Saving For Retirement When You're Not Working
Many individuals these days find themselves out of the workforce, some by choice such as mothers raising small children, others as a result of layoffs and downsizing. When people stop collecting an income, they often stop contributing to retirement savings. However, keeping up contributions, however small, can make a big difference in the total savings a person achieves by the time he or she retires. The problem is finding a retirement vehicle beyond what is offered by an employer can be as much of a challenge as finding the money to put into to it. Fortunately, even in times when you are not earning a steady paycheck, it is still possible to save for retirement, and there are a couple of key retirement vehicles out there to help.
The Solo 401(k)
The solo 401(k), also known as the independent 401(k), is for individuals who are self employed, either as sole proprietors, independent contractors or as members of a partnership. This vehicle is for businesses in which only the individual and his or her spouse are employees. The contributions to this type of 401(k) are made up of a combination of employee deferrals and employer profit sharing. The employee deferral is capped at $17,000 for 2012 and $17,500 for 2013.
For individuals older than 50, there is an additional catch-up contribution of $5,500 for 2012 and 2013. The profit-sharing component for a sole proprietor is 20% of self-employment income reduced by 50% of self-employment taxes. The profit-sharing component increases to 25% of self-employment income (no deduction for self-employment taxes) for incorporated businesses. The total amount of contributions, deferrals and profit sharing to the plan in 2012 is the lesser of $50,000 ($55,500 including catch-up contribution) or 100% of compensation (excluding the catch-up contribution).
For example, suppose that Mary, a 33-year-old marketing manager, had a baby a few months ago and quit her full-time job to raise her baby. She wants to keep her skills current and has decided to find some consulting work. If Mary earns $20,000 of income from a sole proprietorship in 2012, she could put away a total of $17,000 in employee deferrals.
Solo 401(k) plans must be established before Dec. 31 in order for contributions to be allowed for the upcoming year.
The Spousal IRA
Non-working spouses who file joint tax returns also have the option of contributing to a Traditional or Roth IRA as long as their spouses have taxable compensation. The maximum contribution for 2012 for either IRA is $5,000 plus an additional $1,000 for individuals older than 50 years of age. For 2013, this amount increases to $5,500 or $6,500, if your over the age of 50.
For example, let's say Joe, 51, lost his job late last year and hasn't been able to find employment but wants to continue to contribute toward his retirement. His spouse has compensation from her job of $50,000 for 2012. Joe could contribute a total of $6,000 in 2012 to his IRA ($5,000 contribution plus $1,000 "catch-up").
Keep in mind that filing status can affect the amount of allowable contributions. If Joe and his wife filed separately, he would be unable to contribute any amount to an IRA for the year because he had no taxable compensation. If they filed separately and he only had compensation of $2,000 for the year, his IRA contribution would be limited to $2,000.
Contributions to IRAs can be made up to April 15 of the following year. In other words, if you want to make an IRA contribution for 2012, you have until April 15, 2013.
Health Savings Accounts (HSAs)
A third retirement savings vehicle can be, surprisingly, a health savings account (HSA). An HSA is a tax-advantaged account available to individuals with high deductible health plans (HDHP) for use in paying medical expenses. The individuals are the owners of the account. For individuals who are employed, contributions can be made by both the employer and the employee. For those who are not employed, they can make contributions on their own behalf.
Unlike with an IRA or 401(k), where earned income is a requirement, the funds deposited into an HSA by an employee can come from savings, dividends, unemployment compensation and even welfare. In addition, there are no income limits on who can contribute as there are with, for example, Roth IRAs. The maximum contribution for 2012 is $3,100 for an individual and $6,250 for a family. Additional catch-up contributions of $1,000 are allowed for individuals 55 years of age or older. Individuals who contribute funds to the account receive an "above the line" deduction on their taxes.
So how does a medical savings account pertain to retirement savings? Distributions not used for medical expenses are included in income and are taxable. There is an additional 10% tax if these distributions are not due to death or disability or are withdrawn prior to the individual reaching the age of 65. However, you could keep these funds in the HSA and begin withdrawing funds after the age of 65. At that point, you would pay tax on the distributions just like a Traditional IRA but would avoid the extra 10%. Aside from the obvious benefit of saving before tax for medical expenses, contributions to these accounts can serve as a source of income once you are retired.
If you find that you have exhausted all of the previous options and still have more money you want to save for retirement, you could always make contributions to a good old taxable brokerage account. Sure, the earnings won't be tax deferred, but you will be increasing the pot of money that will provide you with a source of income during your retirement. And don't we all want that pot to be bigger?
The Bottom Line
As you can see, there are numerous opportunities for saving for retirement even if you are out of the workforce or participating in it on a part-time or intermittent basis. The more pressing question is not whether there are tax-deferred vehicles to which you can contribute, but how you will manage your cash flow in order to save as much as you need to ensure a comfortable retirement.
It is imperative to first and foremost do your homework. You'll never know how much more you could have saved if you don't know what you are currently spending. Keep track of your spending for about six months and figure out which expenses can be cut down to squeeze in a little more retirement savings. Once you have figured out how much you spend and how much you can save, talk to your tax or financial advisor about which vehicles are best suited to your needs. The time to save is now!