Today’s gig economy makes it easier than ever to earn cash on the side from work that can be both fun and engaging. Many individuals participate in the sharing economy via Airbnb or Uber, while others take the more traditional route of consulting or teaching part time. The income from these side gigs may seem modest, but it can add up to a meaningful amount over time and make a substantial impact on a person’s nest egg.
The additional income can also be saved in various retirement plans, which helps the extra side money grow even further. For instance, adding an additional $500 a month from a side gig to a retirement account could add up to just under $340,000 in today’s inflation-adjusted dollars over the course of 30 years. That scenario has the potential to provide an extra inflation-adjusted pre-tax income of $21,000 every year in retirement, assuming retirement lasts 25 years.1

The Solo 401(k)

Solo 401(k) plans are available for self-employed individuals. Similar to employer-sponsored 401(k) plans, contributions to a solo 401(k) plan are tax-deductible and the growth is tax-deferred until distributions are made from the account. The plan allows for a maximum annual employee contribution of 100% of a person’s earned income, up to $18,500 for the 2018 tax year. As of 2018, an annual catch-up contribution of $6,000 is available for those age 50 and over. In addition to employee contributions, employer contributions are also available. The calculation is slightly more complicated for employer contributions, but a person can contribute roughly 20% of net self-employment income, up to a combined employee and employer contribution total cap of $55,000 in 2018, plus $6,000 if age 50 and over. Another way to think of it is this: self-employed people can make an employee contribution as the individual and they can also make an employer contribution from their business on their behalf. Self-employed folks wear both hats.

In the past, many self-employed individuals chose to use SEP IRA plans, which have features similar to solo 401(k) plans. These plans allow an employer contribution of roughly 20% of net self-employment income, but they do not allow employee contributions nor do they have catch-up contribution provisions. In the past, SEP IRA plans were easier to set up than solo 401(k) plans, but the process of setting up a solo 401(k) plan has been simplified recently. As such, these plans are becoming a popular alternative to SEP IRA plans.

Pitfalls to Avoid If Currently Participating in Another 401(k) Plan

If an individual is currently employed and participating in an employer’s 401(k) plan or if the individual is a teacher with a 403(b) plan2, the employee contribution to one plan offsets dollar for dollar the ability to contribute to the other plan. To put it another way, an employee contribution across any number of 401(k) and 403(b) plans cannot exceed $18,500 — or $24,500 for persons age 50 and older. An employer’s contribution, however, does not offset another employer’s contribution. Here’s an example. Lisa3 is 40 years old and is employed full time as a senior programmer at a start-up. She also has her own business where she consults on the side. As an employee of the start-up, she participates in an employer-sponsored 401(k) plan and as a business owner she contributes to a solo 401(k) plan. She makes the maximum employee contribution of $18,500 to her employer-sponsored 401(k) plan and the start-up generously contributes $36,5004 to the employer-sponsored 401(k) plan each year to reach the full contribution cap of $55,000. Because she has already met the contribution limit in her employer-sponsored 401(k) plan, Lisa cannot make a contribution to her solo 401(k) plan as an employee of her consulting business. She can, however, still contribute an additional $55,000 to her solo 401(k) plan as the employer of her consulting business, assuming she has enough self-employed earned income.5

AccountEmployee Contribution LimitEmployer ContributionTotal Contribution
Start-Up 401(k)$18,500$36,500$55,000
Solo 401(k)$0 (Maximum employee contribution met through start-up's 401(k) plan)$55,000$55,000

Retirement Options for Government Employees With 457(b) Plans

Retirement options can get even better for government employees with a personal side business, or a private-sector employee with a part-time government job. For government workers with a 457(b) plan, contributions to a solo 401(k) plan do not offset the amount a person can contribute to a 457(b) plan. 457(b) plans allow for a maximum annual employee contribution of 100% of your income, up to $18,500 for 2018, and an annual catch-up contribution of $6,000 in 2018 for those age 50 and over.6 For example, Sam7 is a 52-year-old full-time firefighter for San Francisco County and has a side business as a scuba instructor on his days off. Sam can make an employee contribution of $18,500 to his solo 401(k) plan for his scuba business and $18,500 to the county’s 457(b) plan, for a total employee contribution of $37,000 in 2018. Sam is also over age 50 so he can make catch-up contributions of $6,000 each into his solo 401(k) and his 457(b) plan, bringing the total employee contribution to $49,000. That’s a lot of money saved for future scuba trips!

IRA Accounts: Retirement Options Beyond Employer-Sponsored Plans

Beyond employer-sponsored retirement plans and solo 401(k) plans for a side business, employed and self-employed individuals can also contribute to traditional or Roth IRA accounts to truly maximize retirement plan savings. Traditional IRA accounts also benefit from tax-deferred growth, but unlike solo 401(k) plans, the deductibility of the contribution is limited and depends on both person’s income and whether he or she participates in other retirement plans.8 Contributions to traditional IRAs are not restricted by contributions to an employer-sponsored retirement plan or a solo 401(k) plan, but traditional IRAs have a lower annual contribution limit of 100% of earned income, up to $5,500 in 2018. Additionally, they allow for an annual $1,000 catch-up contribution for those over age 50. Distributions are required once an individual reaches age 70½, at which time contributions are no longer allowed.

