As an independent contractor, you are responsible for recruiting clients and building a steady income for your business. Consider these freelancing money tips to help you better navigate the ebbs and flows of self-employment.
Freelancing Money Tips: 8 Ideas to Navigate the Ebbs and Flows
Freelancing opens a world of professional possibilities. You set your own hours, pick your own clients, and work wherever you want. While that may sound like a glamorous lifestyle, freelancing not without some drawbacks. Freelancers do not receive employer-provided vacation time, health insurance, and retirement accounts.
Without proper planning, money flows can be unsteady, creating income volatility that can be frustrating and demoralizing for freelancers. Throw in saving for your kids’ college fund and your own retirement, and it’s tough. Fortunately, there are ways to survive the ebbs and flows of freelance revenue. Even if you aren’t sure what a budget is, you’ve never filed estimated taxes, or you have yet to save a dime for retirement, we have eight freelancing money tips to get you moving in the right direction.
1. Pay Quarterly Estimated Taxes
If you have a “tax guy” or someone else to handle your finances, you’re a step ahead. But if you want to save some scratch and do taxes on your own, you’ll need to do a bit of research and planning. When you quit your traditional job for freelance work, you also quit withholding for Medicare, Social Security, and any other local, state, or municipal taxes. Now you’re responsible for paying them on your own.
When you’re faced with reduced income, as most freelancers initially experience, you may not have budgeted for your taxes. That’s a real problem. Uncle Sam doesn’t take too kindly to unpaid back taxes, so it’s essential to stay on top of the game.
That said, the most effective way to pay freelancing taxes to the federal and state government is by filing estimated taxes quarterly. Each year on April 15, June 15, September 15, and January 15, you’ll send a check to the U.S. Treasury or pay online to avoid any penalties or personal budget incongruities. The form you’ll need is called a 1040-ES. You’ll also need to file one in your state if your state has an income tax.
How much do I pay?
That’s that golden question, and in some regard, a difficult one. Here’s a way to figure your freelancing taxes, or at least get a close estimate.
- Estimate how much your income will be in the upcoming year using last year’s income. Don’t worry if it’s your first year in the industry. A fair estimate is fine. If you pay up to 90% of your taxes throughout the year, there’s no penalty from the IRS.
- From this amount, you’ll need to deduct 15.3% to pay self-employment tax, which is the Social Security (12.9%) and Medicare (2.4%) amount usually withheld by your employer.
- Find your federal income tax rate. Deduct this amount from your income and set it aside.
- Deduct any other local or municipal income taxes.
- Put it all together. Income X (15.3% self-employment tax + federal income tax + local and municipal taxes) = Total tax liability
If you can set this amount aside after each client payment, you won’t have to worry about scrounging a few days before taxes are due. Putting these estimated tax payments in an interest-bearing savings account or other short-term investment can also net you some cash instead of the money sitting idly in a non-interest-bearing account.
Remember that you only report income in a quarter or year if it’s already in your bank account. Accounts receivable doesn’t apply.
By paying your estimated quarterly taxes, you won’t be shocked when you get hit with a massive tax bill at the end of the year. Failure to pay these taxes can lead to a crippling situation, especially if you haven’t put any savings aside.
2. Put Away Some Cash
If you’re like nearly 50% of freelance workers, your income varies drastically month-to-month or seasonally. This means your income sources can dry up quickly after a big project or other unforeseen circumstances. When that happens, you need some extra cash to pay bills, cover business expenses, or even take a much-needed vacation.
As a general rule, you’ll need to have somewhere between three and nine months of living expenses put away for emergencies. The idea is sound, but getting that much money in the bank is no easy task. That’s when you should apply the 50/30/20 principle.
To implement the principle, split your income into three categories:
- Needs (50%): This includes housing, groceries, utilities, insurance, and other expenditures necessary to live.
- Wants (30%): Indulge yourself with shopping, eating out, traveling, sporting events, concerts, and whatever else you love.
- Savings (20%): Put money away in low-risk investments (e.g. savings accounts, CDs, treasury notes) for emergencies, as well as in retirement accounts like an IRA (Individual Retirement Account) if you can swing it.
Remember that IRA investments are subject to a 10% penalty for early withdrawal plus taxes. So if you’re building emergency savings, you’ll want to put them in a more liquid account.
