Creating a Financial Plan
JULY 14, 2017
When Eugene Kim made the decision to leave behind a longtime salaried career as a chef to become a freelance sound mixer for film and television four years ago, he knew he had to get up to speed — on managing his finances.
After years of relying on the security of a steady paycheck and the other perks of full-time employment, Kim turned to fellow freelancers for advice. Today he contributes regularly to a Roth IRA, he’s automated his savings, and he’s careful to avoid debt.
Managing your money when you’re self-employed isn’t easy. Not only is your income unpredictable, you shoulder responsibilities that W-2 workers take for granted, like setting up your own retirement plan, handling tax obligations and paying for health insurance.
Nonetheless, the freelance population is growing: Approximately 55 million Americans today are freelance workers. And it’s not just young people who are embracing the gig economy. More than one-quarter of people ages 45 to 54 are freelancing too, according to a recent Freelancers Union survey.
If you’re already freelancing or are thinking about becoming your own boss ― maybe starting a second career during retirement ― these tips can help you understand what it takes.
1. Track, Track, Track
Freelance pay’s erratic nature makes it critical that you track your spending and income, and then budget accordingly.
“A key challenge for freelancers is managing cash flow,” says Marc D. Rosen, a CPA at Cameo Wealth and Creative Management, an accounting and business management firm that specializes in working with entertainers.
One way to help prevent yourself from overspending is to follow a “50/30/20” budget. First determine your after-tax income: that’s your gross income, less your business expenses and estimated taxes. Of this money, 50% should go toward basic living expenses, 30% to discretionary items and the remaining 20% should be set aside for savings and paying off debt.
2. Steer Clear of Debt
Freelancers can easily slip into debt if they can’t find work or have customers who are slow with payments.
As a result, freelancers should aim to have at least nine months in emergency savings, advises Galia Gichon, the founder of financial education company Down-to-Earth Finance, who teaches personal finance classes for freelancers.
To the extent that you can, avoid making major purchases for your business until you have the cash to pay for them. Says Kim, “I only buy new gear when a job can pay for it in full.”
If you must take on debt to fund your business, make room in your budget for debt payments and do some research on how to lower debt while building savings.
3. Set Goals and Save Aggressively
Freelancers should apply the same rigor to retirement savings as they do to finding gigs.
When you’re self-employed, you no longer have the luxury of an employer-sponsored retirement plan or any kind of company match. That means you’ll need to set up a retirement account and save more than salaried employees — about 10% to 15% of your pay.
This guideline can be particularly challenging to follow if your income fluctuates. So Gichon advises freelancers to “create tangible goals around what your annual savings should be," and do the best you can to meet your target.
Research shows that even young freelancers are getting wise to the importance of retirement planning: Nine out of 10 millennials who work in the gig economy contribute to a 401(k) or to an IRA, according to American Funds’ latest "Wisdom of Experience" survey.
4. Take Advantage of Tax Benefits
Freelancers can choose from several types of retirement savings accounts, including traditional IRAs and Roth IRAs, solo 401(k)s and SEP IRAs. Each has different features, rules, costs and levels of complexity to consider.
Here’s the good news: Depending on the type of account you choose, you might be able to contribute significantly more than you would as a salaried employee. For instance, if you choose a SEP IRA, you can contribute as much as 25% of your net earnings from self-employment, up to $54,000, for tax year 2017. (Try comparing the different types of IRAs if you want to learn more.)
“This is a big advantage of being a freelancer,” says Douglas Boneparth, president of Bone Fide Wealth (a financial advisory firm that specializes in advising millennials) and co-author of the soon-to-be released book The Millennial Money Fix. “You have a lot of flexibility on how you want to save for retirement.”
5. Attack Your Taxes
Being a freelancer means running your own business, and that means being diligent about your taxes.
While employers withhold taxes on behalf of employees, freelancers are generally responsible for paying estimated taxes on a quarterly basis. Those taxes include income tax as well as “self-employment tax” — both the employer and employee portion of Social Security and Medicare taxes. Failure to pay in a timely manner means you might be hit with penalties.
How much tax should you be paying quarterly? A good rule of thumb is to set aside about one-third of your income. To help make this task easier to manage, you might consider setting up a separate savings account for your tax payments.
“Make sure you’re really organized and have a handle on what has to be put away in taxes, and don’t touch this money,” says Caitlin Pearce, director of advocacy and member engagement at Freelancers Union.
While you might be able to master your taxes on your own, Boneparth sees value in hiring a Certified Public Accountant, or CPA. “This is one area where it’s worth hiring a professional so that you can spend more time doing what you do well,” he says.
All of that work might seem a bit . . . taxing. Fortunately, there’s a silver lining: Freelancers are generally entitled to take many more business deductions than their W-2 peers for expenses like office supplies and home offices.
The Bottom Line
As a freelancer, you ultimately have two jobs: running your own business and managing your finances. While neither is easy, the rewards of hard work and planning can be great.
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