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.
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?
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.
External Websites: The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
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.
SoFi Invest®
The information provided is not meant to provide investment or financial advice. Investment decisions should be based on an individual’s specific financial needs, goals and risk profile. SoFi can’t guarantee future financial performance. Advisory services offered through SoFi Wealth, LLC. SoFi Securities, LLC, member FINRA / SIPC . The umbrella term “SoFi Invest” refers to the three investment and trading platforms operated by Social Finance, Inc. and its affiliates (described below). Individual customer accounts may be subject to the terms applicable to one or more of the platforms below.
WM17130
Source: sofi.com