When you first start working for yourself, being self-employed seems to offer nothing but benefits. No commuting (usually), no boss looking over your shoulder, and no 9-5 routine dominating your everyday existence. And best of all, you can keep all of your profits to yourself, right? Not exactly. There are a number of expenses involved with running your own business – what we might call “soft costs” – some of which may catch you by surprise. They are among the unexpected expenses of self-employment.
Be sure to work the following costs into your initial budget as you become a self-employed professional. Being aware of them, and having a plan to deal with them, can make the difference between the success and failure of your business.
1. Dry Spells – The Biggest Surprise Among Unexpected Expenses of Self-Employment
If you’ve decided to take the leap into running your own business because work has been plentiful, don’t forget that this may not always be the case. Do you have enough in savings to get through the lean patches if a client is late with payment or you go a few weeks without landing a project?
Make sure you have an emergency fund with at least six months living expenses in it before even starting your business. It will not only serve to cover emergency expenses, but also to even out temporary income dips. As your cash flow increases, be sure to replenish the fund regularly. Cash flow disruptions are an occupational hazard for the self-employed.
You should also have at least three or four paying clients before starting your venture on a full-time basis. And finding new clients should be a permanent part of your business operating plan. If cash and/or new clients are in short supply, consider taking a part-time job to help you get over a rough patch. Being self-employed may present you with more lucrative part-time or contract arrangements than you ever imagined, so be open to the possibilities.
The point of having cash reserves and plans to increase your cash flow aren?t to suggest that your business may fail, but rather to take steps to make sure that it?s less likely to happen in the first place. Self-employment is all about contingency planning! And it starts when your business does.
2. Taxes
You already know that you’ll need to pay taxes on your self-employment income; that’s not exactly unexpected. However, many new entrepreneurs or freelancers are surprised by just how much money goes into taxes. If you don’t budget properly, you will be stuck with a hefty price tag at the end of the year that must be paid. You’ll not only need to pay for your first year of self-employment income, but also estimated taxes for the following year.
Although eventually this will balance out, the first year’s self-employment tax payment can come as quite a shock. Use income tax calculators as you get started to figure out how much you’re likely?to owe, or if in doubt set aside 30% of your income each month. That?s a large enough amount that you should have your tax liability covered in most cases.
3. Insurance
If you want private medical or dental insurance, you’ll have to pay for your own plan now. This can take a hefty bite out of your profits each month, but going without could bankrupt you. Income protection insurance (disability) is another coverage that’s especially important when you’re self-employed. You need to consider the possibility that you might become sick or injured and can no longer work. Disability insurance can help you get through an illness without losing all of your savings.
Another under-appreciated insurance type is life insurance. When you start a business, you?re usually incurring liabilities that will need to be paid in the event of your death. These can include tax liabilities, open accounts payable, employee or contractor wages, and even business loans. Get the largest term life insurance policy for the lowest premium rate possible. You don?t want to leave your family with a mountain of debt – in addition to a suddenly missing income.
4. Retirement Funding
A retirement savings plan is one of the most common benefits for employees. You’ll need to set up your own retirement fund and be diligent about setting money aside each month. Although you may be able to eventually sell your business at a big enough profit to retire comfortably, it’s vital to create this safety net?just in case that doesn’t happen. Don’t wait until you’re close to retirement to start saving. It’s something to think about now.
At a minimum, start an IRA. It?s the simplest form of retirement savings, and not only will it allow you to save up to $5,500 per year (or $6,500 if you’re 50 or older), but it will also reduce your taxable income by the amount of the contribution (in most cases). Once your business expands and cash flow is greater, look into a Solo 401(k) plan, which can enable you to save and shelter as much as $53,000 per year (for 2015).
5. Holidays, Vacations and Other Time Off
There are many perks to the self-employed lifestyle, but paid days off aren’t one of them. Self-employment means that you are often trading time for money. You can have time off – all that you want – but it will cost you in lost income.
Like slow spells, you’ll need to set aside some funds for sunny days as well. However, the upside is that if you have set aside funds, when you see a great last minute airfare or resort package you can jump on it. That spontaneity is part of what makes becoming self-employed worth all the trouble!
Many new freelancers and start-up entrepreneurs underestimate these soft expenses. If you’re new to the world of accounting and finance, it might be a good idea to take a quick online course to help you set a realistic budget. Course listings sites like training.com or your local community college are a good place to get started. You might also want to set up a high yield savings account and pay yourself a wage, saving the rest for these various expenses. This will help keep you on track so that you can enjoy your earnings – and your life as an entrepreneur.
Have you ever thought about these expenses in connection with self-employment? My sense has always been that efficient cash flow management is as important to self-employment as your basic business concept.