If you’re self-employed, you may have a tough time relating to traditional financial advice. The financial self-help publications are targeted towards mutual fund investing and the on-line sources of information are geared towards employees earning paychecks and not having to worry about all of the things that go through the mind of a self-employed person.
It’s harder to budget when you don’t make the same amount of money each month. If your monthly income isn’t consistent and you have no employer withholding your tax contributions, budgeting and financial planning gets a little more complex.
From saving money for taxes to ensuring your retirement needs are met, here are seven tasks to you should consider implementing if you’re self-employed:
- Save percentages, not fixed $$ amounts
If your monthly income fluctuates, designating a specific dollar amount to emergency savings and retirement accounts could lead you to save too little during high-income months and too much during low-income months.
Instead, allot a percentage of your monthly income to retirement and emergency savings. That way, you’ll contribute more to your most important financial goals when you have more money, and less when you have less. Regardless of what you make in a given month, 10 percent of your monthly net income is always a good rule of thumb for how much you should set aside for your retirement account and emergency savings fund (we’ll tackle “Taxes” next).
- Pay Taxes First
The “Pay Yourself First” theory goes out the window when we’re talking about Taxes! If you are self-employed, your contributions to federal & state taxing authorities must take precedence. While paycheck earners have their taxes withheld, self-employed individuals must set aside taxes on their own. One of the biggest mistakes that self-employed people make is failing to set aside money for taxes and learning they owe $10,000 or more at tax time. And because that first big tax bill is generally unexpected, we find that many self-employed clients don’t have that money when they need it.
Self-employed people also must make estimated tax payments on a quarterly basis. If you pay late, you’ll end up paying interest and penalties, which will ultimately cost you more. To make sure you have enough set aside, stash away 30 percent to 35 percent of your net profit each month for taxes. After we’ve worked with you to maximize your business tax deductions at our South Hills office, it’s likely that your actual tax bill will be lower than that range, but it’s better to be safe than sorry.
- Take Advantage of Time
While you’re preparing for that tax bill, it’s perfectly acceptable to make a little money on the money you’re using to pay your taxes. Though you won’t get rich off of the investment returns, an interest-bearing checking or savings account will at least let you make something on the money that you’re stashing aside. That’s how companies like ADP and Paychex make most of their profits.
While you won’t be writing many checks from this account, make sure you won’t be penalized for low balances because you will be hitting the account hard every quarter to pay your taxes.
Short-term CDs are another option for those who want to make a little money on their tax savings. Unlike checking and savings accounts, which offer more liquidity, CDs tie up your money for a set period of time. For self-employed individuals who know they won’t be touching that money for three or more months, a three-month CD could be a good option for your tax money.
- Make a Budget and Stick to it
You may not be able to predict your income from month to month, but you can determine how much money you need to live on. Figure out how much you must spend on housing, utilities, food and other living expenses, and then use that money to determine how much you’ll be allotted to spend each month. We suggest that you transfer this amount each month from your business checking account to your personal checking account.
If you’re not reaching this number consistently, you’re not making enough money. No crafty accountant can help you achieve your financial goals or save on taxes if you don’t make enough money to live on. If this is the case, make an investment in our services because we may be able to help with a plan to grow your revenue.
If you are making more than what you need to cover your living expenses, don’t increase your spending! We find that some of the wealthiest people we work with are often the most careful with how they spend their money – and that’s smart no matter how much money you have. Ben Franklin’s famous adage “a penny saved is a penny earned” still holds true today.
- Build Financial Confidence by Building Cash Reserves
If your small business is anything like our Pittsburgh Tax Practice, you’ll have more income in some months than others (did someone say “Tax Season”?). When you have a month in which you double or even triple your typical income, take out your percentages for taxes, retirement and emergency funds, give yourself your salary, and put the rest in what we like to call your “Reserve” Fund – and Never, Ever use the money that’s in your Reserve fund! OK, that’s not really true but it’s the mindset you should adopt. If you find that you need funds to cover a substantial expense, be creative and figure out how you can pay for it without touching the Reserve Fund.
As the balance in your Reserve Fund builds up, you’ll gain confidence and increase that much-needed feeling of financial security.
- Tackle Other Financial GoalsOnce you have six months’ worth of operating & living expenses in your Reserve Fund, you should focus on other financial goals. If you have substantial debt, you’ll want to tackle that first. After that, ask yourself how you can best use your extra cash flow. Do you need to invest in your business for expansion, do you have two teenage kids to send to college, do you want some permanent life insurance, or do you want have other financial goals?
Since your basics are covered at this point, the extra money you make in a good month can go toward paying down that debt or building up that 529 college savings plan. If you’re consistently making more money than you need, increase the percentages you’re allotting to retirement and savings. If you’ve made it to this point in the plan, it’s time to begin working with a qualified personal wealth advisor.
- Communicate With your Tax ProfessionalOnce your plan is set and working, check in with us at Franty & Company in McMurray, PA periodically to make sure you’re also on track with taxes. If you haven’t learned this already, you’ll find that taxes can really hit you hard when you’re not prepared.