Roth IRA accounts are an alternative option to traditional IRA accounts. Contributions to Roth IRAs are not tax-deductible but both the growth and distributions are tax-free. A Roth IRA has the same annual contribution limit of 100% of earned income, up to $5,500 in 2018, plus allows for an annual $1,000 catch-up contribution. The ability to make Roth IRA contributions is limited based on a person’s income9, but unlike the traditional IRA, individuals over the age of 70½ are eligible to make contributions and there is no required minimum distribution at any age. The $5,500 annual contribution limit and the $1,000 catch-up contribution for a person age 50 and over apply across all traditional and Roth IRA accounts. Therefore, a $2,000 contribution to a traditional IRA account limits a contribution to a Roth IRA or any other IRA account to $3,500, or $4,500 if age 50 and over.

Account TypeEmployee Contribution LimitEmployer Contribution LimitCatch-Up Contribution for Age 50 and Over
401(k)$18,500$55,000 minus the employee contribution to 401(k)$6,000
403(b)$55,000 minus the employee contribution to 403(b)$6,000
457(b)$18,500$18,500$6,000
Traditional or Roth IRA$5,500N/A$1,000

References:

1. Assumes 7% average annual return adjusted for 3% inflation compounded annually. Inflation-adjusted real return estimated at 3.88% [(1 + nominal return)/(1 + inflation)-1].

2. A 403(b) plan, also known as a tax-deferred annuity plan, allows a maximum annual employee contribution of 100% of earned income, up to $18,500 for 2018, and an annual catch-up contribution of $6,000 in 2018 for those age 50 and over. There are also special catch-up contribution provisions. For more information, visit the IRS website here.

3. The persons and personal stories depicted in the article are fictitious but the examples present financial situations and considerations that certain people may face.

4. Example assumes Lisa’s employer contributes 15% of salary to each employee’s 401(k) account. The IRS caps income used for calculating qualified retirement plan contributions at $275,000, and Lisa’s actual employer contribution is 13.3%, or $36,500.

5. A self-employed person can contribute roughly 20% of net profits as an employer contribution and would need to earn at least $275,000 in net profits to maximize the employer contribution of $55,000.

6. There are special catch-up contribution provisions in the 457(b) plan not covered in this article. For more information, visit the IRS website here.

7. The persons and personal stories depicted in the article are fictitious but the examples present financial situations and considerations that certain people may face.

8. For those who are not an active participant in an employer-sponsored retirement plan, contributions to traditional IRA accounts are tax-deductible under the following schedule (Source: IRS):

If your filing status is...And your modified AGI is...Then you can take...
single, head of household, or qualifying widow(er)any amounta full deduction up to the amount of your contribution limit.
married filing jointly or separately with a spouse who is not covered by a plan at workany amounta full deduction up to the amount of your contribution limit.
married filing jointly with a spouse who is covered by a plan at work$189,000 or lessa full deduction up to the amount of your contribution limit.
more than $189,000 but less than $199,000a partial deduction
$199,000 or moreno deduction
married filing separately with a spouse who is covered by a plan at workless than $10,000a partial deduction
$10,000 or moreno deduction

For those who are an active participant in an employer-sponsored retirement plan, contributions to traditional IRA accounts are tax-deductible under the following schedule (Source: IRS). Individuals whose income is over the limit that allows them to deduct their contribution are able to make non-deductible IRA contributions. If they don’t have other IRA assets, the non-deductible IRA contributions can be converted to a Roth IRA free of tax. This conversion allows both the growth and distribution to be tax-free.

If your filing Status is...And your modified AGI is...Then you can take...
single or head of household$63,000 or lessa full deduction up to the amount of your contribution limit.
more than $63,000 but less than $73,000a partial deduction.
$73,000 or moreno deduction.
married filing jointly or qualifying widow(er)$101,000 or lessa full deduction up to the amount of your contribution limit.
more than $101,000 but less than $121,000a partial deduction.
$121,000 or moreno deduction.
married filing separatelyless than $10,000a partial deduction.
$10,000 or moreno deduction.

9. Roth IRA contributions are allowed under the following income limits (Source: IRS):

If your filing Status is...And your modified AGI is...Then you can take...
married filing jointly or qualifying widow(er)<$189,000up to the limit.
>$189,000 but <$199,000a reduced amount.
>$199,000zero.
married filing separately and you lived with your spouse at any time during the year<$10,000a reduced amount.
>$10,000zero.
single, head of household, or married filing separately and you did not live with your spouse at any time during the year<$120,000up to the limit.
>$120,000 but <$135,000a reduced amount.
>$135,000zero.

Filed under: Retirement Planning

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