Self-employment is a great way to enjoy your time as you see fit. But, how do you do it successfully?

I’ve been a financial advisor for 10 years, over the past couple of years I’ve seen more and more clients move to self-employment. It’s an understandable goal, people enjoy having freedom to take on projects they enjoy at their own pace. Selfishly, it’s also one of my favorite goals to plan for with clients. Many feel relieved after we create a strategy. They have solid next steps and a timeline for when they can transition to self employment. Once they start working for themselves, they feel even better.

Getting to the point where you feel comfortable being self-employed is a big step. That is why planning ahead is imperative.

Every plan is different and we want to ensure your plan meets your personal goals and needs. That being said there are some things everyone should consider before starting self-employment.

What is your break even?

Before starting your business you will need to understand your operating expenses. This should include your personal expenses too. You want to create a realistic pricing model to reach your break even and make a profit. From the start you should set a pricing floor, how much you need to charge for each service or client. That will ensure that you are not underselling your services.

We recommend that you create a spreadsheet with your fixed business expenses and a separate one for personal fixed expenses. Once you have all expenses laid out you can start working on your pricing model. You want to calculate how many clients you need (or how much product you need to sell) at your pricing model to break even. You can always change your pricing down the line, but you don’t want to under sell yourself or create a model where you have more clients than you can handle.

Plan to pay taxes early and quarterly

The biggest mistake I see clients make is not paying taxes before they are due. Many people know that when they are self-employed they need to save money to pay for taxes. But they’re not making estimated payments, many times this results in an underpayment penalty. We want to avoid paying the IRS more than necessary.

Again, set up a spreadsheet! There’s also software, like QuickBooks, to help with tracking income and expenses. You should track all of your sent and paid invoices, within your spreadsheet you can calculate how much you need to withhold in taxes. These are harder numbers to generalize, you need to account for federal, state, and city taxes. Work with a CFP® and a CPA to figure out how much you should estimate for taxes.

Once you know how much you should withhold from every paycheck you will want to transfer that amount to a separate savings account. Having a separate account specifically for taxes gives you peace of mind that you won’t spend money that is allocated for taxes.

At the federal level estimated taxes are split into 4 payment periods. You can make these payments online.

• April 15th (income earned Jan 1st – March 31st)
• June 15th (income earned April 1st – May 31th)
• September 15th (income earned June 1st – August 31st)
• January 15th of the following year (income earned Sept 1st – Dec 31st)

You will also need to calculate how much you should pay at the state and city level if you are subject to those taxes.

Make sure you have a sufficient rainy day fund

Most people know they need an emergency fund. Emergencies and loss of income happen even as an employee. Once you are self-employed, you need a longer runway. Your income will fluctuate and you need to prepare for that in advice.

We recommend having a dedicated emergency fund as well as a separate PTO fund. Now that you work for yourself you won’t have sick days or vacation days to use. This is generally an advantage of self-employment, until you have a lower income month because you took time off.

For your emergency fund we recommend having 6-9 months of business and personal expenses. This fund comes in handy during slow periods. Our clients who are in seasonal industries, such as wedding photographers, we recommend padding this fund during busy season so you can pull from it during slow season.

Don’t stop saving for retirement

Many think that you’re limited to an IRA or Roth IRA for retirement savings when you’re self-employed. That’s not true, there are specific retirement accounts available to self-employed individuals and small businesses. They are:

• SEP IRA
• SIMPLE IRA
• Solo 401(k)

These plans work in different ways, we’ll dive deeper into how each account differs in another post.

The amount you can contribute to these accounts is based on your income. Because of that, the type of retirement plan will vary based on your business type, income, and how much you can save.

SEP IRAs and Solo 401(k) accounts allow you to establish and make contributions for the previous tax year up until the tax filing deadline. This flexibility is key especially in the firs few years of self-employment.

As always, how much to save and in what account is specific to your situation. We recommend working with a CFP® and a CPA to determine what is best for your situation.

Self-employment is possible, with a strong plan

If you think you’re ready to make the switch to self-employment it’s time to start planning.

1. Research your business expenses including startup costs and ongoing expenses.
2. Create a pricing model.
3. Build a fully funded emergency fund, we recommend 9 months to start. You can reduce to 6 months once you have built up a client base.
4. Set up an income tracking spreadsheet to calculate your tax payments due.

Once you start earning income:

1. Set up a tax savings account and transfer the estimated tax payment from every invoice into that account.
2. Set a reminder to pay quarterly estimated taxes and make those payments. (Don’t forget state and city!)
3. Save for retirement, you can save in a savings account until you determine what retirement account is best for you.
4. Establish a PTO fund!