401(k) alternatives to save for your retirement

You work hard to provide for your family and prepare for the future. The money you save is your foundation for a peaceful retirement. That’s why where you put your funds is vital.

The traditional method for putting money into retirement is through a 401(k). The Investment Company Institute found that, as of September 2022, 401(k) plans hold $6.3 trillion in assets for about 60 million active participants, former employees, and retirees. While a popular savings option, there are other choices available. Several 401(k) alternatives exist for people looking for a different way to contribute to their nest egg.

Discover which investment opportunities can effectively serve you in a constantly changing financial industry. Continue reading to learn more about:

• Traditional 401(k) plans
• 401(k) alternatives
• Which plan is best for you

Understanding a Traditional 401(k) Plan

A 401(k) plan lets employees elect to contribute a portion of their wages to an individual investment account. This amount gets deducted from the employee’s gross income—the money earned on their paycheck before income taxes get removed. These plans allow employees to reduce their taxable income by the total contributions made throughout the year and report it as a tax deduction. Depending on the company, the employer may match part or all of that contribution.

Some 401(k)s offer numerous investment options, including mutual funds, guaranteed investment contracts, stable value funds, company stock, and variable annuities. You typically can't invest in specific stocks or bonds in your 401(k) account. Instead, you often choose from a list of mutual and exchange-traded funds. Some funds allow you to actively manage them, while others may be index funds that follow a benchmark index, such as the S&P 500. In any 401(k), having a mix of different investment options is important to meet your specific needs.

Decisions, decisions, decisions

If you're saving for retirement, several options are available to help you reach your goals. No matter how you save, weighing the pros and cons of a traditional 401(k) plan is crucial.

Pros of a 401(k) Plan

401(k) tax breaks

Since 401(k) contributions have a pre-tax basis, you can lower your overall taxable income for the year. Your earnings accrue on a tax-deferred basis, which means the dividends and capital gains accumulated inside your 401(k) aren’t subject to tax until you start withdrawals.

401(k) contribution limits

Compared to other qualified investing plans, a 401(k) lets you contribute more money every year. According to the IRS, the amount a plan participant can put into their account in 2023 is $22,500—up from the $20,500 limit from 2022.

401(k) employer match

Not every employer matches their employee plan investments. However, matching can significantly benefit employees who work for contributing companies. Employers can also provide a profit-sharing component to give a portion of the organization’s profits to an employee’s 401(k).

There are a few different options for 401(k) matches, including:

• A fixed percentage based on the amount of your earnings
• A tiered percentage based on your contributions
• A fixed percentage contingent on the plan’s contribution limits listed above

Cons of a 401(k) plan

Withdrawal age requirements

Sometimes, you need to take out money before you want to. Depending on when you do, a 401(k) can make it costly to take out money early. If you take out money before you reach the age of 59½, expect a 10% early withdrawal penalty fee and other taxes, if applicable. This rule makes it difficult to access funds in the case of an emergency.

Mandatory withdrawals

It's important to note the impact of the Setting Every Community Up for Retirement Enhancement Act 2.0 (SECURE 2.0) on mandatory withdrawals. One noticeable addition SECURE 2.0 brings is the increase in the ages at which required minimum distributions (RMDs) must begin. There are required minimum withdrawals for your account after you reach a certain age.

Once you reach age 72 (or 73 if you turn 72 after December 31, 2022), you usually have to start withdrawing from your IRA, SIMPLE IRA, SEP IRA, or retirement plan accounts. The required beginning date for a person’s first RMD is as follows:

For 401(k)s:

• April 1 of the year that follows the later of the calendar year in which
• You reach age 72 (or 73 if you reach 72 after December 31, 2022), or
• You retire (if your plan allows this)

For IRA plans:

• April 1 of the year that follows the calendar year that you reach age 72 (or 73 if you reach 72 after December 31, 2022)

Lack of broker choice

A 401(k) offered by an employer restricts the options of choosing who can hold and manage your investments. You may be unable to avoid certain investment fees based on who your company selects to broker your account.

