As the gig economy continues to grow, more and more individuals are earning income through 1099-NEC forms. This type of income is typically earned through self-employment, contract work, or freelance gigs. If you or your spouse fall into this category, you may be wondering about the tax implications and retirement savings options for this type of income. Specifically, you may be wondering if 1099-NEC income is eligible for SEP IRA or Solo 401(k) contributions.
What is 1099-NEC Income?
Before diving into retirement savings options, it's important to understand what 1099-NEC income is. Form 1099-NEC is used to report non-employee compensation, such as income earned through self-employment. This includes income earned as a freelancer, independent contractor, or through a side hustle. It is important to note that individuals who receive 1099-NEC income are considered self-employed and are responsible for paying their own taxes.
Retirement Savings Options for 1099-NEC Income
Now that we have a better understanding of 1099-NEC income, let's explore the retirement savings options available for individuals who earn this type of income. The two main options are SEP IRAs and Solo 401(k)s.
A Simplified Employee Pension (SEP) IRA is a retirement savings plan that allows self-employed individuals to contribute a portion of their income into a tax-advantaged account. For 2021, the maximum contribution limit for a SEP IRA is 25% of your net earnings from self-employment, up to a maximum of $58,000. This means that if your spouse earns $20,000 in 1099-NEC income, they can contribute up to $5,000 into a SEP IRA.
It's important to note that contributions to a SEP IRA are tax-deductible, meaning they can help lower your taxable income for the year. However, withdrawals from a SEP IRA are subject to income tax in retirement. Additionally, contributions to a SEP IRA cannot be made by your employer, as you are considered self-employed.
A Solo 401(k) is a retirement savings plan designed for self-employed individuals or business owners with no employees, other than a spouse. This type of plan allows for both employee and employer contributions, making it a great option for individuals who earn 1099-NEC income. For 2021, the maximum contribution limit for a Solo 401(k) is $58,000 for individuals under 50 years old and $64,500 for individuals 50 years old and over.
Similar to a SEP IRA, contributions to a Solo 401(k) are tax-deductible and can help lower your taxable income for the year. However, unlike a SEP IRA, a Solo 401(k) also offers the option for Roth contributions, which are made with after-tax dollars and are tax-free in retirement. This can be a great option for individuals who anticipate being in a higher tax bracket in retirement.
Consult with a Tax Advisor
While SEP IRAs and Solo 401(k)s are both great retirement savings options for individuals with 1099-NEC income, it's important to consult with a tax advisor before making any decisions. A tax advisor can help you understand the tax implications of each option and determine which one is best for your specific financial situation.
In summary, if your spouse is on track to earn $20,000 in 1099-NEC income in 2023, they can contribute up to $5,000 into a SEP IRA or $58,000 into a Solo 401(k), depending on which option best fits your financial goals. However, it's important to consult with a tax advisor to determine the best course of action for your specific situation. As always, it's important to prioritize saving for retirement and taking advantage of tax-advantaged accounts can help you reach your long-term financial goals.