One of the great benefits with starting up a side hustle is the ability to get paid as an independent contractor. When you consider all of the sweet benefits you get from side hustling, you have to assume that the government must want us to side hustle.
Take tax deductions, for example. The government lets you deduct expenses related to your side hustle for things you might already be doing anyway. With a little planning, someone driving for Uber in their spare time could easily offset the costs of driving that they’re already doing anyway.
Perhaps the most amazing thing that the government lets you do as a side hustler is to save money into extra retirement accounts that other people don’t have access to. Start up a side hustle and you can save some- or in some cases, almost all of your side income – into a Solo 401(k), a SEP-IRA, or a Simple IRA. Depending on how much you make and what type of retirement accounts you already have, you could potentially save thousands more per year in tax-advantaged savings.
I’ve always assumed that these type of accounts were only available to people running “real” side businesses. For whatever reason, it never occurred to me that an Uber driver or a Postmates courier could also contribute to these accounts. How would I know, after all? It’s not like Uber or Postmates tells you this stuff. And I don’t think I’ve ever heard anyone in the regular world talk about a Solo 401(k) (or for that matter, a SEP-IRA or any other type of retirement account for independent contractors).
I had no idea there was an entire world of retirement accounts just for side hustlers! Even a lowly delivery person for Postmates can potentially save away thousands of extra dollars per year in a way that a big-wig working a normal 9-5 can’t do.
This year, I finally got around to setting up a Solo 401(k) for myself. I haven’t calculated my final totals for the year yet, but for sure, I’ll be able to contribute well over $4,500 in tax-deferred savings. By opening up a Solo 401(k), I’m creating a bonus retirement account for myself, giving myself years of tax-free growth, and best of all, reducing my tax liability now. And this is all from doing nothing but lowly on-demand, gig economy work.
If you’re doing Uber, Lyft, Postmates, DoorDash, or any other sharing economy type gig, and you haven’t set up a Solo 401(k), you’re totally missing out!
What’s A Solo 401(k) And How Can You Use It?
Most traditional employees will basically have access to two types of retirement accounts – a 401(k) through their employer, and an IRA or Roth IRA. If you’re a little more savvy, you might sign up for a high deductible health plan and contribute to a Health Savings Account.
But, if you’re really savvy, you might pick up an easy side hustle and create yourself another retirement account with a Solo 401(k).
The mechanics of a Solo 401(k) are fairly straightforward. If you’re earning income as an independent contractor, you’re eligible to create this type of retirement account. Basically, you’re creating a retirement plan for your own independent business. There are two parts to it – the employer part and the employee part. As an independent contractor, you’re basically both the boss and the employee of your own little business.
For someone like me, a Solo 401(k) is perfect because it lets me save the most money. My day job doesn’t have a 401(k). Instead, I have a 457 plan at work. The IRS calculates the contribution limits for a 457 separately from contributions to a 401(k). This means that I can max out my 457 (up to $18,000 per year) and still contribute almost all of my side hustle income into a Solo 401(k), treating it as my employee contribution. Not only does this give me the benefit of compound growth, I also get an immediate return by deferring all of the taxes on that income.
A Solo 401(k) also makes sense for me because of my expected income growth. By keeping my side hustle income in a Solo 401(k), I don’t have to worry about any pro-rata rules messing up any future backdoor Roth contributions in the same manner that a SEP-IRA would.
Setting Up My Solo 401(k)
The process of setting up a Solo 401(k) seems like it might be complicated, but it’s actually pretty easy. I ended up going with Fidelity for my Solo 401(k) because they have no administrative fees and you can invest in very low cost index funds. Vanguard is also a fine choice, but they charge you $20 per year for each mutual fund you invest in. Since I only make a few thousand bucks per year in side hustle income, that fee didn’t seem worth it to me.
To set up your plan, you’ll need to first grab yourself an Employee Identification Number, or EIN. You can grab one online through the IRS website. I got mine in just a few minutes. After that, I went to Fidelity’s website, where I filled out an adoption agreement and an account opening agreement. I then mailed the forms out to Fidelity. My Solo 401(k) was set up just a few days later.
I haven’t contributed anything to it yet because I’m still working on figuring out how much I ultimately made this year after any deductions. The deadline for me to contribute is my tax filing deadline, which for me, is April 15th.
*I’ll note that if you’re trying to set up a Solo 401(k) for this year, then you’ll need to do it right away. If you’re looking to make contributions from your side hustle earnings in 2016, you’ll need to set up your Solo 401(k) by December 31st. Once its set up, you have until your tax filing deadline to make your contributions. It took me just 2 days to get everything set up, so you can still get it done if you hurry.
Treat Your Solo 401(k) Like A Bonus Retirement Account.
The absolute best way to use your Solo 401(k) is to treat it like a bonus retirement account. If you’re already maxing out your 401(k) at work, then, unfortunately, you won’t be able to put in quite as much. That’s because you’ll only be able to make employer contributions to your plan. I’ll go more in-depth some time about how much you can contribute to a Solo 401(k) in a future post, but basically, for the employer contribution side, it’s about 20% of your profits for the year.
Still, someone making an extra $5,000 in a year and already maxing out their 401(k) at work can put away an extra $1,000 per year into a Solo 401(k) as an employer contribution. That’s not so bad. If you’re really good and able to make a ton in side hustle income, you can put away even more.
But the real benefit to a Solo 401(k) is if you’re like me and don’t have a 401(k) at work. Then you can really crush it by putting away almost all of the side hustle income you earn. If I’m able to keep making around $5,000 or so per year from side hustles, I can easily put away over $4,500 every year just from my side hustles. Let it compound over time and we’re looking at nearly half-a-million dollars in 30 years. Plus, I’ve still got everything I contribute through my work plans.
Imagine how awesome that would be if I could say that I had an extra $500,000 in retirement because I spent the last 30 years working a few hours per week as a lowly delivery man.
For all you side hustlers out there, are you using a Solo 401(k)? Do you use a SEP-IRA instead? How are you saving that money away?
- I refer to independent contractors a lot in this post, but really, I just basically mean any type of self-employment activity. You only need two things to be eligible for a Solo 401(k) – self-employment activity and no full-time employees. Most people doing side hustles like Uber or Postmates don’t realize that this activity counts as self-employment, since you’re working as an independent contractor, rather than an employee.
- For other reading, consider reading my post on how this might be the easiest time in history to start up a side hustle. As a corollary, it might also just be the easiest time in history to save money for retirement.
- Consider also reading my post on how your side hustle is worth a lot more than you think. You’ll be surprised at how much your meager side hustle earnings can add up if you can stay consistent.
- Note: I’m by no means a tax expert. Consult your accountant or CPA before acting on anything I say!