Many people have side businesses generating income that can be used as a funding source for retirement planning. This is especially advantageous if you have a side business but no retirement plan through your primary employment. But there are ways to increase funding of your retirement plans even if you are covered on your job. In addition, funding a retirement plan with side income is a way of converting a current business activity into a long term benefit that has the potential to provide for you for the rest of your life.

Retirement Account Options for Self-Employed and Freelance Workers

Some people use their side income to accelerate debt payoff or to increase their savings. For the best long term benefit, consider sticking the money you earn on the side into a retirement account. Here are five options to consider (all contribution limits current as of 2014):

Individual Retirement Account (IRA)

BudgetingEven if you are covered by a retirement plan through your main employment you may still be able to take set up an IRA. Contribution limits are $5,500 per year ($6,500 if you’re 50 or older). A single taxpayer covered by an employer plan can take a full IRA deduction with a modified adjusted gross income (AGI) of up to $60,000. After hitting this income level, the deduction phases out until at $70,000 it’s gone completely. For married couples, the phase out begins at $96,000, and is gone completely at $116,000.

However you can still make an IRA contribution even if your total income exceeds these limits. In this case, the contribution itself won’t be tax deductible, but the earnings on it will accrue on a tax-deferred basis until withdrawals begin at retirement. Any withdrawals from the plan will be subject to taxation and a 10% penalty if the money is taken prior to turning 59 1/2. But any contributions made that were not tax deductible will not be subject either to tax or the penalty. Withdrawals are required beginning when you turn 70 ½.

Roth IRA

As with an IRA, you can contribute up to $5,500 per year ($6,500 if you’re 50 or older), but Roth IRA’s are fundamentally different in that they aren’t tax deductible regardless of income level. Roth IRA contributions cannot be used to reduce your taxable income, and for that reason they can be withdrawn at any time (even after retirement) without being subject to tax. Only the earnings on your contributions will be subject to tax when withdrawn. Roth IRAs also have no required minimum distributions, so you are never forced to start withdrawing the funds. Just as with IRA’s, contributions are determined by modified adjusted gross income (AGI). But unlike IRA’s, if you exceed these limits, you cannot make a Roth IRA contribution at all. For 2014, for single taxpayers, eligibility begins to phase out at an AGI of $114,000, and is gone completely at $129,000. For married couples filing jointly the phase out begins at $181,000, and disappears fully at $191,000. Contributions to a Roth IRA must be reduced by any contributions made to a traditional IRA in the same year, however you can contribute to a Roth IRA even if you have another retirement plan, such as Simple or SEP IRA, as will be explained below.

See Roth IRA contribution limits and Roth IRA income limits for up to date information.

Simple IRA

The Simple—or Savings Incentive Match Plan for Employees—can be used for a sole practitioner or for a small business with fewer than 100 employees. The maximum contribution is $12,000 per person ($14,500 if you’re 50 or older) but it cannot be used if you’re covered under another retirement plan (other than a Roth IRA). That means for those under age 50, you can set aside $12,000 in a Simple IRA and $5,500 with a Roth IRA bringing your total annual retirement savings to $17,000. One of the more flexible aspects of this plan is that you can elect to contribute based either on a percentage of income or on a flat dollar amount. However, if you have any employees at all, you will generally be required, as an employer, to provide a matching contribution equal to 3% of their wages. If you have a small freelancing gig and never plan to hire employees, this shouldn’t be a problem. Simple IRA’s have a minimum income limit of $5,500, so if your side income is minimal, this plan may not work for you.


This is one of the simplest retirement plans to set up, and as a self-employed business person, you can contribute up to 20% of your earnings up to a maximum of $49,000. The contribution must come from business income, but if you earn that much you could set aside $52,000 in a SEP IRA and an additional $5,500 in a Roth IRA for a total of $57,500 per year set aside for retirement. You can have a SEP even if you’re covered by a defined contribution plan (usually a 401k) on your full time job. According to the IRS,

“If you contribute to a defined contribution plan, annual additions to an account are limited to the lesser of $52,000 or 100% of the participant’s compensation. When you figure this limit, you must add your contributions to all defined contribution plans.”

Since 401k contributions usually top out at $17,500, and IRA’s and Roth IRA’s at $5,500, you’ll have plenty of room to accommodate the SEP contribution.

Solo 401k

A Solo 401k is a bit more complicated to setup, and you have to be sure you qualify. You must own a business (whether sole proprietor, S Corp, and so on), and you can only set aside money for you, your spouse, and a partner in the partnership. If you have part-time employees that work more than 1,000 hours in a year, you cannot utilize this account. However, if you meet the requirements, you can put back a lot of money for retirement. Solo 401ks have the same contribution limit as a traditional 401k — $17,500 — plus as the employer you can kick in an additional 25% of your pay based on your W2 wages. The total amount you set aside for retirement with a Solo 401k can’t be more than $52,000 in a year.

If you have a side business are you taking advantage of any of these plans to enhance your current retirement plans?

Photo by colros via Flickr

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