For people with access to one, a workplace 401(k) is a convenient retirement savings account that has some important advantages, including the potential to earn employer matching contributions.
But if your company doesn’t provide a 401(k), that doesn’t mean you should give up on getting tax breaks for investing for retirement. There are three other great accounts to contribute to in order to get the government’s help in preparing for your later years.
1. A traditional IRA
A traditional IRA has similar tax benefits to a 401(k). You can contribute to it, and your taxable income for the year will be reduced by the amount you invested. Almost all major brokerage firms and many other financial institutions offer traditional IRAs. And you’ll actually end up with a much broader choice of investment options than you would with a 401(k).
There are income limits for making deductible contributions to a traditional IRA if either you or your spouse has access to a workplace retirement account. These types of limits don’t apply to a 401(k), so check your eligibility before deciding if a traditional IRA is a good account for you.
And the limit for deductible contributions in 2021 is just $6,000 for an IRA or $7,000 if you’re 50 or over. By comparison, a 401(k) allows you to invest up to $19,500 in 2021 or $26,000 if you’re 50 or over.
Still, if you think you’re currently in a higher tax bracket than you will be in retirement and you want an account that comes as close as possible to replicating the tax benefits of a traditional workplace 401(k), a traditional IRA is the right choice.
2. A Roth IRA
A Roth IRA offers different tax breaks than a traditional 401(k), and those tax advantages might be better for some investors.
Roth IRAs accept only after-tax contributions, so you aren’t going to be able to deduct contributions in the year you’re investing in the account. You can, however, take tax-free withdrawals in retirement, unlike traditional IRA and 401(k) accounts. And no matter how much you withdraw from a Roth account, the distributions won’t affect the taxability of Social Security benefits.
Roth IRAs have the same contribution limits as traditional IRAs, and there are income limits for who is eligible to contribute to one. But this account can be a great alternative to a 401(k) if you think you will end up in a higher tax bracket when you’re withdrawing from your retirement savings account than you’re in when you’re contributing to it.
3. A health savings account
Health savings accounts (HSAs) have stricter eligibility rules than 401(k)s, and the rules for withdrawals are different. In order to be eligible to contribute to an HSA, you must have a qualifying high-deductible health plan. You’re also capped at making a contribution of $3,600 in 2021 if you have a single health insurance plan or $7,200 if you have a family health insurance plan, so the contribution limits are a lot lower than with a 401(k).
However, if you are eligible for an HSA, this account can be an especially great alternative to a 401(k) for a simple reason. Not only do you get to make tax-deductible contributions, but you also get to take tax-free withdrawals for qualifying healthcare expenses. So you end up getting a double tax benefit with an HSA, while a 401(k) or a Roth or traditional IRA only provides tax breaks when contributing or making withdrawals, but not both.
If you don’t end up needing the money from your HSA for health expenses, you can withdraw it for any reason after age 65 without penalty, but you’ll be taxed on the withdrawals just as though you were taking money out of a traditional 401(k) in this situation. Since many seniors do incur high healthcare expenses, though, many of them can take advantage of the added tax benefits this account offers. That makes it an ideal 401(k) alternative.
Whichever option you choose, it’s important to take advantage of some of the tax benefits out there for retirement savings — even if a 401(k) isn’t available to you.
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