401(k) alternatives

Alternatives can give more freedom and flexibility to an employee’s retirement investment. Here are several 401(k) alternatives that can deliver the results that they’re looking for. Whatever option you decide to utilize, evaluating the fees in your investments is essential.

Roth IRA

This retirement account enables your money to grow tax-free. You can choose specific assets like stocks, bonds, certificates of deposit, mutual funds, and exchange-traded funds to hold in your Roth IRA. Your account will grow based on the performance of the securities you’ve selected.

You don’t get a tax deduction for Roth IRA contributions. Which means you will not lower your taxable income using this option. But withdrawals from your Roth IRA during retirement are tax-free. In other words, you paid your taxes upfront, so you don't owe anything on the back end. These IRAs can be a good savings option if you expect to be in a higher tax bracket in the future. However, there are income limitations to having a Roth IRA, so not everyone will be eligible for this retirement account.

Simplified Employee Pension (SEP) IRA

A SEP IRA may be a good choice if you’re a small business owner or self-employed. Your business funds your contributions to this plan, which is tax deductible if you're self-employed. Like a Roth IRA, this plan is tax-deferred, meaning you can make contributions after taxes get removed.

SEP IRAs work well with small businesses and self-employed workers because they require you to make equal contributions to all eligible employees based on the percentage of their salary. For example, if you contribute 10% to your account, you must do the same for your enrolled workers.  

Health Savings Account (HSA)

A health savings account is an investment account that assists with medical expenses. If you have a high-deductible health plan, you could be able to use this account. Like a Roth IRA or 401(k), you can invest your HSA funds in securities, but you may have to sell them earlier than expected due to illness before retirement. HSA contributions are tax-deductible, and all earned funds are tax-deferred.

Solo 401(k)

Another option for self-employed workers is a solo 401(k)—a tax-deductible retirement account for sole proprietors with tax-deferred earnings. People with this type of investment option can contribute to their account as an employer or employee, with contributions capped at 25% of their self-employment income. Much like a traditional 401(k), you may have to pay a penalty to access your funds before you turn 59½.

SIMPLE IRA

SIMPLE IRAs are, according to Craig Reid, national practice leader–Retirement and Wealth at Marsh McLennan Agency, “...a cost-effective alternative to the mainstream 401(k) plan.” With this plan, employers can choose to make a nonelective contribution of 2% of their employee’s salary or a dollar-for-dollar match of their contributions of up to 3%. A simple IRA is a tax-deferred retirement savings plan that only requires minimal paperwork and also offers employers tax deductions for contributions made for their employees. Nonetheless, there are specific requirements for employers and employees to meet to use a SIMPLE IRA.

Requirements include:

Employers must be small businesses with 100 workers or fewer and cannot offer any additional retirement plans. They must agree to provide a matching contribution of up to 3% of an employee’s salary or 2% in nonelective contributions annually.

To participate in a SIMPLE IRA, employees must have earned at least $5,000 in the prior two years and expect to receive $5,000 in compensation in the current year.

Real estate investment

Buying property helps you save for retirement by providing current rental income to cover potential expenses and ongoing real estate appreciation. This type of investment differs from other retirement savings plans because you can use funds without receiving penalties. The catch is that you’ll only be able to access the net income of the real estate. You should also note that high returns on this investment would require you to refinance or sell the property, which can be time-consuming and stressful.

Pick what works best for you

With so many 401(k) alternatives available to you, it’s crucial that you pick the ones that fit your needs. Some people may stick with the traditional 401(k) plan for its extensive tax benefits and high contribution limits. Others may need an account that gives them more freedom in choosing their broker or securities for their investment portfolio. Whatever option you want, it’s important to talk to your financial adviser to receive the best possible advice for your unique circumstances.

If you’re ready to offer your employees beneficial retirement savings options, contact Marsh McLennan Agency. Our financial experts are excited to help you reach your financial goals and set you up for success.

Get in touch with our team today to get started.