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Do you work for an employer that doesn’t offer a 401k plan? According to CNBC, you’re definitely not alone. Nearly half of all Americans are either employed by a company that doesn’t have this benefit or they don’t work enough hours to qualify for participation.
I have a friend where he and his wife were in this situation. He worked for a small business, and she sold jewelry on Etsy as a side hustle.
Although they both earned a decent amount of money for what they did, they wanted to know if there was a more tax-efficient they could save for the future instead of just stuffing it into their regular-old savings account.
Here’s the advice I gave to my friend and his wife about how to save for retirement without the help of a 401k plan.
401k Retirement Saving Alternatives
401ks are helpful, but they’re certainly not the only tax-advantaged way to save your money for the future. Here are three other solid options to consider:
1. Start an IRA
An IRA (individual retirement account) is another type of savings fund that has similar benefits to a 401k. With both, you don’t pay any taxes on the contributions you make this year and instead defer them into the future when you retire someday.
According to the IRS, you have to have taxable income to be able to use an IRA. But even in situations where one spouse works and the other one doesn’t, it's still possible to contribute to one. Here’s an article on how that works.
IRA's can be set up as one of two types:
- Traditional – Just like we described above, you’ll skip paying taxes now and instead pay them when you retire.
- Roth – The opposite: You’ll pay taxes on your contributions now and enjoy tax-free income when you retire.
IRAs can be opened at virtually any financial institution or bank of your choice.
2. Contribute to a Self-Employed Retirement Plan
As in the case of my friend’s wife, she was making enough money from her side hustle that it had to be reported to the IRS for tax purposes. That means that technically she’s self-employed and can contribute to one of three different self-employed retirement plans:
- SEP IRA
- Solo 401k
- SIMPLE IRA
Personally, for my own side hustles, I’ve always found the SEP IRA to be the easiest option to use. With a SEP IRA, you can contribute as both the employer and employee. Here are the limits (as of 2021):
- As an employee, you can contribute up to $6,000 (just like a traditional IRA).
- As an employer, you can contribute up to $58,000 or 25% of your net earnings, whichever is less.
Not only does this benefit your retirement goals, but contributing to a SEP IRA will also lower the amount of taxes you’ll owe overall. That’s like getting a double bonus!
3. Capital Gains and Dividends
While a taxable brokerage account doesn't technically have the same benefits as a retirement account, I've found them to still have some taxable advantages over conventional methods of saving your money.
This is because the capital gains and dividends that you earn from stocks and other securities get taxed according to a more favorable tax bracket system than ordinary income does.
To give you some idea, if you file your taxes “married filing jointly”, then you don’t technically owe any taxes on your dividends and capital gains until after your adjusted gross income exceeds $80,000.
For a complete breakdown of the most recent marginal tax brackets for capital gains and dividends, click here.
How to Prepare for Retirement
Another often overlooked benefit of having an employer that provides a 401k plan is that they will also usually provide you with resources that can help you properly plan for retirement.
For example, the HR department at the employer I work for holds multiple workshops throughout the year that are designed to educate us about how saving for retirement works and if we’re on track to accomplish our financial goals.
However, if you work by yourself or for an employer that doesn’t offer 401k plans, then it will be up to you to come up with your own plan. Here’s what you need to do to get ready.
Why Do I Want to Retire and When?
One of the most fundamental questions that anyone can ask themselves about retirement planning is why they want to retire in the first place.
Is it to spend more time with family, travel, switch careers, start your own business, or something else?
Regardless of your “why”, it's important to reflect upon this question because it will determine how your retirement plan should be designed. Particularly:
- When do you want to retire? At age 65 (like most people) or much earlier (like your 50s and 40s)?
- How much money will you need?
For instance, I’ve had a goal for some time now that I’d like to start my own financial coaching business as a second career. Therefore, my retirement plan is to save up a nest egg of $1 million by the time I’m in my mid-40s.
How Much to Contribute to Meet These Goals?
As you might guess, the earlier you want to retire and the more money you believe you’ll need, then the more aggressively you’ll need to save and invest to meet your goals.
But how do you break this down into monthly contributions so that you’ll know you’re on the right track?
If you Google “retirement calculators”, you’ll certainly find hundreds of them to choose from. But to be honest, I like this simple one from the US SEC.
To use it, you only need to enter three main inputs. Here are mine:
- Nest egg goal = $1,000,000
- Retire by age 45. That means I’ve got 20 years to save.
- For the investment growth rate, I use the average rate of a stock market index fund (10%) minus the average rate of inflation (3%) for a net figure of 7%.
Given these numbers, the calculator says that I’ll need to save $2,033 per month to accomplish this goal. You can try your own numbers doing exactly the same thing!
The Bottom Line
Just because you work for an employer that doesn’t offer a 401k, there are plenty of other options for saving for retirement. You could use a traditional or Roth IRA, contribute to a self-employed retirement plan, or just invest in securities that produce capital gains and dividends.
In addition to finding a tax-efficient way to save for retirement, you’ll also want to make sure that you’re taking the right steps to ensure you’re properly planning for retirement.
Spend some time thinking about your goals, when you’d like to retire, and what you’ll have to save each month to get there. It will definitely require some extra effort on your part, but trust me – it will be an exercise that will do wonders for your finances in the future.