Maybe you’re a freelancer or a gig worker or you have a business on the side. Did you know you can still stash earnings for retirement?
Whether you manage your own farm, pen travel articles, paint apartments, sell jewelry online or pick up rideshare shifts, you still need a solid plan for the future. You may already be saving for retirement in a solo 401(k) if you’re fully self-employed. But many people don’t realize that income from a side business qualifies for retirement, too.
According to Pew Research, as of 2020 freelancers and sole proprietors have less saved for retirement than traditional workers, and only 21.9% save in an IRA.¹ But your side income could boost your retirement nest egg if you save in an IRA designed for your situation.
An IRA, or Individual Retirement Account, is a tax-advantaged investment account. It’s available to anyone with earned income. IRAs can be useful for people who don’t have access to an employer-based retirement plan. Or they can supplement employer plans.
Read on to learn about three types of IRAs and how they work.
SEP IRA
A Simplified Employee Pension (SEP) IRA is designed for self-employed workers and small business owners. In essence, you’re the “employer” putting in money from your business on behalf of yourself. (Only employers are allowed to contribute to a SEP, not employees.) If you have a good side hustle, a SEP IRA may let you save more than other IRA options because the limit on how much money you’re allowed to add is higher.
Contribution Limit
A SEP allows you to contribute up to 25% of your total compensation, up to $69,000. (That’s for 2024; the IRS adjusts the limit each year.)
To determine how you much you can contribute, you have to use a special IRS calculation . For most sole proprietors, it translates to roughly 20% of net profit.
Let’s say your net profit was $40,000. Then you could put approximately $8,000 in your SEP.
Compare that to a traditional or Roth IRA. Those let you contribute no more than $7,000 per year ($8,000 if you’re over 50), no matter what your earnings were. With a SEP account, however, in a good year, you could sock away more savings from your business.
Another advantage is that you’re not required to put in money every year. That means that if you work less one year or take a break from your gig work, you can skip your contributions. Plus, money you put in a 401(k) at your day job doesn’t affect how much you can save in a SEP.
Tax Implications
Like a traditional IRA, SEP contributions are tax deductible and grow tax deferred. The money you put in your SEP reduces your taxable income so that you get a lower bill for that tax year. And you don’t pay taxes until you make withdrawals, which can begin after age 59½. If you take out money before that age, you have to pay a 10% tax penalty—in addition to the income taxes on the withdrawal. IRA plans do allow a few early withdrawal exceptions (for things like some higher-education expenses or health insurance premiums if you’re unemployed). In those cases, the penalties are waived.
Required minimum distributions (RMDs) used to begin at age 72, but as of January 1, 2023, under the SECURE Act the age is now 73. It will raise to 75 in 2033.
SIMPLE IRA
SIMPLE IRA (which stands for Savings Incentive Match Plan for Employees) is another retirement account for small business owners, self-employed people or nontraditional workers. The SIMPLE IRA has lower limits than SEP IRAs on how much money you can contribute.
Contribution Limit
For 2024, the maximum you can put in from your earnings is $16,000 with an extra $3,500 “catch-up” allowed for those 50 or older.
If you have a full-time day job where you’re putting money in a company 401(k), you can contribute a maximum of $23,000 across both accounts. That’s $30,500 if you’re 50 or older. The limit makes the SIMPLE a bit different from a SEP account.
On the upside, you’re allowed to put in 100% of your earnings (up to $16,000 or $19,500). If you have a side gig that doesn’t earn more than, say, $10,000, you could save that whole amount in a SIMPLE IRA—as long as you don’t exceed the total limit across retirement plans.
One more thing to know: Employers must make contributions every year. That’s different from a SEP.
Tax Implications
SIMPLE contributions are tax deductible and grow tax deferred. You don’t pay taxes until you take distributions—just like a SEP. The same RMD rules at 73 apply to the SIMPLE, too. Generally, you can’t take out money before age 59½ without penalties (with some exceptions). If you withdraw money within two years of the date of your first contribution, you’ll pay an early withdrawal penalty of 25%.
Deciding between the two retirement plans for your business may depend on the size of your company and contribution flexibility among other factors. Learn how to decide between a SEP and SIMPLE IRA.
Roth IRA
A Roth IRA also isn’t specifically meant for self-employed small business owners the way SEP and SIMPLE plans are. Anyone can open a Roth as long as they have earned income and they don’t exceed the qualifying income threshold. For someone earning a lower side income, the Roth may be a good choice.
Contribution Limit
For 2024, a Roth IRA allows a flat $7,000 annual contribution ($8,000 for those 50 and older). However, Roth owners do have income limits: Your modified adjusted gross income can’t exceed $161,000 (single filer) or $240,000 (married, filing jointly).
Tax Implications
Here’s where the Roth is different from all other IRAs: You pay taxes upfront because you’re using after-tax dollars. But that also means your withdrawals in retirement aren’t taxed the way other IRA withdrawals are.
Other advantages include no minimum distribution at 73. You can keep putting in money beyond that age. And you can withdraw contributions penalty free any time before you are 59½. However, if you withdraw the account’s investment earnings before age 59½, you’ll pay a 10% penalty. Make sure you understand the difference between contributions and earnings if you need to make a withdrawal before your retirement age.
Need help opening a retirement account?
Let’s talk about the best option for your side business.
Pew Research Center Survey: Nontraditional Workers (Also Known as Contingent, Independent, or Gig Workers), July, 2020 https://www.pewtrusts.org/-/media/assets/2021/04/methodology_survey_of_nontraditional_workers.pdf
IRS Circular 230 Disclosure: American Century Companies, Inc. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with American Century Companies, Inc. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.
This information is for educational purposes only and is not intended as tax advice. Please consult your tax advisor for more detailed information or for advice regarding your individual situation.
IRA investment earnings are not taxed. Depending on the type of IRA and certain other factors, these earnings, as well as the original contributions, may be taxed at your ordinary income tax rate upon withdrawal. A 10% penalty may be imposed for early withdrawal before age 59½.
This information is for educational purposes only and is not intended as a personalized recommendation or fiduciary advice. There are different options available for your retirement plan investments. You should consider all options before making a decision. Our representatives can help you evaluate all of your distribution options.
SIMPLE IRAs:
Taxes are deferred until withdrawal if the requirements are met. A 10% penalty may be imposed for withdrawal prior to reaching age 59½.
If withdrawals are made within the first two years of participation in the SIMPLE IRA, the penalty increases to 25%.
Roth IRAs:
Please consult your tax advisor for more detailed information regarding the Roth IRA or for advice regarding your individual situation.
Taxes are deferred until withdrawal if the requirements are met. A 10% penalty may be imposed for withdrawal prior to reaching age 59½.
You could lose money by investing in a mutual fund, even if through your employer's plan or an IRA. An investment in a mutual fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency.