Employer-sponsored 401(k) plans are a popular way for workers to save for retirement, but they’re not the only way. If you’re self-employed or your employer doesn’t offer a 401(k), there are retirement savings vehicles out there that will work for you. Let’s take a look at both solo 401(k) plans and IRAs. If you’d like personalized advice about planning for retirement, consider working with a financial advisor.
What Is a 401(k)?
A 401(k) is an employer-sponsored retirement account that offers tax benefits. A traditional 401(k) will be withdrawn from your paycheck pretax and will only be taxed when you withdraw from it in retirement. A Roth 401(k) is similar, but the money that goes into it is already taxed, so it won’t be taxed when you withdraw from it in retirement. You can withdraw from your 401(k) penalty-free beginning at age 59 ½.
Once you deposit money into a 401(k), it’s invested according to your choices—you’ll be presented with investment options when you complete the paperwork. That money will grow not just through contributions, but through interest and earnings on those investments.
These plans were specifically created to incentivize workers to save for retirement. If you contribute to a traditional 401(k), your taxable income is reduced due to the 401(k) withholdings. If you’re contributing 6% of your income to a 401(k), you don’t owe taxes on that 6% of your income. With a Roth 401(k), instead of saving on taxes in the year, you contribute money to your 401(k) and you’ll enjoy the savings when you withdraw it in retirement.
Can You Open a 401(k) Plan Without an Employer?
As a 401(k) plan is an employer-sponsored retirement account, there’s an option for a self-employed person with no employees to open one with themselves as the sponsor. This is called a solo or one-participant 401(k) plan.
A solo 401(k) works exactly like a traditional 401(k) plan you would get with an employer—you’re just the employer and the account holder. Just like a 401(k) plan with an employer, there are contribution limits, but they’re much higher because you are serving as both employee and employer. We’ll cover those contribution limits later.
If you’re not a self-employed person, your best option is likely an individual retirement account (IRA). Whether you opt for a traditional IRA or a Roth IRA, both are tax-advantaged savings vehicles that will help you prepare for the future and have similar benefits to 401(k) plans.
Some traditional IRAs will also allow you to deposit pretax income and only pay taxes upon withdrawal in retirement. IRAs offer a great deal of freedom because, outside of income thresholds, they are not related to your employment status and you can open one anytime. Roth IRAs are funded with taxed income, but withdrawals aren’t taxed unless you withdraw before the age of 59 1/2.