Side hustles are increasingly popular these days, so much so that an estimated 44 million Americans are doing additional work on top of their regular jobs. Of course, one major benefit of taking on a side gig is having extra money to meet what financial goals are most important to you -- and that includes saving for the future. In fact, 14% of Americans with side hustles say they do that extra work for the express purpose of funding a retirement plan.
Most salaried employees who want to save for retirement have only a handful of choices: They can participate in their companies' 401(k)s, assuming that's an option, or they can open a traditional or Roth IRA. But having a side job makes you self-employed, which means you get the option to save in yet another type of retirement plan, the SEP IRA.
How SEP IRAs work
Short for Simplified Employee Pension, a SEP IRA is a retirement plan designed for independent workers and small business owners. SEP IRAs work just like traditional IRAs in that contributions are tax-deductible the year you make them. In other words, if you put money into a traditional or SEP IRA this year, you'll save money on your 2018 taxes.
SEP IRAs, however, come with much higher annual contribution limits than traditional IRAs and Roth IRAs. Currently, you can contribute up to 25% of your salary, or 25% of your net business earnings -- meaning, your earnings minus your business expenses, SEP contribution, and half of your self-employment taxes -- for an annual maximum of $55,000.
When to use a SEP IRA
If you don't have a 401(k) plan through work, SEP IRAs allow you to contribute far more on an annual basis than what traditional and Roth IRAs allow for. With a traditional or Roth IRA, your yearly contributions are limited to $5,500 if you're under 50, or $6,500 if you're 50 or over.
If you earn enough from your side hustle that your net self-employment earnings total $24,000, and you're 30 years old, a SEP would allow you to contribute $6,000 this year, which is $500 more than what a traditional or Roth IRA would allow for.
Some people who work side hustles do very well for themselves, in which case having that higher threshold can open the door to more savings. But unless you really rack up some sizable earnings on the side, you may not need a SEP IRA.
Furthermore, if you have a side gig but are also offered a 401(k) plan through work, you may be better off taking your extra earnings and using them to fund your employer's plan, especially if doing so entitles you to a larger match on your company's part. On the other hand, if you're not happy with your 401(k) plan, don't get a great match from your employer, and want a wider range of investment choices, putting your side-hustle earnings into an IRA might be the better choice -- but you don't necessarily need to go the SEP IRA route. Rather, a traditional or Roth IRA might serve your savings needs just as well.
In fact, if your earnings don't exceed the threshold for Roth IRA eligibility ($135,000 for single tax filers and $199,000 for married couples filing jointly), a Roth might be the better way to go. Though you don't get an immediate tax break for funding a Roth IRA, your contributions get to grow completely tax-free, and withdrawals aren't taxed in retirement. This gives you access to more income later in life, when you need it the most.
Ultimately, the SEP IRA is a useful tool when you have a side hustle, but only if your earnings are substantial. Because calculating your contributions can be complicated, if you're only talking about a small amount of money, you may be better off using your side income to better fund your 401(k) or a traditional or Roth IRA. But if you make a killing from that second gig, it pays to see whether a SEP IRA is right for you.