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Can You Build Wealth Without Using Your 401(k)?

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The company 401(k) is just one option available for building wealth. If you work for a company that does not offer a 401(k) matching program, or if you are self-employed or don’t have access to a group-sponsored retirement plan, you can still build wealth by opening these retirement and non-retirement accounts.

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Qualified and Non-Qualified Accounts: What’s the Difference?

Before we look at the different types of accounts you might open, Julian Schubach, vice president of wealth management at ODI Financial, said it’s important to differentiate between qualified and non-qualified accounts.

A qualified account, Schubach said, is anything that can be considered a retirement account. This is an account with tax favorability, with specific rules that govern the use of your savings. A few examples of qualified accounts include a traditional IRA, Roth IRA, SEP IRA and Solo 401(k).

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A non-qualified account is a non-retirement account. Schubach said this is money that you already have paid income taxes on and are subject to taxes only on long-term investment gains. Most non-qualified accounts may be withdrawn from at any time with no penalties, unless you purchase a product such as a CD or annuity that may carry a surrender charge.

Traditional IRA

If you do not have access to a 401(k) program, Schubach recommends opening an individual retirement account (IRA). You may choose between a traditional IRA and Roth IRA.

Traditional IRAs are tax-deferred, meaning you may be eligible for a tax deduction each year you contribute. Greg Middendorf, CFP and partner at HCM Wealth Advisors, said earnings grow tax deferred, but you’re subject to ordinary income taxes when you make a withdrawal. Those who withdraw money before age 59½ may be hit with a 10% penalty, which Middendorf said is a good inducement to keep your money growing.

Roth IRA

You will not receive a tax deduction when contributing to a Roth IRA account. However, Middendorf said you can withdraw earnings tax-free at age 59½ if you have held the Roth for five years.

“You’re subject to a 10% penalty if you withdraw earnings before 59½, but there’s never a penalty for withdrawing the money you contributed,” Middendorf said.

Speaking of contributions, there is a maximum limit to how much you can contribute to an IRA each year. In 2022, the maximum contribution is $6,000 if you are under age 50 and $7,000 if over age 50.

Brian Carney, co-founder of RiversEdge Advisors, said opening a Roth IRA is a tremendous way to save for retirement, even if you are offered a retirement plan through your employer.

“As long as the investor is under certain income limits, they have the ability to contribute to the maximum limit to a Roth IRA using after-tax dollars: meaning it has already been taxed through a paycheck,” Carney said. “Those dollars will grow completely tax-free and can be distributed at required ages completely tax-free. By paying taxes on the contributions and none of the growth, it is akin to paying tax on the seed, not the harvest.”

SEP-IRA

Carney said freelancers may use several different options to build wealth without traditional 401(k) plans. First, investors must ask themselves if they would like to save more than $6,000 in a tax year. If the answer is no, their best bet may be to open a traditional IRA. If they hope to contribute more than $6,000, a SEP IRA is likely the best option.

If you are a freelancer or earn a 1099 income, Schubach said you may be eligible to contribute 25% of your adjusted gross income (up to $61,000) into a SEP-IRA account. SEP-IRA accounts are tax-deferred and provide a potential tax deduction each year a contribution is made.

If a freelancer has any employees, Carney said the SEP-IRA will require the owner to make contributions for their employees that are the same percentage of income they contributed for themselves.

Solo 401(k)

A solo 401(k) is ideal for those who have LLCs or corporations and are the sole employees taking W-2 incomes.

“This account is just like a traditional 401(k) but does not carry the same administrative costs or requirements for accounts under $250,000,” Schubach said. “In a Solo 401(k), you can contribute up to $20,500 each year in either a traditional or Roth registration.”

Health Savings Account (HSA)

If you have a health plan through your employer that has a high annual deductible, 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,” Middendorf said. “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.”

Build a Portfolio of Long-Term Investments

Aside from opening an IRA, you can continue building your wealth through long-term investments. Doug “Buddy” Amis, CFP and CEO of Cardinal Retirement Planning, recommends investing in tax-efficient index funds. Like the Warren Buffett portfolio that uses the S&P 500, index funds are a straightforward path to wealth accumulation.

“Unlike actively managed funds, investing in tax-efficient index funds for the majority of your portfolio will work whether or not it’s in a 401(k) plan or Roth IRA,” Amis said. “Certain funds can be extremely tax-efficient, generating only minimum tax drag because dividends tend to be taxed at the preferential qualified tax rate and capital gains distributions are minimal. This helps you keep more money in your pocket and experience the power of compound interest.”

Which Account Is Best To Build My Wealth?

The rules for opening an IRA can be quite tricky. You do not want to accidentally fund the wrong account and have to pull back your contribution. If you are unsure of whether to open a traditional or Roth IRA account, Schubach recommends speaking with a CPA or accountant before establishing and funding a qualified account.

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