One of the great benefits of starting up a side hustle is the ability to get paid as an independent contractor. When you consider all of the sweet benefits you get from side hustling, you have to assume that the government must want us to pick up a side hustle.
Take tax deductions, for example. The government lets you deduct expenses related to your side hustle for things you might already be doing anyway. With a little planning, someone driving for Uber in their spare time could easily offset some or all of the costs of driving that they’re already doing anyway.
Perhaps the most amazing thing that the government lets you do as a side hustler is to save money into extra retirement accounts that other people don’t have access to. If you start a side hustle, you can save a part – or in some cases, almost all of your side income – into special tax-advantaged accounts like a Solo 401k, a SEP-IRA, or a Simple IRA. And depending on how much you make and what type of retirement accounts you already have, you could potentially save thousands more per year in tax-advantaged savings.
I’ll have four tax burgers, one IRS-wich, withhold the lettuce, three dependent size sodas, and a FICAccino.
I’ve always assumed that these types of accounts were only available to people running “real” businesses. For whatever reason, it never occurred to me that an Uber driver or a DoorDash courier could also contribute to these accounts. But yes, even an Uber driver or DoorDash delivery person (or any gig economy person) can potentially save away thousands of extra dollars per year in a way that a person only working a 9-5 job can’t do.
A few years ago, I finally got around to setting up a Solo 401k for myself. By opening up a Solo 401k, I’ve created a bonus retirement account for myself, giving myself years of tax-free growth, and best of all, reducing my tax liability now. And this is all from doing nothing but lowly on-demand, gig economy work.
If you’re doing Uber, Lyft, Postmates, DoorDash, Rover, or working with any other sharing economy or gig economy app, you need to look into the power of the Solo 401k.
What’s A Solo 401k And How Can You Use It?
Most traditional employees will have access to just two types of retirement accounts – a 401k through their employer and an IRA or Roth IRA. If you’re a little savvier, you might sign up for a high deductible health plan also and contribute to a Health Savings Account.
But, if you’re really savvy, you might pick up a side hustle and create yourself another retirement account with a Solo 401k.
The mechanics of a Solo 401k are fairly straightforward. If you’re earning income as an independent contractor, you’re eligible to create this type of retirement account. In essence, when you’re side hustling as an independent contractor, you’re essentially your own small business. This allows you to create your own retirement plan for your own independent business.
There are two parts to the Solo 401k – the employer part and the employee part. As an independent contractor, you’re both the boss and the employee of your own little business.
For someone like me, a Solo 401k is perfect because it lets me save the most money. My day job doesn’t have a 401k – instead, I have a 457 plan at work. The IRS calculates the contribution limits for a 457 separately from contributions to a 401k. This means that I can max out my 457 and still contribute almost all of my side hustle income into a Solo 401k, treating it as my employee contribution. Not only does this give me the benefit of compound growth, but I also get an immediate return by deferring all of the taxes on that income at a point in my life when I’m in a pretty high tax bracket.
A Solo 401k also makes sense for me because of my expected income growth. By keeping my side hustle income in a Solo 401k, I don’t have to worry about any pro-rata rules messing up any future backdoor Roth contributions in the same manner that using SEP-IRA would.
Setting Up My Solo 401k
The process of setting up a Solo 401k seems like it might be complicated, but it’s actually pretty easy. I ended up going with Fidelity for my Solo 401k because they have no administrative fees and you can invest in very low-cost Fidelity index funds. When you’re ready to start your Solo 401k, you can check out the step-by-step guide that I wrote about how to set up your Solo 401k using Fidelity.
Vanguard is also a fine choice for a Solo 401k, but they charge you $20 per year for each mutual fund you invest in. Since I only make a few thousand dollars per year of side hustle income, that fee doesn’t seem worth it to me, especially when I can get essentially the same thing for free elsewhere.
To set up your Solo 401k plan, you’ll need to first grab yourself an Employee Identification Number, or EIN. You can grab one online through the IRS website. I got mine in just a few minutes. After that, I went to Fidelity’s website, where I filled out an adoption agreement and an account opening agreement. I then mailed the forms to Fidelity. My Solo 401k was set up just a few days later.
*Note that you need to set up your Solo 401k by December 31st if you want to contribute for that tax year. Once your Solo 401k is set up, you have until your tax filing deadline to make your contributions. It only took me a few days to get everything set up, so even if you’re running close to the end of the year, you can still get your Solo 401k up and running.
Treat Your Solo 401k Like A Bonus Retirement Account.
The absolute best way to use your Solo 401k is to treat it like a bonus retirement account. If you’re already maxing out your 401k at work, then, unfortunately, you won’t be able to put in quite as much money. That’s because you’ll only be able to make employer contributions to your plan. I’ll go more in-depth some time about how much you can contribute to a Solo 401k in a future post, but basically, for the employer contribution side, it’s about 20% of your profits for the year. (Update: Here’s a post to help you calculate your employer contributions to your Solo 401k).
Still, someone making an extra $5,000 in a year and already maxing out their 401k at work can put away about $1,000 per year into a Solo 401k as an employer contribution. That’s not so bad. If you’re really good and able to make a ton of side hustle income, you can put away even more.
But the real benefit to a Solo 401k is if you’re like me and don’t have a 401k at work. Then you can really crush it by putting away almost all of the side hustle income you earn. If I’m able to keep making around $5,000 or so per year from side hustles, I can easily put away over $4,500 every year just from my side hustles. Let it compound over time and we’re looking at nearly half-a-million dollars in 30 years.
Imagine how awesome that would be if I could say that I had an extra $500,000 in retirement because I spent the last 30 years working a few hours per week as a lowly delivery man.
Additional Thoughts
- I refer to independent contractors a lot in this post, but really, I just mean any type of self-employment activity. You only need two things to be eligible for a Solo 401k – self-employment activity and no full-time employees. Most people doing side hustles like Uber or DoorDash don’t realize that this activity counts as self-employment since you’re working as an independent contractor, rather than an employee.
- For other reading, consider reading my post on how this might be the easiest time in history to start up a side hustle. As a corollary, it might also just be the easiest time in history to save money for retirement.
- Consider also reading my post on how your side hustle is worth a lot more than you think. You’ll be surprised at how much your meager side hustle earnings can add up if you can stay consistent. Also, check out the underrated value of a side hustle for early retirement.
I’m by no means a tax expert, so take anything I say with a grain of salt. Consult your accountant or CPA before acting on anything I say.
