home repair.
If you need funds for an emergency, you can consider turning to a reputable online lender like MoneyKey instead of depleting your retirement savings, which can have long-term negative consequences. An online lender can provide you with quick access to funds without derailing your future retirement goals. Always ensure that the lender you choose is trustworthy, and take the time to carefully review the loan terms before making a decision.
