Side Hustle or Contractor – You have options! Retirement savings options, that is.

Technology and post-Covid acceptance of remote work has created more opportunity than ever for military spouses to be gainfully employed. PCS’ing to Germany? Keep your job, work modified hours, and collect a tax-advantaged US-based salary.

Others are staying in the same industry, becoming 1099 contractors, and taking their skills and career with them when they move. In other cases, we see transitioning service members and spouses opt for side gigs instead of traditional employment because of the flexibility it offers. Often these “self-employed” opportunities generate very respectable income. The additional income can fatten (early) retirement coffers, but can also leave folks hit by a surprise self-employment tax bill.

So what to do?

There are always pre-tax Traditional IRAs, but the contribution limits are so…limiting. At certain income levels, you won’t even be able to deduct those contributions.

Enter the Individual 401k, SEP-IRA, or SIMPLE-IRA as retirement savings options.

Most know about the TSP and employer 401k tax advantages to reduce taxable income. Contribute $22,500 ($30,000 if over 50) and that same amount comes off your taxable income for the year. For a two-income household, this could save $10,000+ at tax filing time. However, if you have self-employed income, you need to know about these other plans.

What is an Independent 401k or SEP-IRA or SIMPLE-IRA?

Anyone with self-employment income (1099 contract work counts) who has no W-2 employees is eligible to open an Individual 401k. The contribution limits for you as the employee are the same for anyone else contributing to a 401k: 100% of your earned income up to $22,500 if you are under 50, and an additional catch-up of $7,500 for a total of $30,000 if you are over 50.

Then things get interesting. As the employer, you may also contribute an additional 25% of your earned income (S Corp or LLC), or 20% of adjusted income if you are a sole proprietor. The combined total cannot exceed $66,000 if under 50 or $73,500 if over 50. You can make Roth contributions, too, if you are willing to pay the tax bill now. You can see how contributions as both the employee and the employer can add up fast.

The SEP-IRA (Self-employed Individual Retirement Account) is an alternative solution if you have W-2 employees, but it is limited to only employer contributions (see some exceptions) that must be made in equal percentages of salary for yourself and all employees. Thanks to the Secure Act 2.0 in 2023, SEP-IRA plans will allow Roth contributions starting in 2024. Both Individual 401k and SEP-IRA contributions can be made until your tax filing deadline.

If you own a business and have W-2 employees, you also have the option of a SIMPLE-IRA. The rules are a little more specific for these plans. See the link in the SIMPLE column below.

What’s the difference between the two?

The table below illustrates the major differences between the three plans mentioned above.

	Individual401k	SEP-IRA	SIMPLE-IRA
Max employee contributions	100% of income, up to $22,500* 100% of income, up to $30,000**	None, with some exceptions	100% of income, up to$15,500* 100% of income, up to $19,000**
Max employer contributions	As much as 25% of net income up to annual additions limit	The lesser of 25% of income or $66,000	3% matching, or 2% non-elective
Max annual total contributions (employer and employee)	$66,000* $73,500**	$66,000* $73,500**	See link above
ROTH contributions allowed	YES	Starting in 2024	Starting in 2024
Employees allowed	No (exception = spouse)	Yes	Yes, up to 100
Deadline for opening account	Dec 31 of tax filing year	Tax filing deadline for your business	Oct 1 of tax filing year

*under 50 years of age
**50 years of age or older

This calculator is also handy for seeing the differences in which plan to choose based on maximizing retirement contributions for your specific situation.

Retirement Savings Options Examples

Example 1 — Self-employed with no other employer-sponsored plan:

Sue is a 1099 contractor working from home for a big insurance company. As a “sole proprietor”, she made $80,000 in 2022 and had only $2,000 in deductible expenses. She is required to pay $11,934 in FICA payroll taxes (15.3% for SS and Medicare).

She contacts her MFAA financial planner about saving for retirement to save on taxes. Her advisor helps her open an Individual 401k to which she contributes $22,500 (Sue is age 38) as her employee contributions, plus another $14,498 as employer contributions for a total of $36,998 in retirement savings for 2023.

She and her spouse are in the 22% federal marginal tax rate; Sue’s state tax rate is 3.5%. The household will save $9,434 on its 2023 tax bill.

Example 2 — Having an employer-sponsored plan AND an Individual401k:

Sue’s spouse John decides to join her in the contract work after retiring from the military. John can make contributions to the Individual401k under the same business tax ID number. John makes $40,000 after retiring in July. Self-employment taxes are $6,120; there are no additional deductible business expenses.

John had contributed $12,000 to his TSP account before retirement, and he is under 50 years old. He can contribute another $10,500 to his Individual401k as the employee and approximately $7,000 as the employer.

Example 3 — Hiring employees who are 1099 contractors

Sue & John have more contract work than they want to handle after military retirement. They hire two military spouses to work part-time virtually with them. The two new hires are 1099 contractors for Sue & John. Sue & John can continue to use their Individual401k. They encourage both of their contractors to save for retirement in their own Individual401k.

Example 4 — Hiring employees who become W-2 employees

Business continues to boom. Sue & John decide to make everyone a full-time W-2 employee. The business now pays half the payroll taxes for both Sue & John and the two employees. Because of this change of having W-2 employees, Sue & John can no longer contribute to their Individual401k. They can either switch to a SEP-IRA or a SIMPLE-IRA. Item of note: you can offer and contribute to both a SEP-IRA and 401(k) in the same tax year, but the same is not true for a SIMPLE and another plan. More details can be found on the IRS website.

How Do I Decide? What’s Next?

If the self-employment income is just you, or you and your spouse, the Individual401k will give you the most capacity to save for retirement. If you need a plan for you and your employees, consider the SEP-IRA or SIMPLE-IRA. Consult your tax professional for definitive advice for your situation. Need more help understanding your retirement savings options and deciding which is right for you? Reach out and connect with an advisor at the Military Financial Advisors Association!