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Dollars and Retirement

Retirement Without a 401(k)

by Phil Tull | September 9, 2021 | Retirement Planning

When we hear the word “retirement” we almost synonymously think 401(k). But what if you don’t have a 401(k)? Can you still invest and plan for retirement??

While a 401(k) is largely the most popular and most well known of retirement plans, it is not by any means the “end all be all” of retirement savings. There are a multitude of other retirement vehicles available and alternative ways to save/invest toward your retirement.

The ultimate question is if I do not have a 401(k) or other retirement plan, what do I do?

If you do not have a 401(k) but have earned income, whether W-2 or 1099 income, there are still options for you to save and invest. You can invest up to $6,000 (+$1,000 if age 50 or older in 2021) into a traditional pre-tax IRA or Roth IRA each year.

“That’s all?!” you may ask.

Yes, that is all for an IRA (see more info on spousal IRAs here) but there is another investment account with no contribution restrictions. Brokerage investment accounts have no contributions restrictions, no earned income restrictions, and even further have no required distributions upon age 72 or other retirement dates. Often the brokerage investment account is pushed aside in favor of the tax benefits that retirement accounts can provide. However, we just have to dig a little deeper to uncover the benefits that a brokerage account can provide to enhance our retirement planning.

One of those benefits is the taxability of appreciating assets. When you sell a security within your taxable brokerage account the capital gain (the difference between what you bought it for and what you sell it for) is taxed. If you hold the security for longer than one year, it is taxed at the long-term capital gains rate. Which are more favorable than ordinary income rates. Additionally, long-term losses can be used to deduct both investment gains or even ordinary income (see IRS limits).

Another attractive benefit is accessibility prior to retirement age 59 ½ with no penalty. Where pre-tax retirement plans require distributions based on the IRS directed age, brokerage accounts have no required distributions. This allows your investments to continue to grow untouched with limited to no taxes, depending on your situation.

Generational planning and estate planning is likely the most valued benefit of brokerage accounts to individuals and their beneficiaries. Upon death, pre-tax retirement accounts have required distributions for beneficiaries. Though those distributions may be able to be spread out over a number of years, they are taxed at the beneficiary’s personal income tax rate. In contrast, brokerage accounts receive a step up in basis upon death. Beneficiaries will then receive the assets at their current value, with often little to no tax implications to them.

Example: Jane invests $500,000 into various stocks and index funds over her lifetime. Her account grows to $1,000,000. Upon Jane’s death her son Tom receives the positions at the stepped-up value on her date of death valued at $1,000,000. The $500,000 of growth is then not subject to tax.

With the consideration of the step up in basis, the door is opened to various generational and estate planning scenarios surrounding the taxability of the assets. Tactics such as “sleeve investing” allow for you to allocate investments based on their market sector to an account in your portfolio that will complement the way those investments historically act/perform. What this means is that you may be able to optimize your portfolio’s after-tax value by holding equity or growth investments in a Roth or Brokerage account and fixed income in an IRA or other pre-tax account.

These tactics are complex and there are many considerations to be made, it is recommended that you consider your options thoroughly and work with a professional. Your financial goals, needs, and values are unique. Do not rule out an option based on someone else’s word or experience. Do your due diligence and work with a knowledgeable financial advisor that can provide all the options objectively without conflict of interest.

What retirement vehicles are out there for employed and self-employed workers?

In an attempt to save and invest in a tax beneficial way toward retirement, most employers and self-employed individuals look to provide a retirement plan, or in some cases multiple vehicles, for themselves and their employees. The retirement plan chosen by your employer is dependent on corporate structure, size, and the overall desires of the control persons for retirement contributions.

Each retirement vehicle has its own requirements, limits, and specifics. It is extremely important to understand your plan in its entirety. Read your plan document and connect with your plan representative to ensure you fully understand the details before making decisions.

401(k) – A 401(k) is a feature of a qualified profit-sharing plan that allows employees to contribute a portion of their wages to individual accounts.

403(b) – A 403(b) plan (also called a tax-sheltered annuity or TSA plan) is a retirement plan offered by public schools and certain 501(c)(3) tax-exempt organizations. Employees save for retirement by contributing to individual accounts. Employers can also contribute to employees’ accounts.

457 Plan – Plans of deferred compensation described in IRC section 457 are available for certain state and local governments and non-governmental entities tax exempt under IRC Section 501. They can be either eligible plans under IRC 457(b) or ineligible plans under IRC 457(f). Plans eligible under 457(b) allow employees of sponsoring organizations to defer income taxation on retirement savings into future years. Ineligible plans may trigger different tax treatment under IRC 457(f).

SIMPLE IRA – A SIMPLE IRA plan (Savings Incentive Match Plan for Employees) allows employees and employers to contribute to traditional IRAs set up for employees. It is ideally suited as a start-up retirement savings plan for small employers not currently sponsoring a retirement plan.

SEP IRA – An SEP plan allows employers to contribute to traditional IRAs (SEP-IRAs) set up for employees. A business of any size, even self-employed, can establish a SEP.

Solo 401(k) – The one-participant 401(k) plan isn’t a new type of 401(k) plan. It’s a traditional 401(k) plan covering a business owner with no employees, or that person and his or her spouse. These plans have the same rules and requirements as any other 401(k) plan.

ESOP – An employee stock ownership plan (ESOP) is an IRC section 401(a) qualified defined contribution plan that is a stock bonus plan or a stock bonus/money purchase plan. An ESOP must be designed to invest primarily in qualifying employer securities as defined by IRC section 4975(e)(8) and meet certain requirements of the Code and regulations. The IRS and Department of Labor share jurisdiction over some ESOP features.

For a full list of retirement plans available visit the IRS website.

As you can see, there are a wide variety of options for retirement savings beyond the 401(k), but choosing the right one for you can be complicated. Talk to a Certified Financial Planner™ professional about the most effective way for you to save for your retirement. At Tull Financial Group, we frequently work with small business owners and self-employed individuals in the Hampton Roads region and beyond who are looking to invest in their future in a variety of ways. To set up an appointment, contact us today at 757.436.1122.