Six Alternatives to Your 401k or 403b Plan
Usually, your 401k or 403b is your best bet for retirement savings. However, there are times when these options might not be available to you. Perhaps you don’t have access to an employer-sponsored plan, or maybe you’re looking for other ways to diversify your retirement portfolio. In this blog post, we’ll explore six alternatives to your 401k or 403b plan, detailing their benefits and limitations. We’ll also discuss how these alternatives can work together, depending on your financial situation.
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Individual Retirement Account (IRA)
What is an IRA?
An Individual Retirement Account (IRA) is one of the most common retirement savings options available. It’s an account that allows you to save for retirement with tax-free growth or on a tax-deferred basis.
Deductibility Limitations for High-Income Earners
For high-income earners, such as physicians or other professionals, the main issue with a traditional IRA is deductibility. Depending on your income level, you might not be eligible for the tax deduction that makes IRAs appealing. To help you navigate this, we’ll include a link to the IRS chart in the notes so you can see if you qualify.
Contribution Limits
In 2024, the contribution limit for an IRA is $7,000. Additionally, if you are over the age of 50, you can take advantage of a $1,000 catch-up contribution.
Investment Flexibility
One of the major advantages of IRAs over 401ks and 403bs is the broader range of investment options available. With an IRA, you can choose from a variety of mutual funds, ETFs, and even Real Estate Investment Trusts (REITs). This flexibility allows you to diversify your portfolio more effectively.
Self-Directed IRA Option
For those who are well-informed and willing to take on more risk, a self-directed IRA allows for investments in real estate, cryptocurrencies, and other non-traditional assets. However, proceed with caution. One misstep could result in significant tax penalties. Before diving into this option, consult a financial advisor or a CPA.
Backdoor Roth IRA Strategy
High-income earners often use the IRA as a stepping stone to a Roth IRA through a strategy known as the “Backdoor Roth IRA.” This involves contributing to a traditional IRA and then converting those funds into a Roth IRA. To avoid any tax pitfalls, ensure that you have no other IRA balances, such as a traditional or SEP IRA.
Roth IRA
What is a Roth IRA?
A Roth IRA, or Roth Individual Retirement Account, is similar to a traditional IRA but with a key difference: contributions are made with after-tax dollars. This means that your money grows tax-free, and withdrawals in retirement are also tax-free.
Income Limitations for Direct Contributions
If you’re a high-income earner, you likely won’t be able to contribute directly to a Roth IRA due to income limitations. This is where the IRA and Roth IRA can work together through the Backdoor Roth IRA strategy.
Contribution Limits
The contribution limits for a Roth IRA are the same as for a traditional IRA:$7,000 in 2024, with an additional $1,000 catch-up contribution if you’re over 50.
Investment Flexibility
Like a traditional IRA, a Roth IRA offers a wide range of investment options, including mutual funds, ETFs, and other investment vehicles. This makes it another flexible alternative to the 401k or 403b.
Backdoor Roth IRA Strategy Revisited
To use the Backdoor Roth IRA strategy, contribute to a traditional IRA and then convert the funds to a Roth IRA. This allows you to bypass the income limitations and still take advantage of the tax-free growth and withdrawals that a Roth IRA offers.
Health Savings Account (HSA)
What is a Health Savings Account?
A Health Savings Account (HSA) is a tax-advantaged account designed to help you save for medical expenses. However, it can also serve as an alternative to a 401k or 403b, especially if you don’t have access to those plans.
Eligibility Requirements
To open an HSA, you must be enrolled in a high-deductible health plan (HDHP). These plans have higher deductibles and out-of-pocket maximums than traditional health insurance plans but come with the benefit of tax-advantaged HSA contributions.
Contribution Limits
In 2024, the HSA contribution limit for individuals will be $4,150. For family plans, the limit will be $8,300. If you’re over 55, you can also contribute an additional $1,000 as a catch-up contribution.
Pre-Tax Deduction Benefits
HSA contributions are made with pre-tax dollars, reducing your taxable income for the year. This makes HSAs a highly efficient way to save for medical expenses and also offers a potential tax shelter for retirement savings.
Investment Options
Many HSAs offer investment options similar to those available in IRAs. This includes U.S. equities, international equities, and sector-specific funds. Some even offer real estate ETFs, providing a wide range of investment choices.
Recommended Strategy
Ideally, you should fund your HSA every year and invest the proceeds. If you can, pay current medical expenses out-of-pocket, allowing your HSA to grow tax-free. This strategy can provide a substantial nest egg for healthcare costs during retirement.
Simple IRA
What is a Simple IRA?
The Savings Incentive Match Plan for Employees, commonly known as a Simple IRA, is designed for small businesses and self-employed individuals. Despite its name, it’s not always the easiest plan to navigate.
Eligibility Requirements
To contribute to a Simple IRA, you need to have self-employment income or 1099 income. This makes it a viable option for freelancers, consultants, and small business owners.
Contribution Limits
In 2024, the contribution limit for a Simple IRA is $16,000. If you’re over 50, you can make a catch-up contribution of $3,500.
