3 Retirement Accounts for Your Side Gig Money

If you’ve taken on a side gig, you may only think of it as a small source of additional income. But when you work a side gig, you are technically operating your own business, and this can open up some additional financial opportunities. Opening a retirement plan for your new side business is a simple step you can take to both reduce your tax liability and boost your retirement nest egg. Here’s a look at three types of retirement accounts you can open for your side gig money, including the features, benefits, advantages and disadvantages of each type.



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Solo 401(k)

A solo 401(k) is a personal version of the 401(k) plans offered by large employers. But the solo 401(k) offers a huge benefit over a traditional 401(k) that you might contribute to as an employee. As a side gig worker, you play the role of both employer and employee. This means that unlike with a traditional 401(k), you can make both employer and employee contributions, thereby significantly boosting the total amount you can put into your plan.

For example, with a traditional 401(k), employee elective contributions are limited to $20,500 for 2022 and $22,500 for 2023 ($27,000 and $30,000, respectively, if you are age 50 or older). But with a solo 401(k) plan, you can also put in employer contributions. All together, you can contribute up to the total amount of your net self-employment earnings after deducting one-half of your self-employment taxes and any 401(k) contributions for yourself. Combined, your employer and employee contributions are limited to $61,000 for 2022 and 66,000 in 2023, which are significant amounts.

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SEP-IRA

If you’re earning a considerable amount of money from your side gig and are looking to sock away as much money as possible, a solo 401(k) might be your best option. However, a SEP-IRA is much easier to set up, and it still offers a sizable maximum contribution. 

Technically, the maximum SEP-IRA contribution is the same as with a solo 401(k) — or $61,000 for 2022 and $66,000 in 2023. But SEP-IRAs have a separate limit of 25% of your net self-employment income. You can only contribute the lesser of these two limits, meaning that in many cases, you’ll be able to put more into a solo 401(k) than a SEP-IRA. But unless you’re pulling down serious money from your side gig, you’re unlikely to hit that higher limit anyway. Plus, with a SEP-IRA, you don’t have to perform the sometimes-tricky calculation as to your maximum contribution limit.

Beyond that, both the solo 401(k) and the SEP-IRA operate like most other retirement plans. You’re granted a tax deduction on the amount of your contributions, and your earnings grow tax-deferred until withdrawal when they are taxed as ordinary income.

Traditional or Roth IRA

If you’re just starting a side gig or don’t have much by way of revenue, a simple traditional or Roth IRA might actually be your best option. Although these accounts have contribution limits of just $6,000, or $7,000 in 2022 and $6,500 or $7,500 in 2023 — subject to earnings limits — if you are age 50 or older, this might be more than enough if your side gig only pulls in $500 or so per month. 

Traditional and Roth IRAs are among the simplest types of retirement plans, but there is a key difference between the two. 

With a traditional IRA, contributions are typically tax-deductible, unless you are covered by another retirement plan like a 401(k) at your primary job. Contributions and earnings grow tax-deferred until you withdraw them in retirement, at which point they are fully taxable as ordinary income.

For Roth IRAs, you don’t get any tax deduction on your contributions, but you can also take tax-free withdrawals of both your contributions and earnings as long as they are made after age 59 ½. You can also withdraw your contributions at any time with no taxes or penalties. 

Although IRAs have low contribution limits compared to other options, like SEP-IRAs or solo 401(k) plans, this doesn’t mean that you can’t open one when you are just starting out. If your side gig is a success and you start bringing in large dollar amounts, you can still keep your original IRA and then open a SEP-IRA or solo 401(k) later. If you prefer to keep your accounts more streamlined, you can always roll over your IRA balance into your new retirement plan. 

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