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SEP IRA – The #1 SEP-arate Side Hustle IRA


Updated 06/07/2023

[Today’s post on SEP-IRAs is educational only and is not tax or investment advice. For more information on the website disclosure statement, visit this page. Some terms used in today’s post are from more advance investing discussions I previously posted on. If they are unfamiliar to you, please take a moment to click on the hyperlinks for a quick explanation on the topics.]

Side Hustle IRA Account

With the ascent of the side hustle in pop culture, more and more Americans are finding a second or third income that compliments their primary job. Whether due to stagnating wages, the rise of the gig economy, or the desire to reach financial freedom sooner, numerous influences have led to a surge in side hustle popularity. However, my focus is not on the merits or ways to create side hustle income but instead on using this SEParate income to save in a little-known IRA.

Why Use A SEP-IRA?

So, you have a primary job at work that offers a 401(k) plan, and you maximize it. You have optimized your savings also to max out your IRA or Backdoor Roth IRA too. Maybe you even make a Backdoor Roth 401(k) contribution through after-tax conversions. Impressive.

But now what? You either aren’t eligible or already contribute to an HSA, so you save in a taxable brokerage account with your remaining dollars. However, could there be a better way?

Enter the SEP-IRA, the SEParate IRA for your side hustle income, allowing you to save up to $66,000 a year as of 2023, depending on how much ordinary income you make.

The keyword here is ordinary income – sorry folks, rental income from real estate portfolios is not eligible!

The Basics. What are the benefits of SEP?

Created for those with self-employed income as a way to save for retirement, the SEP is a fascinating IRA account for dual-income individuals.

You see, 401(k) plans have an individual limit of $22,500 for regular contributions and $66,000 in total – the latter is for any employer and or after-tax contributions. 401(k)s then allow for catch-up contributions of $7,500 for 50+ individuals, separate from the $66,000 limit. 

Meanwhile, IRAs have a limit of $6,500, plus $1,000 for those 50+. And yes, you can save in both at the same time.

Interestingly, unlike 401(k) and IRA accounts, there are no income limits to contribute to a SEP-IRA account, and the contribution limit is separate from the prior two. However, the most important governing factors are that the separate income must be ordinary income from self-employed work and that contributions are deductible on a pre-tax basis on up to 20% of your side hustle’s net income. Once your side hustle net income exceeds $330,000 a year, contributions are capped at $66,000.

Significantly, if you have employees and you contribute to a SEP, you must contribute for them too. So, this is not attractive for those with side hustles that employ others on W2 wages if they are not generous.

Why Not More?

Thus, an individual can contribute to a 401(k), IRA, and SEP-IRA if they have 1) Self-employed ordinary income separate from their primary job 2) Their primary job offers a 401(k) or 403(b) plan 3) Enough leftover after expenses to save in all of these accounts and 4) The desire to reduce their income and save in another pre-tax retirement account.

[Yes, if you have a 403(b) plan and are offered a 457(b) and 401(a) as well, you can contribute to all three plus a SEP and Traditional/Roth IRA. Though, most people will not ever be in a situation where they could maximize these five accounts together.]

So, if you want to lower your current tax bill, go for it and save in a SEP-IRA! Why not contribute more for your retirement if you have the means?

Now In Roth

Thanks to the SECURE Act 2.0, SEP contributions are eligible to be made as traditional or Roth contributions, meaning you could save up to $66,000 as separate Roth dollars annually!

But If You Do A Backdoor Roth IRA, Stay Away

Importantly, SEP-IRAs count as another Traditional IRA if you are doing Backdoor Roth IRA conversions. Thus, you would have a mixture of pre and after-tax dollars when you do your conversions, and the IRS requires you to convert some of these pre-tax dollars. Lame, but they want tax revenue after all. 

Additionally, early withdraws from a SEP-IRA are identical to regular IRA and 401(k) early withdraws, meaning they have a 10% penalty assessed on the gross amount.

So, if you do Backdoor Roth IRA conversions or use the money before 59.5, you may want to stay away from the SEP-IRA. Though, SEP-IRAs do not affect Backdoor Roth 401(k) conversions!

In Closing

Now you know about the SEParate IRA for your side hustle income, will you start using one? There are advantages and disadvantages to the SEP, but if your primary goals include saving as much as you can in a tax-preferential way for retirement, this IRA should be on your radar.

But, what do you think? Will you start using a SEP-IRA, or is the loss of Backdoor Roth contributions a deal-breaker for you? Let me know in the comments below and as always, have a great day!

Mile High Finance Guy

finance demystified, one mountain at a time

mile high finance guy

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