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What Is the Best Alternative to a 401k?

Is a 401k the only retirement vehicle available? Absolutely not! There are plenty of 401k alternatives that can provide an investor with strong returns.

The various alternatives to a 401k can also set one up for a comfortable retirement. If for whatever reason a 401k is not an option for you, consider the following 401k alternatives. 

Table of Contents:

What Is a 401k?

Before diving into the 401k alternatives, let’s take a step back and review what a 401k is.

A 401k is a retirement plan that is sponsored by one’s employer. The employee is able to contribute up to 10% of their income to the 401k, and many employers will match a percentage of the employee’s contribution. 

Pensions were much more popular years ago, but many municipalities, governments, and private employers realized that the cost to sustain a pension is massive. Now, the 401k has replaced countless pension programs.

A 401k is less of a financial burden on the employer, and it also provides the employee with tremendous upside – contingent on the returns of the overall market and underlying investments. 

How Does a 401k Work?

The mechanics behind a 401k is rather simple. If one continuously invests a portion of their income into a 401k, those dollars can grow significantly over the years by the time that individual reaches retirement.

Additionally, if the employer matches a percentage of one’s income, this is essentially free money for the employee and the power of compounding interest only becomes that much stronger. 

This money grows tax-deferred, and in retirement, a 401k can provide additional income streams for the investor. 

What to Consider When Choosing a 401k Alternative 

A 401k is a benefit an employer may provide, although this is not a required benefit. Plenty of employers do not provide any form of a 401k.

If you’re wondering, how do I retire without a 401k, have no fear because there are plenty of 401k alternatives. Consider the following variables thought, before selecting one of the many 401k alternatives. 

Tax Benefits / Disadvantages

One of the first variables you’ll want to consider is the various tax benefits. A 401k has the opportunity to grow tax deferred meaning you will not pay tax on your 401k appreciation until you reach retirement.

Hopefully, in retirement, your tax rate is lower than what it was throughout your career. If you’re exploring a 401k alternative, make sure you look for retirement investment options that grow tax deferred. 

Contribution Limits

Another factor that must be taken into consideration is the contribution limits. Some retirement accounts allow you to contribute more money than others.

Generally speaking, there is some sort of ceiling on how much you contribute within any specific calendar year. Find a retirement savings vehicle that allows you to contribute an amount you are comfortable with. 

Transaction or Management Fees

Last but not least, you’ll want to have a full understanding of what the various transaction and/or management fees are for the 401k alternatives. These fees can quickly erode profit, and the less profit you keep in your account, the less impactful compounding interest will be. 

11 Best 401k Alternatives

Let’s dive into the 11 best 401k alternatives! 

Traditional or Roth IRA’s

Traditional or Roth IRAs can be great alternatives to a 401k. An IRA is simply an individual retirement account, and these accounts provide the investor with a great deal of flexibility. 

How It Works: An IRA allows the investor to save money for their golden years. The money that one contributes today will grow tax deferred in the IRA, and one can deduct any contribution to the IRA from their taxable income in the present day. You can open an IRA at your local bank, or through an investment brokerage such as TD Ameritrade or Fidelity

Who Can Open an IRA: Anyone can open a traditional IRA, there is no restriction or income requirement to do so. However, a Roth IRA is a bit more selective. If you make over a specific amount, you are not eligible to contribute to a Roth IRA. 

Maximum Contribution Limit: Traditional IRA’s cap your contribution to $6k/year. If you are over 50 years old, you can contribute up to $7k/year. 

Tax Implications: One of the main benefits of an IRA is the fact that they are tax deferred. 

Benefits:

  • The account grows tax deferred
  • You can take matters into your own hands, meaning you do not need an employer to sponsor such benefit to take control of your retirement 
  • An IRA provides one with a tremendous deal of investment flexibility 

Disadvantages:

  • Unlike a 401k, an employer will not contribute to an IRA
  • When you reach a certain age, you are required to withdraw money from your IRA
  • There is a ceiling around how much money you can contribute 

What to Keep in Mind: There are a wide range of IRA options available today, and brokerages can manage your IRA if you wish. This allows you to take a hands off approach to your retirement planning. 

Who This Helps: A traditional IRA and a ROTH IRA can be helpful for anyone who would like to self fund their retirement planning. Even if they contribute to a 401k, having an IRA account on the side can only better prepare you for retirement. 

Find the best traditional IRA accounts here

Find the best Roth IRA accounts here

Simplified Employee Pensions (SEP-IRA)

On a high-level, a SEP-IRA is almost identical to a traditional IRA, however, there are slight differences. SEP-IRAs are most common for those that are self employed. 

