What can you do to save if you have no 401k?

So you’re all set to begin saving your literal behind off – you’re on fire about FI/RE, or you’ve just gotten to the point where you know you need to start saving if you’re ever going to get ahead. Problem is, you have no 401k available to you through your employer. Most all advice says to max out your 401k in order to really jump-start your retirement savings, so what can you do to save if you have no 401k? For the purpose of this article, we’re referring to 401k plans in general. If your employer offers a 403b plan instead of a 401k, of course that’s the best replacement. The same is true for 457 or Thrift Savings Plans (governmental), or SEP-IRAs or SIMPLE IRAs where offered.

Turns out there are several things you can do to save with no 401k. The 401k has only been around for 40 years (Actually 40 years this year: Happy Birthday, 401k!), and people have been saving for centuries without 401k plans. Plus, the good news is that even if you have a 401k available to you, many of the options listed below are also available to you, some more limited than others due to your participation in a 401k. But feel free to mix and match savings vehicles as allowed – the more ways to save, the better!

First, let’s take a look at why the 401k is such a popular option:

1. Most often, contributions to a 401k are matched to some extent by your employer. This results in an immediate return on your investment. If you contribute $1,000 to your 401k and your employer matches dollar-for-dollar within that range, your 401k balance will show $2,000. Like magic, you doubled your money!
2. For 2018, you’re allowed to defer up to $18,500, plus another $6,000 if you’re age 50 or older, into a 401k plan. For 2019 the limit is increased to $19,000 plus the $6,000 catch-up if over age 50.
3. Traditional 401k contributions are generally deferred from income tax. So you get a tax break on income that you were planning to save either way. As a result, your take-home pay doesn’t drop as much as you’ve contributed. For more detail on how this works, see the article How a 401(k) Contribution Affects Your Paycheck.
4. 401k contributions are deducted directly from your paycheck, so the saving is automatic. This is in keeping with the rule to “pay yourself first”. If you had to make the decision about whether to contribute to your 401k each payday, you know there would be times when you’d skip a contribution. With direct deposit like this, you’re forced into the discipline of saving first. Sometimes we need that kind of discipline to keep on track.
5. Once contributed, your 401k money can be invested to grow, avoiding taxation until you are ready to take the money out of the account.

There are many more benefits to the 401k, but those are the most significant ones that serve the purposes of this article. Now let’s look at some alternatives.

IRA

If you have no 401k available from your employer and your spouse also does not have a 401k with an employer, you can open and fund a traditional IRA. The contribution limits are significantly less than the 401k limits listed above. Let’s run through the five benefits of 401k’s and compare them to an IRA:

1. There is no matching of your contribution to an IRA like there is with a 401k, so this big benefit is lost. However, there can be a tax credit available to you, depending on your income, called the Saver’s Credit. This tax credit can work a bit like the matching funds – although you won’t be able to add the amount of the credit to your IRA. You can, however, save the amount of the credit in one of the other options listed further below. Within the income limits, the Saver’s Credit can be applied to your 401k contributions if you have a 401k.
2. For 2018 you can contribute up to the lesser of your earned income for the year or $5,500, plus another $1,000 if you’re over age 50. For 2019 this figure is increased to $6,000 plus the $1,000 catch-up for over age 50. This is only about a third to a quarter of the amount you could set aside in a 401k. The excess money can be put to work in one of the other options below.
3. Traditional (non-Roth) IRA contributions are generally tax-deductible. This means that when you file your tax return and you’ve made contributions to your IRA (or will make them before April 15) you can reduce your gross income by the amount of the IRA contributions. This will have the effect of lowering your income, and lowering your tax bill. Roth IRA contributions are not deductible from your income. See below for more information about deduction limitations.
4. Although your IRA contributions are not typically deducted directly from your paycheck, you can set up an automatic payment from your checking account to effectively do the same thing. Just go to your online banking application and set up a recurring payment to your IRA account, occurring on or about the same day as your paycheck each time. This way you can benefit from the forced discipline of automatic savings very similar to a 401k.
5. The IRA contributions can be invested for growth and will avoid taxation just the same as a 401k.

