The gig economy, which now accounts for more than a third of all US workers, is driving the growth in side businesses. If you're among them and want to avoid an intimidating tax burden in April, opening a retirement account for your side hustle might be the best option.
You'll spend more in payroll taxes on self-employed earnings than employee income. For example, just one-half of Social Security and Medicare contributions are withheld from employee salaries, but self-employment net earnings (income after deductions) are subject to both halves, with a tax deduction to alleviate some of the pressure.
Putting some of your self-employed earnings in a non-Roth retirement account can lower your overall tax burden. If the mega-backdoor Roth conversion goes away, it may be one way to stash more money in tax-advantaged retirement accounts now, which would become impossible if the big-backdoor Roth conversion stays.
IRAs, which allow you to contribute up to $6,000 each year in addition to your 401(k) at your full-time job, are well-known. But side hustles and full-time "solopreneurs" have even more options for adding money to their retirement accounts. Professionals believe that most of the differences reside in terms of administration expenses, investment alternatives, and contribution restrictions.
The Self-Employed Pension Plan (SEP) IRA is a popular choice since it's simple to set up and has a larger contribution limit than a traditional or Roth IRA, not to mention the fact that you may contribute to a SEP in addition to your personal IRA and employer-provided 401(k) in the same year.
You can contribute up to 25% of your self-employed income, up to $58,000 in 2021 or $61,000 in 2022 if you have a SEP. But there is a catch: A SEP is only available to people who make more than $290,000 in 2021 and $305,000 in 2022. You can't contribute to a SEP if your income is derived from employment rather than self-employment earnings.
Be smart: To set up a self-employed retirement plan, get help from an expert or financial counsellor.