What's the Best Way to Save for Retirement When You Don't Have a 401(k)?

Dear Carrie,

I'm 27 and my husband is 32. We're starting to think about saving for retirement. He has a 401(k) at work, but I'm a hairstylist at a small salon that doesn't offer any retirement benefits. What's the best way for me to save?

—A Reader

Dear Reader,

Starting to save for retirement early is one of the most important things you can do, so kudos for some smart thinking. At your age, if you save just 10-15 percent of your annual income from now until you reach retirement age, you should be in pretty good financial shape. At your husband's age, he might consider bumping that up to 15-20 percent if he’s just beginning to save in his 401(k).

Your husband is lucky to have a 401(k). It makes saving easier because the money is automatically deducted from his paycheck each month. Plus, he may get an employer match (and if he does, make sure he always contributes at least enough to capture the maximum amount). But like you, not everyone has that opportunity. Currently, about a third of Americans don't have an employer-sponsored retirement plan. But that shouldn't keep anyone from starting to save. It may take a little more effort and discipline to create your own retirement plan, but it's well worth it. Here's what I suggest.

An IRA is a good first choice

An IRA is an Individual Retirement Account that you open in your own name. Like a 401(k), savings grow tax-deferred, which means you don't pay income taxes on the earnings as long as the money is in the account. Currently, you can contribute up to $6,000 a year to an IRA (with a $1,000 catch-up for those 50-plus). That would be a good start to your savings.

You do have a couple of IRA choices, so before you open one you'll need to consider which type of IRA is best for you.

• Traditional IRA—With this type of account you generally get an upfront tax deduction for your contribution. Earnings grow tax deferred but you’re subject to ordinary income taxes when you make a withdrawal. If you withdraw money before age 59½, you may also be hit with a 10 percent penalty—a good inducement to keep your money growing.
• Roth IRA—With a Roth, there's no up-front tax deduction, but you can withdraw earnings income tax free at age 59½ if you’ve held the Roth for five years. You’re subject to a 10 percent penalty if you withdraw earnings before 59½, but there's never a penalty for withdrawing the money you contributed.

To contribute to a Roth IRA, you have to meet certain income limitations. In 2021, if you're married filing jointly, you can make a full contribution as long as your Modified Adjusted Gross Income (MAGI) is less than $208,000 (less than $140,000 for single filers).

If you fall under the income limits and you don't need an upfront tax deduction, a Roth can be a good choice. And those tax-fee withdrawals could be a real plus if you're in a higher tax bracket down the road.

Another opportunity for lower earners is the Saver's Credit, which gives you a tax credit for your retirement contribution if you meet certain income qualifications. You can check to see if you're eligible at irs.gov. 

It's easy to open an IRA at a bank or investment company, in person or online. Look for one that has a low account opening minimum. And don't hesitate to ask questions. A representative should be happy to speak with you and make sure you understand the details.

Setting up automatic contributions makes saving easy

Once you've opened your IRA, set up a monthly automatic deposit from your checking account to your IRA. A $6,000 yearly contribution comes out to $500 a month. If that's more than you can manage, contribute as much as you can and try to add to it with any bonuses, raises or gifts. You actually have until the tax filing date of the following year to make your full IRA contribution.

Check your other options

To me, an IRA is a smart and simple way to get started, but there are a couple of other ways to save depending on your circumstances:

• If you're self-employed—SEP and SIMPLE IRAs and Individual 401(k)s offer sole proprietors and small business owners a way to increase the amount of money they can contribute to retirement each year. Each is relatively easy to set up, have higher contribution limits and offer a lot of flexibility. Anyone in this category should look into the details. 
• If you have a high-deductible health plan—If your health plan has a high annual deductible ($1400 for individuals, $2800 for families in 2021), you may qualify for a Health Savings Account (HSA). Similar to an IRA, an HSA lets you make annual contributions and offers significant tax perks. It's a way to save for current healthcare costs as well as for the future and can be a great complement to an IRA.
• If your state offers an auto-IRA—Several states have recently implemented retirement programs to help workers save, including Auto-IRAs, retirement marketplaces and multi-employer plans. Auto-IRAs require employers who don't offer retirement plans to automatically enroll their employees in a Roth IRA and deduct contributions directly from their paychecks, similar to a 401(k). Workers can decide to opt out once enrolled. Some programs are entirely voluntary for workers. Check to see what type of retirement savings program your state may offer if you don’t have one at work.

Don't just save—invest

The next step is to get your money working. Since you're young and there are many years until you retire, I suggest investing in one or more broad-based stock mutual funds or exchange traded funds that represent different companies, industries and countries. Or you could invest in what's called a target date fund that corresponds to your retirement date. When you open your IRA, talk to the representative about investment choices and advice services. Many financial service companies offer free education and guidance.

Save even more

You and your husband probably have savings goals beyond retirement so as your income grows, consider putting even more away in a taxable account. And don't forget about an emergency fund, which is an essential buffer against all of the unexpected events that can crop up! That way, you'll not only be saving for your individual retirements, you'll be planning and saving for a more secure financial future together.

Have a personal finance question? Email us at askcarrie@schwab.com. Carrie cannot respond to questions directly, but your topic may be considered for a future article. For Schwab account questions and general inquiries, contact Schwab.