How It Works: If you are self employed, you can contribute to a SEP-IRA. This provides many of the advantages a regular IRA has, but it kicks it up a notch. 

Who Can Open a SEP-IRA: A business owner, or one who earns income through freelancing, can open a SEP-IRA. 

Maximum Contribution Limit: The maximum contribution is 25% of one’s income, or up to $58,000 as of 2021.  

Tax Implications: These accounts are taxed upon withdrawing your money, which one can do at age 59 ½. 

Benefits:

  • You can contribute to this and receive tax advantages 
  • One can contribute up to 25% of their income, or $58,000 per year 
  • You can still make contributions to another retirement account, but may not receive the full tax benefits 

Disadvantages:

  • A SEP-IRA is not available to everyone. If you’re not self employed, or have a freelancing gig, you cannot open a SEP-IRA account. 

What to Keep in Mind: If you’re combining a SEP-IRA with another tax deferred retirement account, be sure to work with a trusted accountant or tax advisor. Combining numerous tax deferred retirement accounts can get tricky, and the IRS only allows a certain amount of wiggle room here. 

Who This Helps: A SEP-IRA is most helpful and used for those that are self employed. 

Solo 401k

Another option for the self employed is a solo 401k. There are differences between a solo 401k and a SEP-IRA, which we’ll touch on below. 

How It Works: A solo 401k is for the self employed, but a caveat is, the business cannot have employees except for one’s spouse. If you own your business, you can contribute up to $58,000/year to a solo 401k. There are plenty of advantages, including; tax deferred earnings, investment freedom, and how much one can contribute. 

Who Can Open a Solo 401k Plan: A solo 401k is only an option for those that are self employed, and do not employ any employees. This is a common option for those in the trades. 

Maximum Contribution Limit: The maximum contribution limit is $58,000 – the same as a SEP-IRA. 

Tax Implications: You have the choice to pick what tax benefit you’d like to advantage of. You can contribute money through the traditional route, which will reduce your taxable income in the year the money was contributed, but you’ll pay taxes on withdrawing this money in retirement. Or, alternatively, you can contribute money via the ROTH solo 401k route, which allows you to withdraw this money in your retirement years tax-free. 

Benefits:

  • One can contribute a significant amount of money to a solo 401k 
  • One would also have the option to go down the traditional or ROTH IRA route

Disadvantages:

  • There are strict eligibility requirements 

What to Keep in Mind: If your business ends up hiring employees, you must transition out of a solo 401k and into another retirement savings vehicle, such as a SEP-IRA. This can be a hassle. 

Who This Helps: A Solo 401k is a great option for any one-person business. 

Cash-Balance Defined-Benefit Plan

A cash-balance defined benefit plan is a retirement plan that offers numerous tax benefits. Money is withdrawn from one’s paycheck and is invested into the given plan. 

How It Works: A cash-balance defined benefit plan is a great 401k alternative for business owners who wants to contribute a large amount of money to their retirement plan. Unlike a 401k or IRA, the cash-balance defined benefit plan allows the business owner to contribute significantly more money. 

Who Can Open a Cash-Balance Defined-Benefit Plan: A business owner can open a cash-balance defined benefit plan. 

Maximum Contribution Limit: The maximum contribution is high! You can contribute over $200,000 to a cash-balance plan. 

Tax Implications: Similar to a regular tax deduction, money contributed to a cash-balance plan will reduce your taxable income dollar for dollar. If you contribute $100k to this plan, you’ve reduced your taxable income by $100k. 

Benefits:

  • You can contribute a significant amount of money to this plan 
  • The tax benefits are meaningful 

Disadvantages:

  • This is an expensive option for a business owner if they contribute to their employees accounts as well 
  • There are higher costs in running this plan when compared against a 401k

What to Keep in Mind: As a business owner, this is a phenomenal way to reduce your taxable income that is 100% IRS approved. 

Who This Helps: These plans are very useful for business owners. 

Taxable Investment Account

A taxable investment account is an account that enables the investor to buy securities and receive various tax benefits. Common securities include; stocks, ETFs, and index funds

How It Works: Simply put, a taxable investment account is a type of investment account you can open directly with a broker and/or a financial advisor. These investment accounts get taxed on any gains they receive in the year the gain was earned. Taxes will be taxed at your standard income rate, or at the long term, or short term, capital gains rate depending on how long you’ve owned the investments for. 

Who Can Open a Taxable Investment Account: Anyone can open a taxable investment account. 

Maximum Contribution Limit: No limit! 

Tax Implications: The tax implications are contingent on how long you hold the investment for. Tax is either at your regular income rate, short term capital gain tax rate, or the long term capital gain tax rate. 

