Looking for 401(k) alternatives? Investing beyond a 401(k)

In your journey to save a comfortable nest egg for retirement, maxing out your 401(k) might be one of your mile markers. After all, a tax advantageous retirement account is an incredible tool to plan for your financial future. But when it comes to investment choices, a 401(k) is just the beginning.

Whether you want to add to your retirement savings and/or have other financial goals, it’s important to understand how you could broaden and diversify your investment strategy.

You might start thinking about other investment choices when you’ve maxed out your 401(k). It could also be on your mind if you’re self-employed and don’t have access to an employer-sponsored 401(k) plan.

Or perhaps you have other big financial goals — like leaving an inheritance to your children or building a vacation home.

You have a lot of 401(k) alternatives where you might invest your hard-earned money:

A traditional IRA (individual retirement account) is a savings tool that is open to virtually anyone who has taxable income. A traditional IRA can be used in conjunction with a 401(k) plan or on its own. Check out the IRAs offered through  Ally Invest .

Contributions to an IRA are tax deductible in the year you make them, so an IRA can reduce your income tax burden now, allowing you to save more. You don’t pay taxes on the growth of your investments in an IRA until the money is distributed, which is an added benefit if you expect you’ll be in a lower tax bracket when you retire than you are now.

IRAs also offer a lot of flexibility. While your employer typically opens and directs your 401(k) plan, an IRA gives you control to invest in a variety of mutual funds, exchange-traded funds (ETFs) and individual stocks and bonds of your choosing.

Traditional IRAs have strict contribution limits and tax deduction amounts do phase out based on your modified adjusted gross income. For 2023, the total contribution you can make each year to all your traditional IRAs cannot exceed $6,500 ($7,500 if you’re age 50 or older). If your taxable compensation is less than these thresholds, that figure is the maximum amount you can contribute. 

If you withdraw from a traditional IRA prior to retirement, you’ll face a 10% penalty, as well as the taxes owed for any withdrawals before age 59 ½. You used to be able to only contribute to a traditional IRA until age 70 ½, although the IRS changed that starting in 2020 and now there is no age limit. 

You might consider a traditional IRA if you’re not covered by a retirement plan at work, or if you’re not eligible for a Roth IRA because you make too much money. A traditional IRA also acts as a supplement to a 401(k), especially if you’ve maxed your plan out.

Like a traditional IRA, a Roth IRA is available to virtually anyone with taxable income. The major difference between a traditional IRA and a Roth IRA is when your contributions and earnings are taxed. The two IRA types also have different contribution income limits. The Roth IRA also has a 5-year rule, which imposes a waiting period. Before withdrawing any earnings, the Roth IRA must be at least five years old. Depending on your age and how long you’ve held the account, you may have to pay taxes and or penalties (generally 10% of the distributed sum).  

You make contributions to a Roth IRA after tax, and you can withdraw your original contributions at any time, tax- and penalty-free.  Paying taxes on the front end takes the stress out of being responsible for them when you retire. Years of tax-free growth could possibly also add up to larger savings.

Roth IRAs also offer more flexibility: You can use your savings for some qualified expenses — like first-time home purchases and college expenses — without a penalty. You can withdraw these contributions at any time, and the account balance can be transferred to your heirs.

Roth IRAs are subject to income limits, so if you earn above a certain amount, you may be ineligible. Also note that if your withdrawals before age 59 ½ include earnings, you'll have to pay taxes on them, plus a 10% Internal Revenue Services (IRS) penalty. Check with the IRS for specifics.

Because your money grows-tax free and you withdraw it tax-free at retirement, you won’t get any of the tax savings today like you do with a traditional IRA.

A Roth IRA may be a good option if you’re just starting out in your career and have many earning years ahead of you to take advantage of the tax-free growth. If you’re confident you’ll have a higher income in retirement than you do now, a Roth IRA may also make sense in that situation.

Keep in mind: You can contribute to both a traditional and Roth IRA in the same tax year, as long as your combined contribution does not exceed $6,500 per year or $7,500 if you’re age 50 or over.

A SEP (Simplified Employee Pension) is an IRA for those who are self-employed, own a business or receive freelance income. It has the same investment, distribution and rollover rules as a traditional IRA.

You can deduct contributions in the year you make them, reducing your income tax burden. As a small business owner, freeing up more cash is always welcome. The distributions are not taxed until you retire.

Contribution limits for SEP IRAs are generous — around 10 times higher than limits for other types of IRAs. Contributions cannot exceed the lesser of 25% of the employee’s compensation or  $66,000 in 2023. 

You must make equal contributions, in terms of percentage of salary, to all your eligible employees. For instance, if you contribute 10% of your own salary to your SEP as the business owner, you must also contribute 10% of eligible employees’ salaries to their SEP.

Early withdrawals before age 59 ½ are subject to taxes and penalties.

A SEP can be a good way for small business owners, sole proprietors and freelancers without access to 401(k) to save for retirement for both themselves and their employees.

