Do You Have a Side Hustle? Here's a Massive Tax Break You Might Be Overlooking
If you have any self-employment income, you qualify for special retirement accounts. Keep reading to learn more about your investment options.
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There are some big drawbacks when it comes to taxes and side hustles, such as the self-employment tax. Since you're considered both the employer and employee when you earn freelance or gig income, you have to pay both sides of Social Security and Medicare taxes. However, there are also some major tax benefits, such as the ability to deduct business expenses.
Perhaps the best tax break available to self-employed individuals, including freelancers and gig workers, is retirement savings. And if you're new to the self-employed retirement world, you might not be aware of the options available to you, some of which might let you set aside a lot of income on a tax-deferred basis.
Three great retirement savings options
There are three main types of retirement accounts available for self-employed individuals. Most major stock brokers offer at least one of these account types, and some offer all three.
- SIMPLE IRA: The SIMPLE IRA (stands for Savings Incentive Match Plan for Employees) is designed for small businesses and their employees, but self-employed individuals are eligible as well. SIMPLE IRAs have a contribution limit of $16,000 from employees, with a $3,500 catch-up allowance if you're 50 or older. Plus, since self-employed people are considered employers as well, you can match your own contributions dollar for dollar, up to 3% of your total income.
- SEP IRA: The SEP IRA (stands for Simplified Employee Pension) is also designed for small businesses and self-employed businesses, but the key difference from the SIMPLE IRA is that all contributions are from the employer, not the employee. For 2024, participants can contribute as much as 25% of their net self-employment income, up to a $69,000 maximum.
- Solo 401(k): Also known as a "one-participant 401(k)," the solo 401(k) has the same $69,000 contribution limit as the SEP IRA. But up to $23,000 of it can be considered an employee contribution, with the rest designated as coming from the employer, up to a maximum of 25% of net compensation. Plus, if you're over 50, there's a $7,500 catch-up contribution allowed.
In addition, it's important to mention that these are designed to take the place of an employer-sponsored retirement account. So, if you qualify based on your income, you could potentially contribute to a traditional or Roth IRA in addition to one of these.
How much could you save?
To be perfectly clear, it isn't practical or necessary for many people to completely max out their retirement savings, especially with the high contribution limits of these specialized accounts. Even if you can put $69,000 into a SEP IRA this year, for example, you might not need to contribute this much year after year. But the point is that you have these options available to you that could have a massive impact on your tax bill, and that you might be able to set aside more for retirement than you think.
For example, if you're single and earn $100,000 in self-employment income this year, you'll likely be in the 22% marginal tax bracket. Most financial planners (including me) suggest that 10% of income is a good amount to set aside for retirement, so if you were to contribute $10,000 to one of these retirement accounts, it could lower your taxes by $2,200.
A double benefit
As a final thought, it's important to mention that using one of these retirement accounts isn't just about saving on your taxes, although that can certainly be a nice benefit. Contributing early and aggressively to one of these retirement accounts, and investing wisely within the account, can have a major impact on your financial security in retirement.
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