Benefits:

  • You can withdraw your money at any time and not have to pay a penalty 
  • There is no required distributions 
  • This account can be used for more than just retirement savings 

Disadvantages:

  • These accounts are not employer sponsored, so 100% of the money in the account is self funded 

What to Keep in Mind: It’s important to keep in mind although a taxable investment account could be used as a 401k alternative, it can also be used to fund various aspects or goals in your life. 

Who This Helps: This is a great option for those that have already maxed out a regular 401k, or are looking for a 401k alternative. 

Find the best brokerage accounts here

Annuities

An annuity is another common retirement planning option. Annuities are an insurance product that provides a predictable income stream. 

How It Works: An annuity is an insurance contract. One gives the insurance company a large lump-sum payment, and in return, the insurance company provides regular payments/disbursements. Interest is associated with these payments, so the initial lump-sum is paid back in full plus interest. 

Who Can Open an Annuity: Anyone can open an annuity! 

Maximum Contribution Limit: There is no maximum contribution limit with annuity products. 

Tax Implications: The tax implications of an annuity are dependent on how you purchased the annuity. If you purchased the annuity with pre-tax dollars, your payments will be taxed. If you purchased the annuity with post-tax dollars, your payments will not be taxed. 

Benefits:

  • Annuities provide a consistent stream of income, which is much needed in retirement 
  • Annuities tend to be a safe option 
  • You can dictate whether or not you want to purchase an annuity with pre or post tax dollars 

Disadvantages:

  • The upside is limited
  • Annuities tend to be complex 
  • Inflation can really affect how impactful your annuity is 

What to Keep in Mind: An annuity is a great addition to other retirement plans, but it shouldn’t be your only option. 

Who This Helps: Annuities are helpful for those looking for a predictable and consistent income stream in their retirement years. When combined with other retirement options, an annuity can be very helpful. 

Health Savings Account

A health savings account is more than just an account that can help pay for medical expenses. Health savings accounts can also be used in your retirement years. 

How It Works: Individuals are able to contribute money to a health savings account and receive a tax deduction in the present day. The money grows inside an HSA tax free. Health savings accounts can pay for everyday health expenses, such as prescriptions, glasses, co-pays, or medical equipment. Or, the money can be used in retirement to generate additional income. 

Who Can Open a HSA: As long as you are 18 years of age or older, you can open a HSA account if you enrolled in a high deductible healthcare plan. 

Maximum Contribution Limit: Families can contribute $7,000/year to an HSA whereas an individual can contribute $3,500/year. 

Tax Implications:  Contributing money to your HSA offers a tax deduction in the present year, and your money grows tax free. 

Benefits:

  • This is a way to reduce your taxable income in the present year
  • This allows you to squirrel away more money once you’ve maxed out your 401k 
  • Employers can contribute to an employee’s HSA 

Disadvantages:

  • An HSA is a high deductible plan, which means you’ll pay more money out of pocket before your health insurance kicks in 
  • This is not risk free investing 

What to Keep in Mind: If you are not in good health, this plan may not be in your best interest considering the out of pocket expenses you’ll be facing and the higher deductible you must meet. 

Who This Helps: If you are in good health, this is a great way to reduce your taxable liability in the present day and put more money away in an investment account. 

Find the best HSA account providers here

403(b) Plans

A 403(b) is essentially a 401k. Those who work for tax exempt organizations or public schools will be presented with a 403(b) option instead of a 401k. 

How It Works: Similar to a 401k, money is taken out of the employee’s paycheck each week and invested into a 403(b). There are various underlying investment options the employee can route their money to once inside of the 403(b). The employer will typically do some sort of match, which compounds the interest earning potential of this account. 

Who Can Open a 403(b) Plan: 403(b) accounts are reserved for those employed by a public school system or tax exempt organization. 

Maximum Contribution Limit: For 2021, the maximum contribution is $19,500/year. 

Tax Implications: Money is taxed upon withdrawal, which is typically in your retirement years.  

Benefits:

  • You can reduce your tax liability in the present year by contributing money to a 403(b)
  • The employer may contribute money to your 403(b), which is essentially free money 
  • The admin fees tend to be lower than those within a 401k

Disadvantages:

  • Generally speaking, there are less investment opportunities within a 401(b) when compared against a 401k
  • If you withdraw money before you are 59 1/2 , you will pay a 10% tax penalty

What to Keep in Mind: A 403(b) is very similar to a 401k. If you work for a public school and are concerned the school you work for doesn’t offer a 401k, don’t sweat it! A 403(b) is a great retirement savings vehicle. 

