It’s not the best option for every self-employed individual, but for people with a relatively small side gig, a SIMPLE IRA is a brilliant way of maximizing your retirement savings.
Are you one of the millions of U.S. residents doing some sort of side work to supplement your regular income? Or perhaps a “gig” job is your primary source of income. Maybe you’re a contractor with just one customer.
Nearly half of all Americans are doing something on the side to make extra money. And it’s important to understand this alternative employment doesn’t exclude you from retirement savings options that most conventional corporate employees have. It’s just that your options might look a little bit different.
And there’s one retirement savings account in particular you might be interested in for one often overlooked reason.
Not all self-employment retirement accounts work the same
If you think 401(k) retirement accounts are limited to large employers, think again. Sole proprietors willing and able to handle the paperwork and accounting they require can establish their own one-person 401(k) plan.
The same basic contribution rules and limits that apply to major employer plans also apply to solo 401(k) plans. And these ceilings tend to be high. As an employee you can put in up to $22,500 of any personal earnings into such an account this year, while as an employer, you can chip in up to another 25% of your earnings. The only catch? Not counting catch-up contributions for older workers, you can’t put in a combined total of more than $66,000 into a one-participant 401(k) account this year.
Just bear in mind these limits are raised every year.
There is one downside to such retirement plans though. That is, they can be a bit time-consuming and complicated to manage if you’re not looking to — or are unable to — max out your contributions as an employee and employer.
A SEP (or simplified employee pension) IRA is a reasonable, easier-to-manage alternative. But SEP IRAs have one major potential limitation: You can’t contribute more than 25% of your total earnings. If your side hustle isn’t a huge operation, this contribution cap could prove rather limiting as a retirement savings vehicle.
There’s a third option, however, that may be of interest to you if your big goal with your side job is socking away as much money as you can for retirement. It’s called a SIMPLE IRA.
The SIMPLE IRA makes good sense for most small side gigs
Just like the name implies, SIMPLE IRAs are simple. That’s not how they got the name, though. “SIMPLE” is actually an acronym for “Savings Incentive Match Plan for Employees.”
But you don’t have employees? Well, actually you have one … you! The rules about how SIMPLE IRAs work are the same whether you have up to the legally allowed 100 plan participants or if it’s just yourself.
With just a quick glance, SIMPLE plans look a lot like solo 401(k) plans and SEP IRAs. As an employee, you can’t contribute more than $15,500 into a SIMPLE account this year, while as an employer you are required to annually contribute between 1% and 3% (depending on the terms of the plan) of the employee’s earnings to the same account based on this year’s maximum of $330,000 of personal compensation.
Where SIMPLE IRAs are unique, however, is that there is no percentage-based limit on how much of your self-employment income can be deposited into such an account. You can contribute up to 100% of this income into a SIMPLE account if you want, as long as that amount doesn’t exceed $15,500 this year. That’s a big opportunity for side hustlers to put away the bulk — maybe even all — of a relatively small business’s earnings into a tax-deferring account. Never even mind that SIMPLE IRA accounts are just simpler to open and operate, since they don’t require annual updates submitted to the IRS.
Weigh your personal pros and cons
None of this is to suggest a SIMPLE IRA is inherently the best self-employment retirement saving account in all cases. It isn’t. There are cases where solo 401(k) and SEP IRA accounts do make the most sense. They’re great options, for instance, for relatively high earners, since both of these account types have high overall contribution limits.
Self-employed individuals and contractors should also keep in mind there are limits to how much of your own money can be deposited into any and all of your IRA accounts in any given year. For instance, if you’re simultaneously contributing to a work-sponsored 401(k) plan and a SIMPLE IRA, your net contributions from your personal earnings are capped at $22,500 this year — the same as the 401(k) limit. And your SIMPLE IRA’s cap still remains at $15,500.
For most sole proprietors and gig workers though, that’s not a limitation that comes into play too often.
This cap also doesn’t prevent you from contributing to a traditional or Roth IRA, which aren’t specifically linked to your business. These are retirement saving vehicles open to most anyone with personal earnings regardless of where they came from.
You should also know that most of the contribution limits discussed above are raised for people 50 years old or older, and of course, all of these limits are raised on a regular basis.
One last bit of advice
Although you’re not required to do so, it might be best for self-employed people to establish a business entity with a unique tax identification number that’s different from you and your Social Security number. This won’t alter your personal eligibility to establish and contribute to a SIMPLE IRA, but it could safeguard you if for some reason you ever need to prove you’re operating a legitimate stand-alone business allowing you to contribute to a SIMPLE IRA.
Of course, such a business structure also assumes you’ll be filing all the appropriate tax paperwork every year.
