Maximize Your Side Hustle Income with a Solo 401(k)

Pocket a few extra bucks by contributing
side hustle income into a solo 401(k)

As many personal finance buffs have discovered for themselves, having a side hustle is a great way to give yourself an edge in the wealth accumulation game.  But if you really want to give yourself an edge, you'll try to figure out a way to get a tax advantage from it, too.  Setting up your own retirement plan, like a solo 401(k), a SIMPLE IRA, a defined benefit contribution plan, or other investment vehicle can be a great way to maximize your earnings and accelerate your savings. 

If your side hustle consists of a part time job working for an employer, you might be stuck utilizing whatever retirement plan your employer offers you (if any).  But 10% of the workforce is self employed (see Bureau of Labor Statistics report: http://www.bls.gov/news.release/empsit.t09.htm), and that number doesn't count the vast numbers of workers who have regular full-time jobs plus some sole proprietorship income from freelancing, consulting, real estate*, tax preparation, mowing lawns, Etsy storefronts, you name it.  If you have self-employment income, even if it's from a small side hustle, you owe it to yourself to look into your options to set it aside into a tax-advantaged retirement account.


Last year, after a several-year hiatus from contributing to my Roth-IRA (the subject of a future post), I finally decided that I needed to take the time to get smart about retirement contributions again.  Thankfully, we live in the age of the Internet, and there is a ton of information out there. 

The IRS itself is one of the most helpful sources for information on retirement vehicles for small businesses.  It has a couple of publications that provide a good jumping-off point for determining which types of retirement plans might work best for you.  Here's a good publication on 401(k)s for small businesses, and here's another good one on other types of retirement plans.  A list of all of the relevant forms and publications is here.

For me, I chose the solo 401(k), also known as the Self-Employed 401(k) or the Individual 401(k).  The reason I chose the solo 401(k) was because my side income typically ranges from a low of about $6,000 to a high of about $20,000.  I wanted to be able to contribute all of my self-employment income into a tax advantaged account, and the solo 401(k) would let me sock away up to $18,000 in elective deferrals as an employee, as well as employer contributions of 25% of income, up to a total contribution of $53,000 for 2015.  Because my side hustle income is relatively small, I would be able to defer 100% of it by using the solo 401(k).  Some of the other options, like the SIMPLE IRA, would limit me to a contribution of 25% of my self-employed income, which is a pretty small number.

My solo 401(k) plan's mascot

The idea of setting up a solo 401(k) might sound a little intimidating, but in my experience, it was ridiculously easy.  I hold my investments with Fidelity,** and they have a great solo 401(k) option that is absolutely, 100% FREE.  They have all of the forms online and good step-by-step instructions (https://www.fidelity.com/retirement-ira/small-business/self-employed-401k/overview), so you can get going quickly.  Because I was nervous about it, I spent some additional time calling a Fidelity rep and asking some questions, but if you're ready to just jump in, you could easily set it up just by following their instructions.  So within an hour of deciding my plan of action, I established the Tax-advantaged Retirement EXcellence plan, or T-REX (yes, you get to name your own plan), and I was off to the races.

You don't need to have a corporation to set one up, either.  You do need to apply for an EIN through the IRS website, because you can't use your individual social security number to set up the plan, but that takes all of 5 minutes.

Last year was my first year of the plan, but I was able to sock away my entire $14,247 of self-employment income (net of the self-employment tax), which is pretty darn awesome.  I not only avoided paying tax on that amount last year, but I now have it in an investment account that I can trade in without having to recognize capital gains every time I flip out of an underperforming stock, mutual fund, bond fund, etc.  Having the tax deferral for my income now is a huge help, but even better is the ability to be nimble with my investments without losing a chunk of income to the capital gains tax along the way.

Do you have any self-employment income from your side hustles, and if so, are you using any tax advantages to further leverage your earnings?  If you've set up your own retirement plan, please leave a comment with the type of plan you set up, the reasons you chose that type of plan, and how easy or difficult it was to get it going.

Footnotes:
* Rental real estate income is typically considered passive income, and is generally not eligible for contributions to a 401(k).  But there are ways to pay yourself a management fee that would enable you to use your real estate management income to contribute to a 401(k).  That is beyond the scope of this blog post, but I may get into that in another post.

** For the record, I am not being compensated in any way by Fidelity.  There are some other online providers who offer solo 401(k)s, and they may be just as good or better.  I'm only writing about Fidelity because it is the only firm I have personal experience with.