While we've all heard that the 401(k) has its advantages as a foundational retirement planning account, there are other vehicles available that might prove to be even more desirable when it actually comes time to retire. Remember that the future has no obligation to look like the past. In other words, plan for and expect changes to occur in your work environment and through tax policy.
Traditional 401(k)s come with restrictive rules governing when you can withdraw money. In most cases, you'll need to be at least 55 to avoid penalty (except in the case of unusual hardship, where various amounts may be loaned or withdrawn). Many 401(k) plans also come with high fees and a limited investment menu. And last, many plans require that you work for your employer for a certain number of years before the entire account is actually yours.
Let's look at three ways to save for retirement completely independent of your employer-sponsored 401(k).
1. Roth IRA
With a Roth IRA, you'll deposit money that's already been taxed, invest it in the portfolio of your choice, and let time do the work. Once you've decided it's time to retire, you can withdraw Roth IRA money (contributions plus any earnings) entirely tax-free, assuming you're at least 59 1/2 and have held the account for at least five years. Fortunately, your contributions to a Roth IRA are always accessible tax-free and penalty-free, which, unlike a 401(k), gives you a bit of flexibility, even after you've made deposits to the account.
Roth IRA contribution limits tend to be on the lower end, with the maximum contribution for 2021 set at $6,000 if you're under 50 and $7,000 if you're over 50. This is why it's especially important to ensure you max out, or at least come close to maxing out, your Roth IRA every year. Consistent contributions can lead to exceptionally large balances over decades of compound interest, which, in a rising-tax-rate environment, is going to make your tax-free Roth account a particularly valuable asset.
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2. Health Savings Account
A common "off-label" use for the popular Health Savings Account (HSA) is to use it as an extension of your Roth IRA. Earners who have the means to fund their health expenditures through other savings can use their HSA to invest tax-free for retirement, because all contributions compound tax-free and are withdrawn tax-free, as long as you use the money to cover qualified medical expenses -- which the IRS carefully defines.
The purpose of an HSA is to fund medical expenses, not your retirement. But you can make use of the tax-advantaged investment space at least until it comes time to retire. At the age of 65, if you use the money for a non-medical expense, you'll be spared a penalty, but you'll still be taxed at ordinary income rates on your withdrawal. Alternatively, you can use the account as a medical emergency fund that will likely come in handy many years down the line.
3. Solo 401(k)
With more and more people working for themselves or freelancing at least part-time, the solo 401(k) has emerged as the new darling of the financial-planning world. The solo 401(k) is intended for people who run their own businesses by letting them act dually as both their own employer and an employee.
The main advantage of the solo 401(k) is the hefty contribution limits. In 2021, someone under 50 is able to contribute $19,500 as an employee and a maximum of $38,500 as the employer (or up to 25% of total compensation). Limits are even higher ($26,000 and $64,500, respectively) if you're over 50.
When you create a 401(k) plan, you make the decisions. You can allow various activities within the plan, like holding life insurance, making loans, and permitting Roth contributions.
Some people like the additional control that comes with administering their own plan, but others would rather not have to bother. Either way, rest assured that there's quite a lot that can be done in the way of retirement planning when you're the captain of your own ship.
One size doesn't fit all
You have many options when you're saving for retirement. Be sure to know which ones are available to you, and take the time to do the necessary research to optimize both your tax and retirement plan. Often, making very small changes to either your investment allocation or contribution amounts can have a very significant effect on your account balances -- which can ultimately cut years off your working life.
