Taking a second job or launching a sideline business and shoveling the income into a tax-advantaged retirement savings plan can grow your nest egg astonishingly fast.
Even if you’re taking full advantage of your 401(k) or other workplace retirement plan at your day job, you can still stack some retirement savings on top of that. Not only will you be bulking up your reserves, you’ll also lower the tax bite that comes with a second income.
Here are five ways to work your plan.
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Maximize your deferred income
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Tax-advantaged salary deferral — the employee contribution portion of savings in a workplace 401(k) and a separate side-gig retirement savings plans — is limited in 2016 to a combined total of $18,000 if you’re younger than 50 and $24,000 if you’re 50 or older.
CFP professional Brad Berger, author of “Stop Trying to Keep Up With the Joneses: They’re Broke Anyway,” suggests that you figure out how to divvy up that deferral so you get the most bang for the buck.
He offers these retirement savings strategies:
If you have two W-2 jobs, you may be able to split the deferral amount between both employers and grab both matches.
Accept just the employer contributions to your 401(k) and make your contributions from your side-job income. Since self-employed people pay both the employee and the employer’s share of Social Security taxes, assigning the whole deferral to your self-employment income may lower your taxes.
If your employer doesn’t offer a Roth 401(k), you could open your own. (Keep reading for details.)
If your spouse is involved in your side business, analyze all income sources and choose a deferral strategy for each of you that maximizes your joint savings.
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Consider a SEP-IRA
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If your second job is entrepreneurial — you’re mowing grass evenings and weekends, for instance — a SEP-IRA is probably the easiest way to save because it requires the least amount of IRS paperwork and allows for substantial savings.
Fund the plan at your day job if your employer matches your contributions. “Make sure you’re getting the full match at work — don’t pass up the free money — then go with a SEP-IRA,” says CFP professional David Rae, vice president of client services at Trilogy Financial Services.
The IRS does allow you to have both a 401(k) at one employer and a SEP-IRA for your small business, taking full advantage of tax deductions up to the limits.
For 2017, contributions to a SEP-IRA can’t exceed the lesser of 25 percent of the employee’s compensation or $54,000. A plan can be set up and contributions made right up to the tax payment deadline.
On the downside, it doesn’t allow catch-up contributions for those 50 and older.
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For some people, a solo 401(k) is better
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The solo 401(k) requires more IRS paperwork, but its structure allows some workers to save more than they are able to save in a SEP-IRA.
If you contribute to a 401(k) at work, you can’t duplicate the employee share of savings in the solo 401(k), but you can pick and choose. If you don’t contribute to your plan at work, or if you limit your workplace savings to the amount that gives you the maximum employer match, then you could put aside — tax-advantaged — the balance of the allowed $18,000 amount ($24,000 for those 50 and older) in the solo plan. This can be good for people with sideline businesses that generate modest earnings.
Plus, because you are your own employer, you can contribute up to 25 percent of net earnings from self-employment, up to $54,000 (after deducting your $18,000 or $24,000 elective contribution and half the self-employment tax).
Solo 401(k)s also have a Roth option, while SEP-IRAs don’t. And when both halves of a couple participate in the side business, both can have a solo 401(k), maximizing the family savings.
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Retired and still working
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If you’re 70 or older and are still working for someone else or running your own business, you have some limitations in how you save for retirement.
The IRS doesn’t allow contributions to a SEP-IRA or even a traditional IRA after age 70, but at that age, you can continue to contribute to a solo 401(k). The catch is that beginning at age 70 1/2, you must start taking required minimum distributions, or RMDs, so for many people, opening these plans in late life seems counter-productive.
A better idea is to open a Roth IRA. While the contribution limits are low, you can put aside $6,500 annually, including the catch-up contribution.
“You won’t get a deduction, but the money will grow tax-deferred and there is no RMD on a Roth,” says Rae.
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Big earners may consider a pension plan
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High earners may want to consider opening a defined benefit plan — a traditional pension plan.
“If a couple has a solid business and they really don’t need the income, by opening a small defined benefit retirement plan, they can put about 80 percent of their earnings away pretax,” says Thomas Hamlin, CEO of Somerset Wealth Strategies. “You have to contribute every year for at least five years.”
The couple have to be committed to this strategy, and it does require an actuary to determine funding levels and file the necessary paperwork with the IRS.
But for retired executives who are delving into a second career, it pays off. “They don’t need the income — they are set — but it doesn’t make sense to pay taxes unnecessarily on money that they aren’t using for daily income. This keeps them from having to do that,” Hamlin says.