3 Retirement Accounts for Your Side Gig Money

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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.

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For example, with a traditional 401(k), employee elective contributions are limited to $20,500 for 2022, or $27,000 if you are age 50 or older. But with a solo 401(k) plan, you can also put in employer contributions. Altogether, 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, which is a significant amount.

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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. 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.

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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 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.

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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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