Side Gig Finances and Self-Employed Income

 Self-Employed Retirement Plan Options 

 

When you work for yourself, whether in a side gig or as an independent contractor, you don’t have the benefit of a regular retirement plan sponsored by an employer because you are the employer. This doesn’t mean you miss out on tax advantaged retirement plans, though. You actually may be able to put away MORE money towards retirement. Here are some great investing options that are often overlooked. If you're not sure how to invest within your plan, check out the investment options section of our personal finance primer. We also have a page on the three-fund portfolio strategy.

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Solo 401(k) plans

These show up under several different names, such as: self-employed 401(k); one-participant 401(k); individual 401(k); solo-k, i401(k); uni-k; and one-participant k. A self-employed plan is a 401(k) plan covering a business owner (and their spouse if they work for the business) who doesn't have any other employees.

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Below, you’ll see both employEE and employER when discussing contributions. Make sure to distinguish the two as there are different rules and limits based on the role you play as each.

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Most online brokers, such as Fidelity and Vanguard, offer solo 401(k) plans, at low to no fees depending on your portfolio value. You will likely need to register for an EIN specifically for your solo 401(k) plan with the IRS. Make sure the EIN number you register for your 401(k) is used only for the 401(k), as you don’t want the IRS confusing your 401(k) plan income with other self-employed income revenue streams.

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You used to have to open and fund the employEE portion of the plan by December 31st. With the SECURE Act 2.0, the government extended this to your tax filing date. The employER portion can generally be funded until the tax filing deadline for the tax year (including up until the date you file if you file an extension).

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Once you reach a balance of $250,000 in your plan (for 2024), you are required to report your plan annually to the IRS with a Form 5500. Regardless of your plan balance, you should keep detailed records of your employer and employee contributions to your solo 401(k) plan. 

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Many solo 401(k) plans offer both traditional and Roth options, and you can contribute to both for the employEE portion. EmployER portions, however, must be made to a traditional solo 401(k).

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Learn more about how to choose between a traditional 401(k) or a Roth 401(k).

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Contribution Limits

Since you are both the employEE and employER for your self-employed business, you can make contributions as both. This is one of the great features of a solo 401(k) plan, as it offers some tax advantages.

 

EmployEE contributions can be made up to 100% of "earned income", up to a $22,500 total limit for 2023 ($30k if age 50+ with catch up contributions allows)

 

EmployER contributions can be made up to 25% of compensation.  Talk to your accountant about this to make sure you’re calculating 25% of the right number before you make your contribution, as this calculation can be more complicated when accounting for deductions, expenses, etc.

 

The TOTAL MAXIMUM CONTRIBUTION between the employEE and employER contributions for a participant is $66,000 for 2023 (plus catch-up at age 50+). 

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Multiple 401(k) Rule

If you have multiple 401(k) plans/accounts, your total employEE contribution for the year remains $22,500 total across all your 401(k) plans you may be contributing to. So if you are maxing out your 401(k) at your primary physician job to maximize your match, you would not be able to contribute as an employEE to your solo 401(k), but you could still contribute as the employER portion to the 66k max assuming that you have the self employed income to support it. 

If you have multiple self-employed businesses, you may be able to have multiple solo 401(k) plans to take advantage of employer contributions for each, though you would have to ensure that the businesses/companies are completely separate under IRS control group definitions.

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Earned Income Calculation

Above, you’ll notice “earned income”. This is a special term the IRS uses. It is calculated by taking the net self-employment earnings and deducting one-half of your self-employment tax plus contributions for yourself. There is also a special calculation to figure out the maximum amount of employer + employee contributions you can make. This math can get a little complicated, so we recommend using a self-employed retirement contributions calculator.

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Learn more about pros and cons, how to open an account, and more on our dedicated solo 401k plans page.

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SIMPLE (Savings Incentive Match Plan for Employees) IRA

The SIMPLE IRA is another retirement option available for the self-employed entrepreneur. SIMPLE IRAs are available for small businesses up to 100 employees. They generally offer low administrative costs and are typically easier to implement with less reporting and recordkeeping/paperwork requirements than a solo 401(k).  

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In a SIMPLE IRA, the employer must contribute to the employees’ plan. They must either:

• 100% match employees’ contributions up to 3% of their earnings

• Contribute 2% of the employees’ earnings up to a stated compensation limit, which is $330,000 for 2023. (Employee contribution limits for the SIMPLE IRA as of 2023 are $15,500.)

 

While SIMPLE IRAs are nice if you have other employees since that disqualifies you from a solo 401(k), it can become a costly benefit the more employees you have.

 

SIMPLE IRAs do not offer a Roth component for employee contributions. As such, it acts like a traditional IRA with pre-tax contributions that grow tax-deferred with required minimum distributions (RMDs) once you’ve reached retirement age.

