Many people start saving for retirement when they have access to a plan through an employer, such as a 401(k) or 403(b). It’s recommended to take advantage of that opportunity, especially because these accounts offer serious tax benefits that can boost your ability to save, and your company may offer to match a share of contributions, which is essentially free money.
But what if you don’t have access to those benefits? Perhaps your employer doesn’t offer them, you don’t qualify based on part-time or contract status, or you’re self-employed.
Guess what? That’s no excuse to not save for retirement. Understandably, it can seem daunting to figure out which retirement account may best suit your needs on your own. But there are great options out there for you—including traditional, Roth, and SEP IRAs—and they’re not as hard to use as you might think.
What Is an Employer-Sponsored Retirement Account?
Employer-sponsored retirement accounts, such as 401(k)s and 403(b)s, are retirement savings vehicles. Employers usually offer them to full-time employees as part of a compensation package. Among private sector employees, 401(k)s are the most common options, whereas only public employees and certain nonprofit employees receive 403(b)s.
Employees can make elective contributions to these accounts, and can potentially save a lot of money each year. For example, in 2022 , employees can contribute up to $20,500 each year to their 401(k), and employers may provide matching contributions. Overall contributions cannot exceed $61,000.
Contributions to 401(k)s are made with pre-tax dollars, which can lower your taxable income and income tax bill. Those contributions then grow tax-deferred inside the account, and you pay income tax when you make withdrawals.
Employer-sponsored accounts like these are powerful tools for savings. But here’s the rub: Not everyone has access to them. However, that doesn’t mean you can’t or shouldn’t save in a retirement account anyway.
Saving for Retirement Even If You Don’t Have a 401(k)
Planning for retirement is critical, especially as the Social Security system stands on precarious footing and pensions are becoming extinct in many fields. And building your nest egg is likely to be the most ambitious financial goal of your life. That’s why it’s helpful to start saving as soon as you can and to find ways to boost your savings.
In many cases, it’s a good idea to make sure your retirement savings are on track before saving for your children’s college education, or even aggressively paying down your own student debt depending on the terms. After all, while you can borrow money to pay for education, you likely cannot borrow to pay for your retirement.
A key reason to start early is the power of compounding. Your investment returns can be reinvested and start earning returns, which may help your savings grow much faster than they otherwise could. The sooner you start investing, the longer you have to take advantage of compounding growth.
What’s more, if you save inside of a tax-advantaged account, such as an IRA, returns inside the account aren’t subject to taxes and can grow even faster. Anything you put in now has the opportunity to grow over time, just keep in mind that all investing comes with risk of loss.
Why Open a Retirement Account?
Before we get into the types of retirement accounts to consider, you may be wondering: Why open a retirement account in the first place? Maybe you’re already saving for retirement, but you’re keeping the money in a checking or savings account instead.
You’ve got the right idea by putting money away. But, if you’re leaving your savings in cash, that money is likely barely keeping up with inflation—or worse, losing relative value over time. It could be challenging to reach your retirement goals without investing the funds, which does come with risk but can possibly provide much higher returns over time.
You may also be saving in a brokerage account, which allows you to invest and potentially grow your savings faster than in a bank account. However, the government really wants you to save for retirement.
So they sweeten the deal by allowing retirement accounts that provide the potential benefits of investing while offering some tax advantages. If someone’s only saving through a brokerage account or bank accounts, they’re losing out on these valuable tax benefits.
Funding a Traditional IRA
An Individual Retirement Account, or IRA, is a savings tool that provides individuals with tax-advantaged savings opportunities. There are a few different types of IRAs.
The first one you may consider is a traditional IRA. These accounts allow you to contribute up to $6,000 a year in 2022, or $7,000 if you’re age 50 or older.
You make contributions with pre-tax dollars. The contributions are tax-deductible and may lower your taxable income for the year they are applied.. Once inside the account, your contributions can be invested in a variety of ways and grow tax-deferred.
This is where compounding interest potentially really starts to shine. You don’t pay any taxes on your earnings until you withdraw them from the account.
You can make withdrawals starting at age 59 1/2. Any withdrawals you make before then may be subject to income taxes and an additional 10% early withdrawal penalty.
Traditional IRAs require that you take distributions, known as required minimum distributions (RMDs) by age 70 1/2.