Employer Match Considerations
One unique feature of the Simple IRA is the employer match. While this can be beneficial, it often requires careful planning to maximize your overall retirement savings.
Comparison to Other Options
Compared to other alternatives like the SEP IRA or Solo 401k, the Simple IRA has lower contribution limits. This can make it less attractive for those looking to maximize their retirement savings.
SEP IRA
What is a SEP IRA?
A Simplified Employee Pension (SEP) IRA is another option for self-employed individuals and small business owners. It’s designed to offer higher contribution limits than a traditional or Roth IRA, making it a compelling alternative to a 401k.
Eligibility Requirements
You need self-employment income or 1099 income to contribute to a SEP IRA, which, like the Simple IRA, makes it ideal for freelancers, consultants, and small business owners.
Contribution Limits
The SEP IRA allows you to contribute up to 25% of your net profit, with a maximum contribution of $69,000 in 2024.
Investment Flexibility
Similar to other IRAs, a SEP IRA offers a wide range of investment options, including mutual funds, ETFs, and more. This makes it a flexible option for diversifying your retirement portfolio.
Drawbacks
One major drawback of the SEP IRA is that it interferes with the Backdoor Roth IRA strategy. If you have a SEP IRA balance, you can’t take advantage of the backdoor conversion, limiting your options for tax-free retirement growth.
Solo 401k
What is a Solo 401k?
A Solo 401k, also known as an individual 401k, is a retirement plan designed for self-employed individuals and small business owners with no employees. It offers many of the benefits of a traditional 401k but is tailored for solo entrepreneurs.
Eligibility Requirements
To open a Solo 401k, you need self-employment income or 1099 income. This makes it an excellent option for freelancers, consultants, and small business owners.
Contribution Limits
The contribution limits for a Solo 401k are high, making it a powerful retirement savings tool. In 2024, you can contribute up to $69,000. This includes both employee and employer contributions.
Two-Part Contribution Structure
The Solo 401k allows you to contribute as both an employer and an employee. The employee contribution limit is $23,000 in 2024. The employer portion makes up the rest, allowing you to maximize your contributions.
Flexibility and Customization Options
One of the significant benefits of a Solo 401k is its flexibility. You can set it up through financial institutions like Fidelity or Vanguard, offering a wide range of investment options. Additionally, some plans include a “mega backdoor Roth” option, allowing you to further enhance your retirement savings.
Combining Strategies for W-2 and 1099 Income
Utilizing Both Employer-Sponsored and Self-Employed Plans
If you have both W-2 and 1099 income, you can take advantage of multiple retirement plans. This could include a 401k or 403b from your employer and a Solo 401k or SEP IRA for your self-employed income.
Contribution Limit Considerations
While combining plans, it’s essential to keep track of contribution limits to avoid exceeding the IRS limits. Working with a financial advisor can help you navigate these complexities.
Working with Financial Advisors and CPAs
Consider consulting with a financial advisor or CPA to optimize your retirement savings. They can help you understand your options and ensure that you’re making the most of each plan.
Approaching Employers About Retirement Plans
Benefits for Both Employees and Employers
If your employer doesn’t offer a 401k or 403b, consider approaching them with the idea. These plans benefit both employees and employers by providing tax advantages and helping attract and retain top talent.
Tax Advantages for Businesses
For business owners, offering a 401k or 403b plan provides significant tax benefits. Contributions are tax-deductible, and these plans can help reduce the overall tax burden.
Attracting and Retaining Talent
Good retirement benefits are a crucial factor in attracting and retaining talented employees. A robust 401k or 403b plan can set your business apart in a competitive job market.
Carving Out 1099 Income from W-2 Salary
Discussing Options with Employers
If you’re unable to get your employer to offer a retirement plan, consider discussing the possibility of carving out 1099 income from your W-2 salary. This could allow you to take advantage of self-employed retirement plans.
Potential for Opening Solo Retirement Accounts
With 1099 income, you can open a Solo 401k or SEP IRA, providing additional avenues for retirement savings.
Fallback Options for High-Income Professionals
Backdoor Roth IRA
Even if you can’t contribute directly to a Roth IRA, the Backdoor Roth IRA strategy is a viable option. This allows you to enjoy the benefits of a Roth IRA despite income limitations.
HSA with a High-Deductible Health Plan
If a high-deductible health plan makes sense for you, consider opening an HSA. It’s a tax-advantaged way to save for medical expenses and can serve as an additional retirement savings vehicle.
Importance of Tax Deferral in High-Income Years
Current High Tax Brackets
As a high-income professional, you’re likely in a high tax bracket. Deferring taxes through retirement contributions can provide significant savings.
Potential for Lower Tax Brackets in Retirement
In retirement, you may be in a lower tax bracket, making tax-deferred growth even more beneficial. Strategic planning today can result in substantial savings in the future.
Conclusion
If you don’t have access to a 401k or 403b plan, several alternatives can help you build a robust retirement portfolio. Consider combining these options based on your financial situation, and always consult with a financial advisor to maximize your benefits. Whether it’s an IRA, Roth IRA, HSA, Simple IRA, SEP IRA, or Solo 401k, understanding and leveraging these alternatives can ensure a secure financial future.
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