Someone with a morbid sense of humor coined the phrase “There’s more than one way to skin a cat.” While the adage may or may not be true in the literal sense — I have no experience in cat-skinning — the underlying message definitely applies to retirement savings. You may have heard 1,000 times that you should be funneling at least 15% of your income into your 401(k), but that’s not the only way you can retire rich.
It’s easy to argue that a 401(k) is your first and best choice for retirement savings. Payroll deductions put your 401(k) savings on autopilot. You get tax deductions on your contributions, which helps your cash flow while you save. You might even get some free money via employer-match contributions. And your earnings grow tax-free so you can build wealth without the disruption of an annual tax bill.
But even with those benefits, access to a 401(k) isn’t what determines how rich you’ll be in retirement. The critical factor is your skill at developing a source of income to replace your paycheck. That income might come from an investment account, a business, or some combination of the two. Here are three non-401(k) options to explore.
1. Save in an IRA
IRAs, like 401(k)s, offer tax-free earnings growth for your retirement savings. The big downside is that IRAs have much lower contribution limits relative to 401(k)s. In 2020, you can contribute up to $19,500 to your 401(k), or $26,000 if you’re older than 49. IRA contributions are capped at $6,000, or $7,000 for savers older than 49. Those limits apply to the total deposits you make to your traditional and Roth IRAs.
Even with relatively low contribution caps, you can save a bunch of money in an IRA if you start early. Say you deposit $6,000 in your IRA annually and invest it; the money will grow at 7% on average — roughly equal to the stock market’s long-term growth rate. In 30 years, you’ll have more than $600,000. And after 40 years, you’d have more than $1.2 million.
Whether you make those contributions to a traditional IRA or Roth IRA depends on your tax situation and your current income. Distributions from your Roth after age 59 1/2 are tax-free. That makes the Roth a good choice if you expect to be in a higher tax bracket later in life. But Roth IRA contributions are not allowed for single filers who make more than $139,000 annually or married filers who make more than $206,000 annually.
There are no income thresholds for contributions to a traditional IRA, though your income could determine if you get a tax deduction for your contribution. If you make more than $75,000 as a single filer or $124,000 as a married filer and you participate in a 401(k), your contribution won’t be tax deductible. Either way, your traditional IRA distributions after age 59 1/2 are taxed as ordinary income.
2. Save in a taxable brokerage account
The tax advantages of IRAs are nice, but you accept some serious restrictions in return. You can’t, for example, withdraw your traditional IRA funds before age 59 1/2 without paying taxes and penalties. In a Roth IRA, the contributions are fair game, but earnings are off-limits, also until age 59 1/2. Traditional IRAs are also subject to required minimum distributions (RMDs) — mandated, taxable withdrawals you must take from your account starting at age 72.
You can bypass those restrictions by investing in a taxable brokerage account instead. You will have to pay taxes each year on any interest, dividends, or realized gains in your account. But it may be worth it if you want the freedom to spend your money — or not spend it — on your own schedule.
Tax-efficient investing can help you manage the tax consequences of growth in your brokerage account. Individual stocks are tax-efficient if you hold them for the long term since you only realize a gain when you sell. When you own mutual funds, you realize gains and losses when the fund makes trades in its portfolio — so your best fund options are those with low trading activity. Look to passively managed mutual funds and index funds.
Since there are no contribution caps, a taxable brokerage account can easily supplement your IRA savings. If you invested $500 monthly, for example, you could amass about $500,000 in 30 years, or $1 million in 40 years, after taxes. That assumes a 25% federal and state income tax rate and average annual growth of 7%. Combine that with your IRA savings and you’ll be in good shape to retire comfortably.
3. Invest in a low-maintenance business
Retirement savers commonly ask, “How much do I need in my savings to retire?” But the account balance is less important than the income that money provides. If you need $100,000 to live comfortably each year, that cash can come from your retirement accounts, or it can come from somewhere else — like a low-maintenance business that throws off cash.
Starting a business isn’t for everyone because there’s risk involved. You can mitigate some of that risk by leaning on your specialized knowledge and keeping your initial outlay to a minimum. Online businesses are attractive in this regard — the start-up costs are minimal, and the options are endless. If you like to write, you could launch a blog on nearly any topic (though I’d advise against cat-skinning). If you like to make your own jewelry, you can sell your designs on Etsy. You can produce music and sell it via TuneCore, or take photos and license them out for royalties on Shutterstock. You could even set up an e-commerce website on Shopify, selling products that are manufactured and shipped by someone else.
Save now for income later
If you can save, you can retire rich without a 401(k). Even better, set your sights on saving and spinning up another stream of income that doesn’t require you to work too hard. That’s your best strategy for making your dream retirement a reality.