Funding a Roth IRA
Another common IRA you may encounter is the Roth IRA. Some of its features overlap with the traditional IRA, but the key difference lies in when your contributions are taxed.
As with a traditional IRA, in 2022, you can contribute up to $6,000 a year in a Roth with an additional $1,000 a year in catch-up contributions if you’re age 50 or older. Unlike traditional IRAs, you must fall within certain income limits to make contributions to a Roth. If you make too much money, the amount you are allowed to contribute begins to phase out.
Contributions to Roths are made with after-tax dollars. They are not deductible so they don’t lower your taxable income in the year you make the contribution. Once invested inside the account, your investments can grow tax-free.
However, if you withdraw earnings, you can only do so penalty free at age 59 1/2. Additionally, distributions (earnings) may be subject to a 10% penalty if you withdraw them before five years have passed (based on the first taxable year the contribution was made). This is known as the 5-Year Rule.
Roth IRAs are not subject to required minimum distributions (RMDs).
Funding a SEP IRA
If you’re self-employed, you may want to consider a Simplified Employee Pension, or SEP IRA. This type of account potentially allows you to sock away much more money than a traditional or Roth IRA. In a way, SEPs are the self-employed person’s answer to the savings power of the 401(k) due to their higher contribution limits.
SEPs essentially allow you to treat yourself as your own employer. You can make contributions of up to 25% of your net earnings from self-employed work up to $61,000 a year in 2022.
A SEP IRA is a type of traditional IRA, so aside from the different contribution limits, it otherwise follows the same investment and distribution rules. Contributions are tax deductible, they grow inside the account tax deferred. You only pay income tax when you make withdrawals from the account, and early withdrawals before age 59 1/2 are subject to income tax and a 10% penalty.
Additionally, it’s important to keep in mind that the 5-Year Rule applies here as well.
What Type of Account Is Right for You?
The type of retirement account you choose to open will depend largely on your needs.
Generally speaking, if you owe a lot of taxes now and want to lower your taxable income, you may choose a traditional IRA. You may also choose a traditional IRA if you think your taxes will be higher now than they will be when you retire.
You might go with a Roth IRA if you already tend to owe very little in taxes and you think that you might owe more in taxes when you retire than you do now. For example, if you’re just starting your career and you’re in a low tax bracket, you might consider funding a Roth assuming that when you’re older you’ll be better established financially and in a higher tax bracket. It is recommended that you consult with your tax advisor.
If you’re a freelancer, have an independent side hustle, or otherwise work for yourself, you can open a SEP IRA. Like a traditional IRA, a SEP IRA can help you reduce what you owe in taxes today.
Maintaining a Mix of Retirement Accounts
You aren’t limited to only one type of retirement account. To a certain extent you can mix and match them, which can even be a beneficial strategy to take.
You can fund both a traditional and Roth IRA, though combined contributions cannot exceed the $6,000 contribution limit, or $7,000 for those age 50 and older. Funding both types of account can give you some flexibility in terms of the taxability of your retirement income.
You can also have an IRA at the same time you have a 401(k). If you already have a 401(k) left over from a previous job you can open an IRA. Sometimes an older 401(k) can stick you with higher maintenance fees or limit your investment options. In that case, you may consider a rollover of your 401(k) into an IRA of your own choice.
If you get a job that offers you an employer-sponsored plan, you can keep your IRA(s) and start funding your workplace plan at the same time, allowing you to save even more for your retirement. Contribution limits for IRAs do not have an effect on contribution limits for your 401(k).
Ways to Open a Retirement Account
Once you’ve decided which retirement account is right for you (which you can do with the help of SoFi’s IRA calculator, opening one is relatively easy. Brick and mortar banks, brokerage firms, and online financial institutions may all offer IRAs. It’s worth doing your research to make a decision on the best fit.
After setting up an IRA account, you’ll make your first contribution. From there, if you have a lot of time before retiring, you might choose to invest your contributions and take advantage of growth.
Overall, although it may seem intimidating at first, setting up an IRA is relatively easy—and saving for retirement isn’t only for those with access to a 401(k).
SoFi Invest® makes opening an IRA easy. Sign up for an investment account online, in less than five minutes. We can help you pick an appropriate mix based on your age and retirement goals. And if you have any questions or want personalized advice, you can set up a complimentary call with a SoFi Invest advisor.
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Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
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