3. Bulk Up Your Retirement Savings
Putting money into a retirement account that penalizes you for early withdrawal doesn’t sound like a great way to hoard extra cash for help when your income gets a bit light. However, it can reduce your overall tax bill at the end of the year, which also may work to your advantage. To save for your retirement, you have three key options, and each has its own benefits:
- Roth IRA. A Roth IRA is ideal if you’ve already paid taxes and want your money to grow tax-free in a retirement account. There’s a penalty for early withdrawals, but you won’t pay any income taxes on it. The contribution limit is $5,500 annually.
- Traditional IRA. To lower your tax bill, open a traditional IRA. For every dollar you put in a traditional IRA, you’ll save a percentage relative to your tax rate. For example, if you’re in the 22% tax bracket and invest $500 in a traditional IRA, you’ll knock $110 (22%) off your taxable income. You’ll have to pay income tax when you withdraw money, but the idea is that you’ll withdraw at a lower tax rate in retirement. The contribution limit per year is $5,500.
- Solo 401(k). If you’re running a high-volume or high-profit business, you may need a larger tax cushion than an IRA affords. That’s when you should opt for a solo 401(k). This works much like an employer’s 401(k) plan, but you can contribute up to $18,500 a year, lowering your tax liability significantly.
If you can’t put any money into your retirement savings during the year, it’s not the end of the world.
Building a freelancing business can take some time. And don’t forget that the government gives you until April of the following year to put money into an IRA for the previous year, effectively giving you a 16-month window.
4. Figure Your Monthly Needs
Freelancers end up using credit cards or paying late on bills because they don’t figure their monthly needs correctly. Fortunately, budgeting for each month is easy if you treat it as a fixed cost. Add up all the costs you need to live (e.g. food, utilities, rent or mortgage, and insurance) and divide them by 12. This will give you a fixed-cost basis for the rest of your budgeting. If you can see a dip in income coming up, this will allow you to save a little something extra for your next month’s bills.
5. Limit Your Discretionary Spending
You’ve set aside 50% of your income for necessities, 20% for savings, and you have 30% leftover, but that’s only if you’re organized. If you don’t have an established budget, your discretionary spending could get out of control.
Many freelancers will justify their expenditures by writing them off as business expenses. However, spending more money than you have ultimately plunges you into debt, even if you’ll make that money back on a tax refund. Don’t spend money on business upgrades or expenditures unless you have the capital to do it at the current time.
You should also limit your personal expenditures if possible. As much as you’d love to have the latest Game of Thrones box set with bonus footage and interviews, you might prefer to have that cash on hand for when you need it.
6. Take Advantage of Shopping Apps
One of the latest crops of apps gives you rebates when you shop for the things you’re already going to buy. Similar to coupons, these apps will give you cashback on certain purchases just by uploading a photo of the receipt. Apps like Ibotta, Coupon Sherpa, and Checkout 51 are a nice way to save money on everyday items, and you can cash out once you hit $20 in savings. It may not seem like a ton of money, but free money is always welcome.
7. Start Small
Between finding your freelance niche and building a clientele, you may have gone months without earning a dime. In fact, you may have dipped into your savings. But that’s all part of self-employment. If you’re at this stage, don’t get discouraged. Just start small.
Even if you can only put $100 away, it’s a gesture that will build momentum well into the future. From $100 you can increase your savings by a paltry $50 a month and boost your savings exponentially in a short time. While you may not feel as though you are saving enough initially, remember that some of the world’s most financially successful people started with almost nothing.
8. Keep Your Cool
When your income stalls, the best thing you can do is keep your cool. You put the effort forward to start your freelancing career, which shows fortitude, ingenuity, and confidence. You’re an intrepid person who’s not afraid to go their own way, even if it means bearing extra risk. Not everyone has that type of charisma. If you’ve put enough effort to get your business moving, chances are you can make it through any tough ebbs in freelance income unscathed.
Maintaining a healthy financial situation as a freelancer is no easy task. It takes discipline, commitment, and planning. With the proper budgeting and saving measures, you can ensure that even the worst month financially won’t break the bank.
iStock Photo Credit: 1. AndreyPopov; 2. William_Potter
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