Another option for retirement saving for the self-employed is a solo 401(k), which is for a business owner with no employees. You can also participate in a solo 401(k) if you have a 401(k) through your main job and earn extra money on the side as a freelancer or gig worker.

The tax structure of a solo 401(k) is similar to that of a standard 401(k). You can choose between a traditional solo 401(k) and a Roth solo 401(k), so you have your choice of receiving a tax break now or later. A solo 401(k) has no age or income restrictions.

You can contribute up to $22,500 in 2023 and $30,000 to a solo 401(k) if age 50 or older, as well as 25% of your compensation as defined by the plan. 

A solo 401(k) is only for yourself, not employees. One exception is your spouse. That means if you’re a married sole proprietor, and your spouse earns income from your business, you can double your contributions.

You might consider a solo 401 (k) if you’re self-employed, or if you have a 401(k) through your main job but earn extra money on the side as a freelancer or gig worker.

Created to help people with high-deductible health insurance plans, HSAs (Health Savings Accounts) are another investment option beyond retirement accounts.

An HSA allows you to set aside funds on pre-tax basis to pay for qualified medical expenses, including deductibles, copayments and coinsurance. You can also choose to accumulate these funds until you retire and/or when you become eligible for Medicare.

You get a federal tax deduction on your HSA contributions the year you make them, and the interest or other earnings on the account are tax-free.

HSAs offer a lot of flexibility in that both you and your employer can contribute to them. In 2023, you can contribute up to $3,850 for self-coverage and up to $7,750 for family coverage, and HSA funds roll over to the next year if you do not use them. 

IRAs can be rolled into an HSA for major medical needs, and you can also use HSA funds for medical expenses for your spouse or dependents. HSAs have no minimum required distribution. You can always withdraw money tax- and penalty-free at any time for qualified medical expenses. 

Once you turn 65, you can use the funds to pay for employer-sponsored health insurance if you’re still working. And when you retire, you can use them to pay for Medicare premiums or for any reason you choose, including non-medical expenses.

HSAs can only be used in conjunction with a high-deductible health insurance plan, so you may not qualify. If a major health need arises, you could use all your HSA funds to pay your medical bills. Non-medical withdrawals before age 65 may be subject to both taxes and a 20% penalty. You can no longer contribute to an HSA once you’re on Medicare.

If you qualify for one, an HSA can be a great way to pay for both planned and unforeseen medical expenses. You can also look at an HSA as additional retirement income.

Investing in real estate is another way to potentially boost your retirement savings or fund other financial goals. You can invest directly by purchasing property or through REITs (real estate investment trusts).

Real estate typically appreciates over time, so if you have a longer time horizon, buying a home now and hanging onto it may possibly result in a large nest egg when you retire and are ready to sell and downsize.  

You can buy property and rent it out, which allows you to live off the rental income or sell the property for profit. Investing in real estate comes with unique tax benefits, as rental income is not subject to self-employment tax and provides a lot of opportunities for deductions.

If you invest through REITs, you can expect regular dividends, as these companies must distribute at least 90% of their taxable income to shareholders in the form of dividends.

While real estate generally appreciates over time, you still need to think about the potential risks of a declining market. Property values may drop and can affect your investment. 

You typically need a sizable amount of cash upfront to fund the down payment , closing costs and repairs that may be needed to maximize rental income. Especially in the case of rental property, real estate investing requires a time and/or financial commitment, as you’re now acting as a landlord and responsible for managing the property and making repairs.

In addition, non-traded REITs lack liquidity and sometimes have to be held for a specific number of years.

Real estate investing should be seen as a long game. It might take time for the value of property to appreciate, so don’t necessarily look to investing in real estate as a quick way to build wealth. 

Home ownership is a common and generally reliable path to building wealth. If you’re prepared for the responsibility and commitment involved, investing in rental property can also be a sound way to earn passive income. 

You may not think of life insurance when you consider 401(k) alternatives, but whole life coverage is another financial vehicle available to most people.

In addition to the death benefit — the payout your beneficiaries receive when you die — whole life insurance includes a cash savings component that you can borrow against or cash out if needed while you’re alive. For instance, if an unexpected financial emergency pops up, you can use the cash value. 

From an investment perspective, whole life insurance does not offer any actual returns from investments compared to 401(k)s and securities-related IRAs. Whole life insurance has a cash value component that acts like savings account with the insurer paying a lower fixed interest rate.  Also, any cash value is generally not included in the death benefit. 

Whole life insurance is usually seen as most advantageous to wealthy investors. Setting up an irrevocable life insurance trust can be a way to transfer wealth to your heirs to avoid estate taxes. 

A 401(k) is an excellent way to save for retirement and invest in your financial future, but it’s also just one of the tools you can leverage on your journey to retirement. With careful consideration of the alternatives and their unique risks and benefits, you can build an investment strategy that’s right for you and your individual goals.