Going Out on Your Own? 4 Ways Finances Differ for the Self-Employed

There’s nothing like the fantasy of saying goodbye to your office job and hello to being your own boss. But if you’ve got entrepreneurship on your mind, it’s important to understand the whole picture of what it means to be self-employed, especially with regard to finances.

Beyond the nearly limitless income potential comes complexities that, if not understood, can cause big problems.

Not that finances should scare you away from your dream of being self-employed. Individuals planning to strike out on their own can learn to manage the financial risks and differences that come along with self-employment.

So before you put in your two weeks’ notice, spend some time reading up in small business publications about finances for the self-employed.

1. Your cash flow will vary.

There’s a comforting predictability that comes with a salary. But in exchange for predictability, employees often accept limitations on their earning potential. For those who are self-employed, available finances can increase significantly — and decrease in an instant.

Depending on your industry, you may be able to charge a handsome rate for your services. But regardless of your hourly or project-based pricing structure, one thing is true for entrepreneurs across industries: income variability.

Even if you’ve locked down contracts and have an agreed-upon retainer, you’re not always in control. Some clients may have invoicing requirements ranging from 30 to 90 days. Also, depending on the documentation you need to provide for work completed, payment turnaround can slow.

As you consider entrepreneurship, identify the base-level requirements for your income and your business’s operations. Even if you have low overhead, you need to secure a minimum threshold that allows you to maintain stability.

Many entrepreneurs build a substantial nest egg prior to going solo. This cash reserve can help business owners confidently pursue their dreams. And while a savings balance will only last so long, it can help fill the gap between invoicing and payments.

Establish a process that outlines the payment terms you expect from your clients. Use this data to influence your rate structure and whether you charge per hour or per project.

Some business owners find project rates to be more profitable, but it puts pressure on being efficient with their time. Conversely, hourly rates can skyrocket, especially considering you’ll be on the hook to cover health insurance, retirement, and taxes. Don’t be shy in researching all the intricacies associated with taking on the entire scope of responsibility.

2. Securing loans requires predictability.

When you start to work for yourself, you gain a new type of freedom. However, much more responsibility is on you to keep pace and deliver for your clients.

Frequently, entrepreneurs also reap the rewards of greater income by working for themselves rather than for a corporation. But this increased financial bandwidth doesn’t allow you to side-step established lending practices.

Most employees in the U.S. are employed at will, meaning they could be fired at any time. Yet would-be creditors tend not to see things that way.

Even if your self-employed income and available finances are substantially higher than in years prior, in lenders’ eyes, it’s a whole new ballgame. You’ll likely need to provide more proof that you’re a credit-worthy customer. Like it or not, self-employment often indicates a level of risk for the lender.

Research mortgages for self-employed individuals to get an understanding of the differences compared to traditional lending. To bolster your loan application, you’ll need to provide a year-over-year history of income, usually two years or longer.

Also helpful is proof of long-term contracts that can provide stability of income. For example, if you’ve signed a five-year retainer for consulting services, this can give loan providers assurance that your income is solid.

3. Taxes present complexities and opportunities.

Taxes are often one of the most dreaded realities of entrepreneurship. Along with the complexities of managing variable income, entrepreneurs are on the hook for some hefty taxes.

On the up side, the self-employed enjoy a robust list of deductions and write-offs associated with conducting business.

Check with the Internal Revenue Service’s website for specifics on the current year’s tax laws. These will shift year over year, so it’s a smart move to save this website to your favorites list. Additionally, engaging an accountant with self-employment expertise can help you avoid tax mishaps and maximize your opportunities.

If you have a home office, you can account for business use on your taxes, reducing your overall tax obligation. There are standardized or specific ways you can do this, so simulate both to determine which provides the best benefit. Get familiar with the deductions available and reduce your overall taxable income.

Every dollar you save on taxes can be devoted to growing your business, saving for the future, or simply enjoying.

If you’re ever unsure about your tax obligation, don’t just guess. Discrepancies on your self-employed taxes may flag your return for an audit. And if you’re audited, you will be required to provide documentation for your claims. Even if you were able to confirm the accuracy of your return, the time lost due to an audit has consequences.

Keep scrupulous tax records so that in the event of an audit, you’ll already have everything you need.

4. Retirement savings is 100% on you.

Gone are the days of an employer match to your 401(k), but that doesn’t mean you can’t secure a solid retirement. Self-employed individuals will simply need to take a strategic approach to retirement savings.

Just like a W-2 employee, you’ll need to determine how much you can afford to set aside for the future. Research your retirement plan options across Roth IRAs, SEP-IRAs, Solo 401(k)s, and others available for the self-employed.

Pay special attention to account fees, expense ratios, and minimums to select the option that works best for you.

Leverage the tax-saving potential of pre-tax contributions while taking advantage of the long-term benefits of post-tax accounts like Roth IRAs. Especially if your income level is likely to rise in the future, a Roth IRA can yield major tax savings.

Consider your current and future potential tax brackets to make wise choices now. The better you plan your retirement strategy today, the more flexibility you’ll have as you advance toward retirement.

Celebrate the power of being your own boss.

Waking up each day with a renewed sense of purpose is one of the hallmarks of happy entrepreneurship.

While it comes with significant responsibility and a steep learning curve, it can be one of the most rewarding life choices you can make. Whether your dream is to achieve more autonomy, make an impact, or harness your creativity, self-employment creates opportunities.

Celebrate the power of your self-employment by bringing fresh perspectives and high-quality service to your clients. They’ll appreciate the expertise you provide, and you’ll enjoy a vocation that uses your talents for the highest good. Meanwhile, you can benefit from the financial opportunities that come along with self-employment now and in the future.

Image Credit: Anete Lusina; Pexels; Thanks!