Now, if your spouse is participating in a 401k or other retirement plan from his or her work, there can be limits on the deductibility of your IRA contributions. If your spouse participates in a 401k plan, you can fully deduct IRA contributions if your household income is below $189,000, and limited deduction is available up to $199,000 (2018 figures). These figures have increased to $193,000 and $203,000 respectively in 2019. Above those limits, the tax-deductibility benefit (#3) of contributions is lost. At this stage you would make the decision of whether it makes sense to still make non-deductible contributions to your IRA, or choose another option from the choices below for your saving activities.

A point in favor of an IRA (versus a 401k) is that you are not limited to an arbitrary list of possible investments like most 401k plans are. So you are free to make wise decisions about your investments in the IRA account, keeping the internal costs low in order to keep more of your money working for you.

Another item that makes the IRA a bit more favorable is that you can access the money much more easily than when it’s in a 401k (especially if you’re still employed by that employer). The downside is that with this flexibility comes the responsibility to maintain discipline and not raid your long-term retirement savings until you’re actually in retirement. There are penalties for early distribution from an IRA to help with maintaining this discipline, but you’re still in charge. Don’t blow it!

So the IRA, although limited in the amounts that can be deferred, and with the income limitations in some cases, matches up pretty well with the 401k for benefits, with the virtually unlimited investment flexibility as a positive point for the IRA. As mentioned, a Roth IRA could be another alternative if the tax-deduction feature is not as important to you.

This is a good place to start. Let’s see what other options are available to save.

Health Savings Account

If you have this option available to you, a Health Savings Account (HSA) can be another avenue for longer-term savings. If you have a High Deductible Health Plan available via your employer or you have set one up as a self-employed person, the Health Savings Account can provide a good place for savings.

Looking at the list of 401k benefits versus an HSA:

1. In general, HSA contributions are not matched by an employer. However, many employers do make contributions to an HSA plan on behalf of the employee – it’s just not as common.
2. HSA contributions are limited to $3,450 for single individuals, or $6,850 for a family policy (2018 figures). There is an additional “catch-up” amount of $1,000 allowed if you’re over age 55. These limits are increased to $3,500 and $7,000 for 2019, with the catch-up amount for over age 55 at $1,000.
3. HSA contributions are deductible from your income, in a manner similar to deductible IRA contributions.
4. It is common to have HSA contributions deducted directly from your paycheck, much the same as your 401k contributions. If this isn’t an option for you, use the automatic investment strategy outlined for IRA contributions to make the savings automatic.
5. Your contributions to the HSA account can be invested to grow tax free and your future withdrawals from the account, if used for medical purposes, will be tax free. This is another positive point for the HSA over the 401k.

If you don’t need to raid the HSA during your pre-retirement years to pay for medical expenses, a HSA can provide a significant resource for paying medical expenses later in life.

As you can see, the HSA is yet another alternative that can work in a positive way toward your savings goals when you have no 401k. They’re much more limited in the amounts you can contribute, but otherwise have most of the same features available as a 401k.

Taxable investment account

Don’t let the inclusion of “taxable” in the name of this savings vehicle put you off. It’s really not as bad as all that – this name is used to make it clear that this account is not allowed to defer income tax in the manner that a 401k or IRA can. With a taxable investment account, any time there is an income event, you will be responsible for including that income on your tax return and paying tax as applicable. This type of account can be easily set up at a multitude of brokerages, mutual fund companies, and the like.

