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If you have no 401(k) at work, or if you're not eligible to contribute to one, you may want to consider alternative options. Traditional individual retirement accounts (IRAs) offer tax-deferred savings, which makes them similar to 401(k)s. Since IRAs have certain income limitations, other options, such as variable annuities and taxable brokerage accounts, may also be worth considering.
Traditional IRA
Like a traditional 401(k), contributions are made to a traditional IRA on a pretax basis. Growth is tax-deferred and distributions are taxed as ordinary income. The maximum annual contribution to a traditional IRA is $6,000 for people under 50, according to the IRS. An additional $1,000 annual catch-up contribution may be made by those age 50 and over.
Roth IRA
Like a Roth 401(k), contributions are made to a Roth IRA on an after-tax basis. Qualified distributions in retirement are therefore tax-free provided that certain criteria are met. You must be at least age 59 1/2 and have had the account for at least five years to take qualified distributions. The maximum annual contribution to a Roth IRA is the same as a traditional IRA: $6,000 for people under 50 and $7,000 for people age 50 and over for 2022.
SEP IRA
A Simplified Employee Pension (SEP) IRA is available for self-employed individuals with zero to five employees. Contributions are made on a pretax basis and may not exceed the lesser of $61,000 per year for 2022 or 25% of annual income, according to the IRS.
Nonqualified Variable Annuity
Contributions to a nonqualified variable annuity are made on an after-tax basis and growth is tax-deferred. The earnings are taxed as ordinary income. There is no annual maximum contribution amount and there are no income limitations to make contributions. Although nonqualified annuities are not designed to be retirement savings vehicles, they might help increase your tax-deferred growth.
Taxable Brokerage Account
Contributions are made on an after-tax basis. Account holders pay taxes annually on dividends, interest and capital gains.
The maximum annual contribution to a 401(k) plan is $20,500, with catch up contributions of $6,500 per year for those over 50 allowed by the IRS for 2022. Employers may make matching contributions to a 401(k) plan on a pretax basis.
Distributions from a traditional 401(k) are taxed as ordinary income for the calendar year in which they are withdrawn. Qualified Roth 401(k) distributions are tax-free, as long as you are at least age 59 1/2 and have had the account for at least five years, because the account holder pays taxes on contributions. The IRS imposes a 10% early withdrawal penalty on both traditional and Roth distributions made prior to age 59 1/2. We recommend you speak to a tax advisor about your situation.
Bottom Line
If you don't have a 401(k) at work, you might want to contribute regularly to a retirement plan or to a long-term investment account that will suit your personal financial situation. Whether you do it yourself, or if you work with a financial representative, consider alternatives to a 401(k) that will work for you.
