Got side income? It’s a great opportunity to add to your retirement nest egg. But if you have a day job too, evaluating which retirement plan to open up, and how much money you can put in each plan is tricky. “There are traps,” says Scott Kaplowitch, a CPA with Edelstein & Co. in Boston.
But figuring it out sure pays off. A college professor client of his is saving $74,000 a year in tax-favored retirement plans. For 2014, he’s putting $23,000 in his university-sponsored 403(b) plan (it’s like a 401(k) plan) and another $52,000 into a SEP-IRA plan he set up to shelter a big chunk of his side consulting income. (He makes more than $300,000 consulting.)
The fourth quarter is the time of year to pay attention to maximizing your retirement account savings, especially if you have side income from a consulting job or a side business (income that you report on Schedule C of your 1040 tax return). That lets you fund a solo 401(k) or a SEP-IRA. If you have two jobs at employers that sponsor 401(k)s, it’s important to check that you’re coordinating your contributions to the two plans while you still have time to correct any mistakes by year-end.
For more savings potential, pad your nest with more than one retirement account. (Credit: iStock)
One of the traps for a solo 401(k) is you have to set it up within the calendar year. The deadline for 2014 is Dec. 31, 2014. By contrast, you can open and fund a SEP-IRA until the due date for your 1040, with extensions–meaning you can open one and make 2014 contributions until Oct. 15, 2015.
Just because you have one plan set up, that doesn’t mean that’s the right one to stick with going forward. A marketing executive in his mid-60s on the verge of retirement came to Kaplowitch in 2012 having maxed out his 401(k) at work. Kaplowitch had him set up a SEP-IRA for 2012 and fund it with $20,000, based on consulting income he brought in that year. But the next year, setting up a solo 401(k) let him save more. He ended up with $86,000 of Schedule C income and was able to defer $39,000. His wife brought in $300,000, so the $39,000 deduction on their joint return saved them roughly $16,000 in taxes. Plus, it boosted their retirement kitty. “I felt like he hadn’t saved enough in his 401(k) at work,” Kaplowitch says.
Here’s how stacking retirement plans works. Say you have wage income from a day job at an employer that offers a 401(k) plan. For 2014, you can put away $17,500—or $23,000 if you’re 50 or older—either pretax or in a Roth account if your plan has one, depending if you can use the deduction for the pretax contributions or not. For 2015, there’s a little more room to save: $18,000—or $24,000 if you’re 50 or older.
You want to save some of your self-employment income too. Typically the SEP-IRA is the best choice for someone who has already maxed out a 401(k) at work. Your annual SEP-IRA contribution, all of it pretax, can be as much as 20% of your net earnings, up to a maximum of $52,000 for 2014, $53,000 for 2015. (We’re assuming you operate as an unincorporated sole proprietor reporting your business earnings to the IRS on Schedule C. So that’s 20% of your net earnings after subtracting the one-half of your Social Security and Medicare taxes that are deductible.)
The other plan to consider is a solo 401(k), which is made up of two parts. First, there’s the employee contribution–for 2014, up to $17,500, or $23,000 if you’re 50 or older, the same limit as for workers at a big company. Then there’s the employer contribution, which can equal up to 20% of your net earnings, with a combined employee/employer 2014 contribution limit (including the $5,500 extra for the 50-plus crowd) of $52,000—or $57,500 if you’re 50 or older. The big catch here: You can only make that $17,500/$23,000 salary deferral piece once, in either your day job 401(k) or your solo 401(k); you can’t double dip.
The same rule applies if you have two “day” jobs and both employers offer 401(k)s: no double dipping. Kaplowitch is helping a new client, a doctor with 401(k)s at two practices, take back excess contributions. He was on track to contribute $23,000 to a 401(k) at one employer’s plan and $23,000 at another employer’s plan.
There are cases where you should be contributing to two employer-sponsored 401(k) plans—in order to grab any employer matching money, for example—but you have to keep track of the combined max ($17,500 or $23,000, depending on your age). It’s like spreading your Individual Retirement Account contributions between a traditional IRA and a Roth IRA (you get one annual maximum for 2014 of $5,500 or $6,500 if you’re 50 or older). “You have to be very careful,” Kaplowitch says.
Finally, don’t forget IRAs as a simple alternative for additional savings. Despite their lower annual contribution limits, if you’re diligent in saving every year, it can really add up. For more on IRA savings, see How A High-Earning Couple Got Roth IRAs And You Can Too.
