If you make over $1,000 per month from work outside of your ordinary income, then you are in an elite group of ‘side hustlers’ who have the opportunity to contribute more to retirement than an IRA or 401(k) will allow. The value of the side hustle comes through generating income beyond that which your day job provides. This extra money is great for the occasional discretionary expenditure or bill payment, but what if you want to put that money to work for you and accelerate your retirement savings?
With side hustle income over $1,000 per month, you may choose to incorporate or work under a sole proprietorship. One of the many benefits of working under this legal title is the ability to open a One-Participant 401(k), also known as the Solo 401(k). The Solo 401(k) is perfect for maximizing the value of your side hustle earnings. It has higher contribution limits than the traditional IRA, while still allowing you to save for retirement with tax-free contributions. Solo 401(k) plans are perfectly designed for the side hustle, as they can only be utilized by business owners without employees. The Solo plan, much like the traditional 401(k) you may have at your full time job, allows for a tax advantaged retirement savings account. Unlike the traditional plan, Solos can be self directed, meaning you do not have to pick your investments from a limited list given to you by your plan director.
The Solo plan allows you to seize any investment opportunity, including real estate, while expenses or income related to the investments will be paid or received through the plan. You can even deduct your contributions to your plan from any taxable income your side hustle generates. The Solo plan also provides an efficient means of sharing and saving the profits from your business with yourself, profit sharing contributions can be made up to 25% of your salary. Salary deferral contributions can be made up to 100% of salary or $18,000. After the age of 50, salary deferrals can be up to $24,000. Total combined contributions for fiscal year 2017 can be up to $54,000 and $60,0000 if you are age 50 or older. A traditional IRA only allows a maximum contribution of $5,500 over the same time period.The staggering discrepancy makes it clear why the solo 401(k) can be advantageous. Keep in mind that if you have a 401(k) at your full time job the contribution limit between both your plans cannot exceed $54,000 including company contributions, while your personal deferral can not exceed the $18,000 and $24,000 limits referenced earlier. It is worth noting that if you are contributing the combined maximum each year, you are probably ahead of the curve in terms of retirement savings.
With such large contribution limits there could be a risk of putting too much money away, so if you underestimate the capital requirements for your side hustle or personal life and need a loan to finance your activity, the Solo plan allows for this. You are able to draw a personal loan of up to $50,000 or 50% of your account balance if you meet certain requirements. The loan can be used in any manner you choose, from personal investments to business purchases. The flexibility provided from a self-directed Solo plan is perfect for individuals who have the time, and want to put in the effort to make the important decisions regarding their investment management. Please consult a tax or financial advisor before taking any loans as they are not the cheapest way to access money.
For individuals who do not wish to spend their time on money management, but rather focus on their job and their freelance efforts, Solo plans do not need to be self-directed. Just like the traditional 401(k), Solo plans can be managed by a plan advisor. For most people this is the preferred choice, as finding a healthy balance between your side hustle, personal life, full time job, 401(k) investment research, and portfolio management can become an unsustainable act. These advisor-based accounts have more limited investment options, however the options are already carefully vetted and selectively chosen by certified investment professionals.
If you are planning for retirement and love to work a side hustle, it is certainly worth considering opening a Solo 401(k) plan over the traditional Roth IRA plan. With higher contribution limits, more optionality in investments, and the liquidity from personal loans, the Solo 401(k) should be a strong candidate in your search for a retirement plan. As with all retirement products, it is best to consult with a tax advisor and a fiduciary financial advisor to understand all the nuances and determine which plan is best for you.
If this is something that interests you, the first step would be to contact an attorney or check out your state’s division of corporations.
If you are already incorporated, you can talk to your financial institution about opening a solo 401(k).