Being self-employed comes with a variety of challenges when you work for yourself, and remain the main tenants of personal finance – saving, spending, investing and protecting. For example, you’ll need to manage money on a disproportionate income, pay for your own health insurance, and get your head around the various retirement savings options.
As I near my full 8th year of self-employment, here’s what I wish I knew about managing my finances as a small business owner, freelancer and gig economy worker, presented by myFICO had gone.
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Understand the importance of buffer funds
Because freelancing is prone to feast-or-famine cycles, and in turn inconsistent income, you’ll want to have a buffer fund to tide you over during those lean months. What is the difference between Buffer Fund vs Rainy Day Fund? While a rainy day fund, or emergency fund, is intended for real emergencies, a buffer fund is money you can use to cover living expenses if you experience a cash-flow gap. are doing.
While advice like this may prompt an eye roll and have you wondering: How do I set aside money for a buffer fund when you’re struggling to cover the bills? There are a few strategies you can adopt to save on variable income. For example, save a percentage of your earnings after covering monthly expenses, a portion of your tax refund, or cash in during high-income months.
Know your tax responsibility
When you work for yourself, you must pay for your own employment tax, or FICA (Federal Insurance Contribution Act), which is made up of Social Security and Medicare taxes. The current rate for 2022 is 15.3%, up from 12.4% for Social Security and 2.9% for Medicare. When you work for someone else, your employer pays half of those taxes, while you are responsible for the remaining half. But when you are self-employed, you are on the hook for the full amount.
In addition to self-employment tax, you are also responsible for paying quarterly taxes. How much you owe in taxes each year depends on a few factors, such as your marital status, number of dependents, tax bracket, income, deductions and credits. In turn, how much you’ll need to set aside varies. A general rule of thumb is to save anywhere from 25% to 30% of your earnings.
Chances are, you won’t need to tap into all that savings to pay Uncle Sam. That’s because of how much you owe from the tax deduction. But it’s better to set that money aside until you file your tax return.
create business budget
In addition to coming up with a personal budget when you’re on a variable income, you’ll need a business budget. A business budget typically includes expenses such as:
Accounting and Productivity Software
Office supplies, and the tools needed to run your business
cell phone and internet
Advertising and marketing expenses (ie, web hosting)
Car expenses (if you use your car for work)
Food and Entertainment for Work
Any other expenses necessary to run your business
Consider health insurance multidimensional
When I first transitioned to full-time freelancing, adding my health insurance premiums to my business expenses, I also considered the following:
Long term disability insurance. A few months after I started freelancing, my eye started hurting. In turn, I could not work for almost a month. This got me thinking seriously about buying long-term disability insurance. If I am unable to work, disability insurance can help me stay on top of my bills. Disability insurance is also available from private insurers and organizations such as the Freelancers Union.
HSA. Since I’m on a high-deductible health plan (HDHP), I throw the money into a health savings account (HSA). An HSA can be used for medical-related expenses other than premiums, such as co-pays, procedures, and qualified supplies and equipment. In addition to medical expenses, some HSA brokerages have the option of investing any contributions not used for your health care.
Explore retirement options
While you work for yourself, you also need to focus on your retirement savings. While you won’t have access to an employer-defined contribution plan such as a 403(b) or 401(k), you will need to consider the following:
Ira. An IRA is a retirement savings option with tax benefits. While it’s not just for the self-employed, it can be a great option to save for retirement while you’re working for yourself.
The two main types of IRAs are Roth and Individual IRAs. The main difference is when you are taxed. While contributions to a Roth IRA aren’t tax deductible, you don’t have to pay taxes when it’s time to make withdrawals. Contributions to an individual IRA are not taxed, but you will need to pay taxes when you start withdrawing money from your savings plans. For 2022, the maximum contribution to IRAs is $6,000, and $7,000 if you are age 50 and older.
September Ira. A SEP IRA can be a good option if you have employees other than yourself. When I started exploring retirement options as a freelancer, I found the process of opening a SEP IRA fairly straightforward and easy. While you can save for employees, it can be used when you are the only employee in your company.
The contribution limit for 2022 is either 25% of net compensation, or $61,000, whichever is lower. So if you’re your own employee, and you pay yourself $60,000 per year, you can contribute up to $15,000 annually to a SEP IRA.
- 401(k) only. Also known as an Individual 401(k), a Solo 401(k) is a retirement savings plan that only works if you are self-employed and have no employees. The beauty of the Solo 401(k) is that the contribution limits are high. You can contribute as both an employer and an employee. For 2022, you can keep up to 25% of your compensation on the employer side. On behalf of the employee, you can contribute up to $20,500.
By getting your head around the aspects of wealth management that are typical of being self-employed, such as budgeting and saving on a variable income, and considering retirement and health insurance premiums, you can stay on top of your finances. Stay tuned and make better decisions.
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