Let’s do the comparison to a 401k:

1. As with the IRA, there is no matching of your contributions to a taxable investment account. Doubly against this savings vehicle, contributions to a taxable investment account are not eligible for the Saver’s Credit either.
2. There is no limit to the amount you can save annually in a taxable investment account. Point in favor of the taxable investment account!
3. There is, sadly, no tax deductibility for your contributions to a taxable investment account.
4. Similar to the IRA, although typically not deducted from your paycheck, you can set up an automatic payment to your taxable investment account in order to instill the “pay yourself first” discipline.
5. Taxable investment accounts do not have the tax deferral feature that 401k and IRA account have. However, certain growth-focused investments may mimic tax deferral for you. For example, if you invest in high-growth stocks or stock funds, you will not be taxed on the growth of the investment until you sell the investment. If dividends are paid you’ll have taxes to pay on that income, but growth isn’t taxed until the income is realized (the investment is sold). And then the tax rate on long-term capital gains is much lower than ordinary income tax (and can be zero!).

We give up points #1 and #3 to the 401k in this comparison, but you have no limits (#2), you can set up the automatic contributions (#4), and depending on your investment choices, the taxation or tax deferral may be even more favorable in a taxable investment account.

Even more than with the IRA, you have pretty much unfettered access to your taxable investment account for withdrawal at any time, regardless of your age. This can be a positive or a negative, depending on the circumstances. If you have a short-term need for some money that can’t be found elsewhere, this account can be just the ticket to allow you to not go into debt. But you need to be cautious, especially if your taxable investment account represents a significant portion of your retirement savings. You don’t want to derail the hard work you put into saving that money by withdrawing before its intended use in retirement.

Self-employed options

If you happen to be self-employed (even with a small side hustle), you have several alternatives available to you. One of the obvious options is a one-person 401k plan, or solo-401k. Although there can be some paperwork headaches involved, this option gives you the same flexibility as an employer-sponsored 401k, except that you’re in charge. Your contributions are limited to the same limits as a 401k from your earnings, but you can also make contributions as the employER in the arrangement as well. You can contribute up to 25% of compensation as the employer, up to a total of $55,000 in 2018, or $56,000 in 2019. This amount is reduced by the compensation deferral amount, not including your catch-up contributions.

Another alternative for a self-employed individual or small business is the SIMPLE IRA. This option is a bit less onerous than the solo 401k, with lower contribution limits. As the employee, you can defer up to $12,500 of your compensation with a $3,000 catch-up contribution if over age 50 (2018 figures – for 2019 the contribution limit is increased to $13,000, with the catch-up still at $3,000). As the employer you are required to make either a matching 3% contribution or a non-elective 2% contribution to all plan participants. If you’re a one-person shop, this can be a good alternative, offering matching benefits to a 401k plan, except for the contribution limits.

Still another option for the self-employed is the SEP-IRA. Again, with limited paperwork versus the 401k plan, the SEP-IRA gives a self-employed individual the ability to defer up to 25% of your compensation, with the limits of $55,000 for 2018 or $56,000 in 2019, plus the over-50 catch up amount of $6,000.

Other alternatives

In several states, there may be an option available soon: Oregon is the first, and California is starting in 2019, to offer state-based retirement plans for small employers. If you’re in one of the states that are planning these accounts (Oregon, California, Illinois, Maryland, Connecticut, New Jersey, New York, Washington state, Vermont and Massachusetts), keep your eye out for more information. This can be a good option if you have no other means to start saving.

Some folks would also recommend looking at an annuity as an alternative when you have no 401k available. Annuities can have many of the features of a 401k plan except for tax-deductibility, with the additional benefit of flexible contributions with no annual limits. A downside to annuities can be the internal costs – because you are paying for insurance against your longevity, these internal costs can be a significant drag on your returns in an annuity. A plus for annuities is that they can provide guaranteed lifetime income to you upon retirement, where most other plans have no such capacity for guarantee.

As a last point, keep in mind that you can use many types of investment for your retirement savings – including all of the above in varying amounts, plus other types of investments like real estate. The best sort of retirement savings plan includes portions of many types of investing and saving activities, providing a varied type of income from many sources through your future retirement. Use as many of the above types of investment as you can!

Do you have other alternatives to offer that I’ve overlooked?