Alternative Options to a 401(k)
A 401(k) plan with matching contributions is an excellent retirement investment vehicle. Unfortunately, based on statistics from the Investment Company Institute, only a third of American workers are enrolled in such a plan. As such, there are over 100 million workers who could use an alternative source of retirement savings.
Fortunately, individuals can save for retirement via alternative means. Below are two of the most common methods of doing so.
An individual retirement account (IRA) is similar to a 401(k) in that contributions are tax-deferred. It also shares the following key features:
- Penalty-free distributions begin at age 59 ½ or when owner becomes disabled
- Distributions must begin by age 70 ½
- Upon distribution, both contributions and earnings are taxed
However, an IRA is established by an individual, not an employer. This means there will be no employer contributions to the plan. Also, contributions limits are much stricter with an IRA. The maximum annual contribution for those under age 50 is $5,500 and $6,500 for those 50 and above versus $17,500 and $23,000 for a 401(k).
Yet, an IRA offers one key advantage: portability. Unlike a 401(k), an IRA is not dependent on a given employer. 401(k) owners often roll their funds over to a new 401(k) or IRA when they leave an employer, which can be a bit tedious. Or, they just leave it with their former employer, leading to multiple 401(k) accounts. However, by choosing an IRA from the beginning, an investor eliminates the mentioned hassles.
A Roth IRA is similar to an IRA. However, it has three very important distinctions.
First, contributions are made with after-tax dollars. For example, a Roth IRA account owner who adds $5,000 to her account this year would not be able to deduct this amount from her taxable income.
Second, earnings grow tax-free. Thus, taxes are not paid upon distribution, as contributions have already been taxed and earnings are not taxable.
Finally, there are no required distributions, giving owners the flexibility to delay their withdrawals or pass all funds to their beneficiaries upon death . Typically, those who expect to be in a higher tax-bracket during retirement opt for a Roth IRA while those who believe they'll be in a lower tax-bracket select a traditional IRA. But, the decision is not always so simple and many find it necessary to enlist a financial professional.
Establishing an IRA or Roth IRA is fairly easy and can often be done online via one's bank or credit union. Another way to do so is to hire an investment advisor or use an online broker. Online brokers typically offer the lowest fees.
The Bottom Line
IRA and Roth IRA plans are key alternatives to a 401(k) for those who don't have access to an employer-sponsored plan. Both are very similar, but differ on the most important factor of all: taxation. As such, those who are uncertain about their future tax situation may wish to seek professional advice to maximize their retirement wealth.
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