Who This Helps: A 403(b) is not for everyone. Depending on where you’re employed will determine if you’re eligible to invest in a 403(b) or not. 

457(b) Plans

A 457(b) is another investment option that is related to the 401k. However, a 457(b) is for government employees. 

How It Works: A 457(b) works just like a 401(k) but is reserved for employees of the government. Money is taken out of the employee’s paycheck and invested into a 457(b). This money grows tax deferred and can be used in the employees retirement years. 

Who Can Open a 457(b) Plan: Employees of the government can open a 457(b) account. 

Maximum Contribution Limit: The maximum amount of money one can contribute is $19,500 a year. 

Tax Implications: Investing money in the present day reduces your present day taxable income. Taxes are paid upon withdrawal of the money, which can start at 59 ½ years old. 

Benefits: All the benefits of a 401k are present, however, the fees in a 457(b) tend to be reduced! 

Disadvantages:

  • There may be less investment options/choices than a traditional 401k
  • There is a 10% early withdrawal fee 

What to Keep in Mind: State and local governments are known for providing their employees with great benefits. A 457(b) is one of the many benefits you’ll receive if you are employed through a state or local government agency. 

Who This Helps: A 457(b) is used for state and local employees only. 

Real Estate

Investing in real estate is a great alternative to a 401k! Real estate investing is arguably the most flexible option on this entire list! 

How It Works: There are numerous ways one can invest in real estate! The two most common options would be:

  • Flipping homes: Flipping homes is when one purchases a home that needs work. The work is completed on the home and the homeowner sells the home for a healthy profit. An example of a flip would be purchasing a run down home in a nice neighborhood. You may buy the home for $200,000 and put $50,000 of work into the home within 3 months of owning it. Once the work is completed (such as new floors, an updated kitchen, remodeled bathroom, etc.) you list the house for sale at $300,000. If/when the house sells, you’ve generated $50,000 of profit in hopefully a timely manner. 
  • Investing in rental properties: This is when one purchases a home and instead of flipping the property for a quick profit, they rent the property to tenants. The tenants will typically cover the expense of the entire mortgage, and ideally a little bit more for a profit in the here and now. Once the home is paid off, this rental property is a cash generating machine. 

Tax Implications: Investing in real estate has many tax nuances. Short term and long term capital gains must be taken into consideration. 

Benefits:

  • There is no cap on how much money you can invest in real estate 
  • You can have complete control over your investment decision and location 
  • You can generate a incredibly healthy return 

Disadvantages:

  • Investing in real estate takes time. If you’re a landlord, you’re always on call if something breaks down. If you’re looking to do a flip yourself, this can take a great deal of time, energy, and resources. 
  • There is great risk when it comes to investing in real estate

What to Keep in Mind: Real estate investing is tried and true. When you find the right property, it can be widely profitable. 

Who This Helps: If you have an appetite for risk, and don’t mind rolling your sleeves up and doing some construction labor yourself, real estate investing is a great retirement option for anyone! 

Wildcard: Investing in a Startup

Investing in a startup is a bit more unorthodox, but it provides significant upside potential. Startup investing isn’t for everyone considering the risk involved, but for those that have extra cash to spend, this may be a great option. 

How It Works: There is no crystal ball on how to invest in a startup. Startups can be within your local community, or you can be an accredited investor and leverage various startup websites to begin your startup investment journey. No matter what route you take, some principles remain the same.

Investing in a startup business is when one provides cash/liquidity to a business when the business is in their infancy stages. In exchange for cash, the business provides the investor with equity. If the business gets off the ground and the valuation grows, the investor can make a substantial return on investment. 

Benefits:

  • The return on investment can be absolutely phenomenal 
  • You may be able to have a voice in how the business is run, and the various decisions the business makes
  • Startups are often fun and innovative companies

Disadvantages:

  • Startups are risky 
  • They are not as liquid as investing in regular securities traded

What to Keep in Mind: You should not put your life savings into a startup if you’re not ready or willing to take on great risk. Nor should investing in a startup be your only retirement plan. 

Who This Helps: Investing in startups can help anyone, but they should only be for those that can tolerate the increased risk exposure, 

What Do You Do If You Have No 401k?

As mentioned above, there are plenty of 401k alternatives out there that can help prepare you for retirement! Despite how popular a 401k is, they are not the be all, end all, retirement investment account.

With that said, the sooner you start planning for retirement, the better! If you are young, time is on your side as the right investment can grow significantly over the years. If you’re questioning if you are making the right retirement investments, consider working with a financial advisor.

A financial advisor will be able to present you with the best retirement planning options to maximize your return and reduce your taxable liability. You want to enjoy your golden years, and the best way to do that is to ensure you have health and money on your side!