It is well known that Americans are not saving enough money for retirement in their employer-sponsored plans. But what if you don't have access to a 401(k) or other work-based option? In this case the task is even more daunting, and demands familiarity with alternatives to help save for a more secure retirement.
Probably the most recognized option is the traditional Individual Retirement Arrangement or IRA. In its purest form, the IRA allows savers to make tax-deductible contributions each year into an account that grows tax-deferred until retirement distributions begin after attaining age 59 1/2. Account holders then decide when and in what amounts to withdraw funds which are then taxable as ordinary income. Beginning at age 70 1/2, the IRS requires that at least a Required Minimum Distribution (RMD) be withdrawn each year aimed at fully depleting the account over your statistical lifetime. Any residual value in the account may be left to designated beneficiaries.
You may contribute up to $5,500 per year ($6,500 if you are at least 50 years old), fully tax-deductible if you do not have access to a plan at work. If you do have a work plan, your tax deduction phases out above certain income levels.
What about spouses who do not work outside the home? They also may make deductible contributions (up to the same limits) into their own IRA account, even if they have no taxable income. If the working spouse has an employer plan, the spousal deduction phases out above certain income thresholds ($186,000 for married filing jointly).
IRA accounts are essentially regular brokerage or bank accounts but carry a tax shield that allows deferral of income taxes until withdrawal. Savings may be invested in virtually any publicly traded security like stocks, bonds, mutual funds and ETFs at the discretion of the account owner. Alternative assets like real estate and gold may be held as well but require a specialized custodian and must follow strict rules. Still, the possibilities are nearly endless.
Another option worth considering, especially for younger taxpayers just getting started, is the Roth IRA. Created in 1997, this variant only accepts after-tax contributions (no tax deduction), but allows the earnings to grow tax-free, subject to a few simple restrictions. That means you may withdraw investment gains after age 59 1/2 with no tax liability whatever if the account has been funded for at least five years. This could be substantial over a 30- to 40-year investment horizon. And the Roth IRA does not dictate mandatory withdrawals, so that the assets may be passed tax-free to the next generation if not required during retirement.
The same contribution limits apply ($5,500 plus the $1,000 catch-up beyond age 50), but income thresholds constrain contributions ($186,000 for married taxpayers filing jointly). One additional benefit is the ability to remove any of the after-tax contributions regardless of age without penalty, increasing the flexibility of the account and encouraging larger contributions in the earlier years.
The best way to save for retirement is through regular automatic deductions. Employer-sponsored defined contribution plans utilize payroll deduction, but savers with no work option should replicate the idea. Consider a payroll deduction directed toward your IRA account each pay period to automate the process. If that is not feasible, you can establish a regular automated transfer from your bank account into your traditional or Roth IRA account. Just be sure to limit your annual contribution to the legal maximum to avoid penalties.
Starting early and saving systematically is the key to a successful retirement. Without an employer plan, IRAs are essential tools to help get the job done.
Christopher A. Hopkins, CFA, is a vice president and portfolio manager for Barnett & Co. in Chattanooga.