Last week I talked about my first investment experience. When I asked folks to share their first investment story, there was a recurring theme:
I got started simply through my 401k– Latoya @ Femme Frugality (& Life and a Budget)
Like Latoya, I got started with my company retirement plan–Gary @ Super Saving Tips
My first investing was at 24 in a 401K.–Brian @ Debt Discipline
Employer-sponsored retirement plans are probably the most common way most people begin investing and building retirement savings. Work plans make it easy to set money aside for retirement on a regular basis. Employers often give the initial enrollment paperwork at the same time that employees are already filling out other benefit enrollment forms, so joining them is convenient. Once you join the plan, deductions are automatic and tax deductible. The spectrum of investments is usually limited. While that means plan options don’t always provide the best investments, it does make it easier for beginning investors to make their choices.
But what if you don’t have an employer-sponsored retirement plan? Half of Americans aren’t covered by a 401(k), 403(b) or other employer plan. Maybe they work temporary jobs or part time, or for a small employer who doesn’t offer a plan. Maybe they work as independent contractors or for their own business. Maybe they are stay-at-home caretakers.
These Americans still have to find a way to build enough retirement savings without an employer-sponsored plan.
I worked for a used book company for 17 years. For the first 10 years I worked for them, they did not offer employees any retirement plan.
I found ways to save for retirement, and so can you.
Starting Your Retirement Savings
The biggest roadblock that you have to building retirement savings when your employer doesn’t offer a retirement plan is that you have to set up a plan yourself. Beginning investing is daunting. You have a lot of options to explore: type of plan (which I’ll go over in more detail), where to save, and what investments to pick.
All of those options can overwhelm you. Don’t let it.
Pick a type of plan. Pick a place to save. If you can’t pick an investment right away, at least start accumulating money with regular contributions. You can always make your investment choice later (and having more money will give you more options.)
Restarting Your Retirement Savings
If you had a retirement plan at a previous employer, you still need to take some steps to keep moving toward a comfortable retirement. Because you already have some experience with investing and saving, you may find retirement savings a little easier to restart than someone starting from scratch.
It’s usually a good idea to roll your old retirement plan into an IRA. You’ll save the tax status, have a wider variety of investments to choose from, and probably pay lower fees. Your biggest change will be that you’ll need to set up the transfers into the retirement account yourself instead of relying on an employer transferring the money for you.
Either way, make saving easier with automatic transfers. If you make saving automatic, you’re much more likely to save successfully. If your income fluctuates, you may want to set up a low monthly transfer and then periodically move larger surpluses. But save, and save regularly.
Open an IRA
The most common way to build retirement savings if you don’t have an employee-sponsored retirement account is to open an Individual Retirement Account.
You can open a traditional IRA and reduce your taxes now, or open a Roth IRA and reduce your taxes later. Either way, you’ll have a broad range of investments that you can choose from to earn money between now and the time you reach retirement age.
As long as you (or your spouse) have earned income that doesn’t exceed the income threshold, you can put up to $5500 per year aside in an IRA. That limit increases to $6500 if you are over 50. You can’t contribute more than your earned income unless you are married to someone who is earning sufficient income to let you contribute.
The nice thing about retirement accounts is that you really don’t need a lot money in order to open an account. Where a lot of companies might require you to have hundreds or thousands of dollars to set up brokerage accounts, the minimums for IRAs are lower. Some companies don’t even require opening balances if you set up a monthly transfer into your account.
If you don’t have access to an employer-sponsored retirement plan, an IRA should be your first option for building retirement savings. If you do have an employer-sponsored plan, you may still want an IRA to increase your retirement investment options, shelter money from current or future taxes, and increase the amount of money you save.
You can set one up with any brokerage or at most banks with a minimum of fuss and paperwork.
The problem? $5500 a year is a lot lower than the limit for 401(k)s ($18,000). If you want to save more for retirement, you may need to look at other options.
Plans for Self-Employed People
Self-Employed workers have a couple of attractive options not available to those working for others.
