If you’ve been on someone else’s payroll, the biggest initial adjustment may be learning to survive on a not-so-regular paycheck. Getting established and developing a steady stream of business takes time, and a disruption or lost client could interrupt cash flows and throw plans into disarray.
The best bet is to take time to get organized and plan. Here are five tips to get started:
1. Track your income and budget
Keep track of your business income, so that you can figure out how much you’re earning on average each month. From there, you can develop a robust budget that accounts for all your expenses, including your own salary. If you have months where you earn more than the average, set aside the overage to help smooth out slow periods.
Research apps and software on the market to help automate and organize your efforts. Accurate recordkeeping is critical, so keep all receipts, as you may be able to claim some tax deductions later to save cash. And consider opening bank accounts for dedicated purposes — business, personal, emergencies and taxes.
2. Save, save… and then save some more
Inconsistent income is a reality for sole proprietors, especially in the startup phase when developing contacts and a steady stream of business. Even those that are well established may have difficulty getting clients to pay up and on time, as some organizations can take weeks to process invoices.
To help get through leaner times, be consistent about setting aside funds in an emergency account. One rule of thumb is to have four to six months’ worth of living expenses set aside. If your expenses run high, it may be wise to err on the conservative side and save more. Try to avoid relying on credit cards, as debt can quickly mushroom.
3. Pay attention to your taxes
The days of focusing on April 15 as the tax day are, sadly, over. As your own employer, the responsibility of paying federal and state taxes falls entirely to you. In addition to paying self-employment tax, income tax must be paid on business profits.
In general, most sole proprietors need to file an annual return, but estimated taxes should be paid quarterly. This process allows you to smooth out tax payments over the year, so you’re not met with a huge sum at the end. Consider transferring 25 to 30 percent of each client paycheck to your tax account to help cover payments.
The IRS offers guidance on the process as well as the tax breaks and deductions that could apply. For instance, you may be able to write-off costs associated with your home office, business supplies, Internet access, phone and travel, as well as take deductions for retirement savings or health care premiums.
4. Secure your health insurance
Saying goodbye to a company job means saying goodbye to its healthcare plan, too. Healthcare is a big-ticket item to replace, but it’s a necessity no matter how young and healthy you are.
Federal programs are available for those who qualify – such as Medicare or Medicaid – and healthcare.gov serves as a marketplace for private plans, but be sure to confirm open enrollment dates. Depending on your situation, you may be able to qualify for some subsidies.
High-deductible plans tend to cost less on a monthly basis, but you’ll pay more out-of-pocket when you visit the doctor. These plans tend to work well for those under 30 and in good health. In some instances, a health savings account could be compatible, allowing you to save pre-tax dollars for qualified medical expenses.
5. Don’t forget about retirement
Retirement may seem a long way off, but now is the time to set aside funds to give them time to grow. For the self-employed, the Simplified Employee Pension IRA (SEP IRA) is an option and another is a one-participant 401(k).
A SEP IRA is similar to a traditional IRA, and contributions may be made up to a percentage of your compensation, with an annual cap adjusted annually. The IRS provides details on how to calculate a contribution.
A one-participant 401(k) is for sole proprietorships and allows for higher contributions, as you can contribute twice: once as an employee and once as an employer. Check with the IRS for rules.
Tap into available resources
With some research and planning, you can learn to live with the income ups and downs that are part of being self-employed. Many resources are available to help you be financially awesome, including those from your bank, the IRS and the Small Business Association.