If you don't have a 401(k) or other employer-sponsored retirement plan, you can (and should) still actively save for retirement. There are some great savings options available to you, and although saving for retirement on your own obviously requires a little more effort than passively investing in a 401(k), it doesn't need to be intimidating or difficult.
A 2-minute introduction to IRAs -- the smartest way to save for retirement
An individual retirement arrangement, or IRA, is a tax-advantaged investment account designed to make it easier to save money for retirement. Money you contribute to an IRA can be used to purchase pretty much any stock, bond, or mutual fund you want. You're allowed to contribute up to $5,500 to an IRA during the 2015 tax year (or $6,500 if you're aged 50 or older).
IRAs come in two main varieties: traditional and Roth. The primary difference is how the IRS treats the contributions. In a traditional IRA, your contributions may be tax-deductible depending on your income. However, all of the money you withdraw after retirement will be taxed as income. A Roth IRA works in the opposite way: Your contributions won't be deductible now, but all of your post-retirement withdrawals will be tax free. You qualify to contribute to a Roth account if you earn less than $131,000 ($193,000 for married joint filers).
Both types of IRAs allow your money to grow and compound on a tax-deferred basis.
While there are some other differences between traditional and Roth IRAs, it basically boils down to when you want your tax benefit -- now or later.
Maxing out your IRA contributions means setting aside approximately $210 every two weeks. You may be surprised by how this can add up over time. The S&P 500's average total return is about 9.5% per year, so at this rate, check out how much your account could grow by the time you're ready to retire:
|Years Invested||Total IRA Contributions||Account Balance|
Bear in mind that this assumes the IRS will keep the contribution limit at $5,500, while in reality it is likely to increase over time. So, by investing in an IRA, you could literally build a nest egg of $1 million or more, making your 401(k)-reliant friends envious.
Once you open an IRA, check out this article (and other Motley Fool content) for suggestions on how to invest your money. With a little homework, you can set yourself up for years of investment success.
The government could even pay you to invest
In addition to the tax benefits I mentioned above, savers with low to moderate income are entitled to yet another perk: the Retirement Savings Contributions Credit (also known as the Saver's Credit). Essentially, if your income falls below a certain threshold, the government will give you money in order to encourage you to save for retirement.
The benefit can be rather generous. Depending on your income, you can receive a tax credit equal to 10%, 20%, or even 50% of up to $2,000 in IRA contributions (or $4,000 if you're married and file your taxes jointly). Note: The credit can also be taken for contributions to an employer-sponsored retirement plan, but we're focusing on people who don't have that option.
Here's a guide to determine how much the credit could be worth to you:
|In Order to Be Eligible for...||Single Taxpayers' AGI must be...||Head of Household's AGI must be...||Married Joint Filers' AGI must be...|
|50% saver's credit||$18,250 or less||$27,375 or less||$36,500 or less|
|20% saver's credit||$18,251 to $19,750||$27,376 to $29,625||$36,501 to $39,500|
|10% saver's credit||$19,751 to $30,500||$29,626 to $45,750||$39,501 to $61,000|
|No saver's credit||more than $30,500||more than $45,750||more than $61,000|
Even if your AGI puts you in the 10% credit bracket, few other investments will give you an instant 10% return, so this is definitely worth taking advantage of if you qualify.
What if you want to invest more?
If you want to invest more than you're allowed to contribute to an IRA, then there's nothing wrong with investing some retirement money in a standard (taxable) brokerage account. And if you use a little strategy, the tax burden shouldn't be much worse than an IRA's.
There are two main types of taxation you need to worry about when investing: capital gains and dividends. The latter is relatively easy to avoid; just keep the stocks that pay dividends in your IRA and the stocks that don't (or those that pay low dividends) in your taxable account.
Furthermore, you only pay capital gains taxes when you sell. In other words, it doesn't matter how much your stocks rise each year -- you won't owe a dime until you sell your investments. And if you hold your investments for more than a year before selling them, you'll pay the long-term capital gains tax rate, which is relatively low (15% for most tax brackets). On top of that, if you incur capital losses (hey, nobody picks winners all the time), then you can use them to offset your gains and thereby lower your tax burden.
As an example, I keep my shares of AT&T and Realty Income in my IRA, as they both pay dividends of more than 5% per year. On the other hand, I keep my Google and Berkshire Hathaway shares in a taxable brokerage account, as neither company pays a dividend, and I don't plan to sell either stock anytime soon.
Just because your employer doesn't offer a 401(k) doesn't mean you'll be less prosperous in retirement than those who have employer-sponsored retirement plans. With a little bit of effort on your part, you can set yourself up to enjoy years of tax-advantaged compounding -- and you might even get the government to cover some of your tab.