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SEP (Simplified Employee Pension) IRA

The SEP IRA is a retirement plan available for employers, including self-employed individuals. With a SEP IRA, only the employer makes contributions; there is no employee side. Since employer contributions are required to be pre-tax funds, it acts like a traditional IRA (no Roth option) with contributions growing tax-deferred. Like a SIMPLE IRA, it has required minimum distributions (RMDs) once you’ve reached retirement age.

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One of the advantages of the SEP IRA is that, similar to the Solo 401(k),  it allows employers to contribute as much as 25% of your net earnings from self-employment (not including contributions for yourself), up to $66,000 for 2023. A SEP IRA plan is also available if you have other employees, where a solo 401(K) is only available if it’s you and a working spouse.

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These plans are typically easy to set up and are low cost to operate, generally with no filing requirements for the plan. They work great if you are self-employed without any employees. Once you have other employees, though, as the employer you have to contribute equally for all eligible employees.

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Note: if you use this option, you will NOT be able to do the backdoor Roth without worrying about the prorata rule. Many physicians like to do the backdoor Roth IRA for additional tax advantaged options, but you would violate the pro rata rule of the backdoor Roth with any IRA other than a traditional Roth IRA. We talk about this much more on our guide to the backdoor IRA.​ The solo 401(k) does not have this limitation, which is why many of us prefer it even though the paperwork gets more complicated after you accumulate the $250,000 balance in the solo 401(k).

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Defined Benefit Plan

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*Big disclaimer: Defined benefit plans and cash balance plans are extremely complicated, and we have tried our best to summarize these to the best of our understanding, but you should double check everything we say about defined benefit plans and cash balanced plan with a professional that specializes in these. These are not plans that you run by yourself, and will require a lot of expertise to set up.  They come with substantial administrative fees and paperwork, so most people do not consider these unless they are able to put substantial amounts of tax advantaged money into these that justify the reliance on someone else to run these, and the fees associated with it.  Also, please note that contributions made to these plans may affect how much you can put into other retirement accounts, again necessitating the need for appropriate advice before setting these up.

However, they can be great tax advantaged outlets, so it’s worth looking into them if you’re someone that has the financial bandwidth to put more money into retirement accounts.*
 

While the solo 401(k) plan works like a traditional employer 401(k) plan and the SIMPLE and SEP IRAs operate more like traditional IRAs, defined benefit plans are more on par with a traditional pension plan.

 

Under a defined benefit plan, as the name suggests, the plan provides a specific, defined guaranteed annual benefit to you and your employees at retirement, usually based on salary and years of service. They can be powerful tax strategy tools if you have enough stable side income or 1099 income to support larger contributions.

 

There are different ways to calculate the benefit payout at retirement. Contributions are calculated by an actuary based on the benefit you set and other factors (employees’ ages, expected returns on plan investments, etc.). One standard takes the employee’s average earnings during a period of their career (the last few years or over their entire career) and multiples a percentage of that earning amount by the number of years of service.

 

Employee contributions are allowed, but generally the employer makes most or all of the contributions to guarantee the retirement benefit payout amount, which from an employer cost makes this plan better suited for side-gig and small businesses.

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Please note that if you decide to contribute to a defined benefit plan, it will affect how much you can put into your other self-employed retirement plans like the solo401k. You must tell your plan administrators about the solo401k as you will not be able to max the employER side of the 401k.

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Advantages: 

• Does not prevent you from having other tax-advantaged retirement plans

• Allows for high contribution limits (depending on age, the annual benefit limit for 2023 is $265,000)

• Contributions are generally tax deductible

• Tax-deferred growth

• They produce steady income at retirement age

 

Disadvantages:

• Quite complicated, requiring actuarial calculations and relevant expertise

• Expensive to set up and maintain (you cannot do this yourself)

• Since they operate outside of market fluctuations, they can add a long-term financial burden if you have employees

• Benefits are set when the plan is determined, so it’s important to take into account long-term forecasts

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Cash Balance Plans

Cash balance plans are a type of defined benefit plan where the retirement benefits are based on a cash balance formula in a hypothetical individual account. Since they are a type of defined benefit plan, you can manage one alongside a 401(k), but likely cannot manage one alongside a SIMPLE IRA or SEP IRA.

 

Each year, the participant's account is credited with a "pay credit" (for example, 6% of their income) and an "interest credit" which is either a fixed interest rate or a variable interest rate linked to an index such as a treasury bill rate. This builds the participant's account balance. 

 

When the participant retires, they have the right to an annuity based on their overall account balance. Many cash balance plans also offer a lump sum benefit equal to the account balance versus the annuity. The lump sum benefit can be rolled into an IRA or other qualified retirement plan.

 

Advantages:

• Offer more ease of adjustment than a traditional defined benefit plan

• Can be amended periodically, typically prior to any employee working 1,000 hours during that specific plan year

• Plans can also be terminated or frozen with advanced notices

 

Disadvantages:

• Can be more expensive to operate than a traditional defined benefit plan, especially depending on ages with more employees, and require nondiscrimination testing every year

• The sooner you want to retire, the less advantageous they are

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