The Simplified Employee Pension (SEP) IRA and the Solo 401(k) both have higher contributions limits than traditional and Roth IRAs. If you have enough income, you can contribute as much as $53,000. The rules are a little convoluted. You can’t save more than 20% your self employment income (income minus expenses and 1/2 of the self employment tax) in a SEP IRA. You can save 100% of your self employment income in a Solo 401(k), but only up to $18,000. Then it’s back to 20%.
(For more on the rules and breakdown of self-employed plans, you can see what Hannah’s done in her excellent overview over at Unplanned Finance.)
These are even nice options if you have an employer plan and some self-employment income as well. You can have both your employer plan and your self-employed plan, which gives you the ability to save a lot more in dedicated retirement accounts than most people.
Buy an Annuity
If you are older and looking to put a lot of money aside for retirement, you might want to consider buying an annuity. An annuity is an insurance policy that works like a pension. You put in money now, then the insurance company pays you an income stream over time. You can invest as much as you want in an annuity, and it will guaranty an income stream in retirement.
The guaranty is the attractive part. The insurance company is contractually obligated to pay you out. The pay out varies according to the options you pick,which can be shorter, longer, go to your heirs, or end when you die.
Annuities aren’t the best choice for every investor, but can be a nice option for adding to other retirement income as long as you are careful in your choices. You won’t get a lot of asset growth in an annuity. Lots of annuities have high expenses.You’ll pay taxes on any annuity payments, and while the growth may be tax-free the contributions won’t be tax-deferred.
Invest in a Taxable Investments
Anyone can invest in taxable investment accounts and use them to build retirement savings. If you don’t have earned income, you can still put income in taxable investments. If you want to save more than the IRS limits on IRAs or other retirement accounts, you can save in taxable investments.
You only need to do one thing to convert a taxable investment account into a retirement account:
Don’t Use the Money Until You Retire.
As long as you’re saving the money and not using it, you are saving for retirement.
The disadvantage of the taxable account is that you have to pay taxes on any income or realized gains. You can mitigate this by investing in tax-efficient investments like index funds, growth stocks, and tax-free bonds. You can also use tax-harvesting strategies to offset gains and investment income by selling some investments at a loss.
The best advantage of taxable investments? Your range of investments is almost limitless. You can invest in real estate, annuities, individual stocks, or even alternative investments. You can also use them to fund anything anytime, including early retirement, travel, sending your kid to college, or that dream sports car. But if you don’t have sufficient retirement savings, you’ll probably need to save the assets in your taxable account to fund retirement.
Taxable investment accounts usually take more money to open than IRAs. I love having one, but I’d recommend building up an emergency fund and paying down non-mortgage debt before bulking up a brokerage account.
If you lack an employer-sponsored retirement plan, building retirement savings falls to you. You have to take action if you want a comfortable retirement. You’ll need to save a little bit more because you don’t have that employer plan and match working for you.
And you’ll need to keep up your savings if you move from a situation with an employer sponsored plan to one without.
The first way I built retirement savings was to set up an IRA. For most people, that should be step one in building retirement savings. (If you are self employed, consider a SEP or Solo 401(k).)
If you can’t decide between a Roth or a traditional IRA, look at your last tax return. You owed little or no income tax? Open the Roth. Had a big tax bill? Use the traditional IRA to reduce your taxable income next year.
Because IRA rules discourage you from taking the money out early with tax penalties, they encourage long-term thinking and savings habits. That’s what you’ll need to build your retirement savings.
If you have a small amount of money to invest, consider one of the robo advisors like Betterment or Wealthfront. Robo advisors do most of the decision making for you, have low fees, and small thresholds for beginning investors. They are a great way for beginning investors to start accumulating retirement savings.
Investors who have more money and want to make the decisions themselves have more options. It’s hard to beat Vanguard index funds for cost and performance, but there are a lot of solid investment choices.
If you can max out your dedicated retirement account and still have a surplus, a healthy emergency fund and little debt, start building up a taxable brokerage account.
Make it automatic, live below your means, and put your windfalls to work to build a comfortable retirement.
You can do it.
What’s your best advice to building retirement savings without an employer-sponsored plan?