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Comparing Retirement Income Strategies

Comparing Retirement Income Strategies

A 401(k) plan can be an attractive way to invest because it gives employees the ability to increase their contributions before tax and tax-deferred income until retirement. According to the Bureau of Labor Statistics, about 50% of employers offer cash compensation for contributions, which is an added incentive to save.

Unfortunately, according to American Retirement Association estimates in 2019, more than 5 million employers in the United States did not offer retirement savings at work (401(k), 403(b), 457), leaving 28 million full-time workers and over 23 million part-time workers without this savings capacity. To improve access, Congress passed the SECURE Act in 2019 to make it easier for businesses to offer 401(k) plans. As a result, many companies are expected to implement retirement savings plans for their employees in 2021.

Suppose your employer's current plan is not right for you, offers only limited investment options, or the options offered are above average. It may be wiser to accept and save for retirement by yourself.


Alternatives to your company's 401(k) 

If your employer's retirement plan isn't perfect, here are some investment options to consider.


Traditional IRA

This type of IRA is one of the most popular ways for a person to save for retirement, regardless of other retirement plans. The traditional IRA allows the employee to keep the money in an account that allows them to grow tax-free. You only pay taxes when you withdraw your retirement money. Contributions to the account can also be deducted from your taxable income, so you avoid taxes on that income today.

Main advantages:

  • Increased deferred tax

  • Exemption from tax on today's contributions

  • Full flexibility of investment options


Disadvantages: 

Contributions have a yearly maximum: $6,000 for children under 50 in 2021 ($7,000 for people over 50). Minimum age-related distributions (RMD) should be taken. The entire contribution may not be deductible depending on your income.


Roth IRA

A Roth IRA is another way for workers to save money for retirement and has two main differences from a traditional IRA:

The Roth IRA allows you to increase your money tax-free, and you can withdraw some of the money when you withdraw completely tax-free. In return for this benefit, your contributions are paid after tax. This means that you don't get any tax savings from the Roth IRA today.

A Roth IRA may be better for you than a traditional IRA, but it depends on how your current income and tax rate compare to what you plan to have in retirement, so consult a financial advisor.


Main benefits: tax-free growth and social security, flexibility in the use of contributions for certain eligible expenses (like university expenses and buying a home for the first time) without fines, full flexibility in investment options, no capital gain on the sale of the asset and the account balance can be transferred to the heirs.


Cons: Forgo a tax advantage today for the promise of tax-free withdrawals after retirement. Contributions have an annual maximum of $6,000 in 2021 ($7,000 for those over 50). RMDs also apply here. 


SEP IRA

The IRA or SEP Simplified Employee Pension is an IRA for self-employed who have a business or have income from self-employed or parallel jobs. The SEP-IRA has the same distribution, investment, and reinvestment rules as a traditional IRA. One notable difference is that instead of the traditional IRA limit of $6,000 (for those under 50) in contributions, participants can contribute up to $58,000 in 2021 or 25% of eligible salary, depending on the lowest amount.




Main advantages: higher contribution limit compared to traditional IRAs, full flexibility of investment options, the amount paid each year may vary, increase in deferred tax contributions, and higher maximum contributions.


Disadvantages: contributions are limited to 25% of the company's profits. All employees working for the company must receive the same contribution (although prohibited from making optional salary deferrals or replacement contributions), and RMDs apply.


Solo 401(k)

You'll need your business to take advantage of the 401(k) plan on your own and only have your spouse as an employee, but it's a powerful savings vehicle if you have extra work to do. You can contribute up to $58,000 for 2021, although this amount is divided into components for you as an employee ($19,500 for 2021) and for you as an employer ($38,500). If you are over 50, your employee limit is $26,000 for 2021, bringing the total potential contribution to $64,500.

One of the best benefits of this type of plan, especially if you earn enough money in your main job, is saving 100% of business income up to an annual contribution limit of $64500. This could be a significant advantage over a SEP-IRA, where your contribution is limited to 25% of your business's profits. Your contributions can be before or after taxes.


Main benefits: you can contribute substantial amounts to the plan as stated above, full flexibility in investment options (including the capacity to invest in real estate and/or cryptocurrencies), contributions can be before or after tax.

Cons: This program has additional IRS rules and reporting requirements. You must have a business to participate in. Optional carryover limits are person-based, not plan-based; this is an important distinction for entrepreneurs who are also employees of a second company and participate in 401(k). It can get complicated if you are hiring employees.


Health savings accounts

HSAs (Health Savings Accounts) aren't just for health care, although they were formed to help Americans with high-deductible health plans pay for their care.

The HSA offers a big benefit to those who can accumulate savings in their account until retirement and/or are covered by Medicare. You are eligible for an employer-provided health care plan that is considered a high deductible health care plan and has a minimum deductible of $ 1,400 (individual coverage, $ 2,800 family coverage) and costs a direct maximum of $7,000 per person; $14,000 per family. In 2021, the plan allows people to contribute up to $3,600 to an HSA and families up to $7,200. Employees 55 years of age or older (at the end of the fiscal year) may contribute an additional $1,000 as an upgrade allowance.

In return for your contribution to the HSA, you will receive a tax deduction today, and all interest or other income in your account is tax-free. Account distribution is free if you use your account to pay qualifying medical bills. But the real benefit comes at the age of 65. Then you can avoid the 20% fine for non-medical uses of the plan, although these withdrawals/fees are considered taxable income. Even if your employer doesn't offer an HSA plan, you can create one yourself.


Key Benefits:

  • All contributions to the HSA are deferred or may be deducted from your gross income on your tax return.

  • Employers can contribute to the plan.

  • Funds can be used to pay eligible medical bills for spouses and dependents, even if your health plan does not cover them.

  • HSAs allow flexible use of contributions.

  • IRAs can be transferred to an HSA if there is a significant medical need.

HSA does not have a minimum distribution required. In most plans, investment opportunities are available for HSA contributions after reaching a certain account balance. If you are still working after 65, the funds can be used to pay for employer-sponsored health insurance. After retirement, the funds can be used to pay Medicare or Medicare Advantage plan premiums.

Cons: Investment options may be limited as you will likely want to keep an adequate amount of your vital health funds in liquid and safe assets. You can also use up all funds if you have significant medical needs while you are still working. Once you enroll in Medicare, you will no longer contribute to an HSA, although you can continue to use the funds you have raised.


Taxable brokerage account

If you've exhausted other retirement savings options or aren't applying, you can still save money in a taxable brokerage account. Here you will not receive any help from your employer, for example, without money, but you can invest in whatever you want, and you can choose the broker that best suits your needs. So if you are looking for low-cost brokers or need to trade specific funds for free, you can do that.


Main advantages: no contribution limit, full flexibility of investment options, possibility to access cheaper options compared to a 401(k), easy to configure, no limit to the number of accounts, you can withdraw funds anytime, mercilessly.


Disadvantages: Realized capital gains are taxable, lack of diversification or a declining market can limit gains, contributions are after-tax.


Bottom Line

The above plans are designed to encourage workers to take an active role in retirement planning.

While it's great to have a company-sponsored 401(k) plan, workers have other options if their employer doesn't offer this type of pension plan if they have the money. 


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