Money Management Challenge: The Risks (& Rewards) of Self-Employment
Self-employment has some real rewards. You get to be your own boss, set your own hours and control your own destiny. However, running your own business also means that you get paid when clients pay you and, frequently, that won't be on a regular schedule. You'll also have periods of high cash flow and lean times through which you have to stretch your money. Further complicating matters is that fact that you have to set aside your own money for taxes since you don't have an employer doing your withholding for you. All of this leads to some real money management challenges.
When you're self-employed, planning for taxes is a real concern. "Of all of the risks that self-employed people take, none are as dangerous as not paying the Internal Revenue Service," says small business attorney and adviser Ben Brickweg. To be prepared, many self-employed workers set aside a portion of each client payment into a special account from which they make their quarterly estimated tax payments: it's essentially do-it-yourself withholding. The amount you should set aside varies depending on your personal tax situation and on your business' profitability, but "setting aside a little bit more than you need is a good idea since you can always keep it if you don't need it," points out Brickweg.
Create Separate Accounts
The key to money management as a self-employed person is to create separate accounts. While separating your business and personal funds is important, Brickweg recommends that you go further and "Deposit your business income into a single account and immediately transfer it into a tax account, a business operating account, a business capital reserve account and a personal account." This helps to ensure not only that you have the cash that you need to meet your personal and business expenses but also that you don't overspend in any one area.
Control Fixed Personal Expenses
Self-employment income is variable, but expenses like car payments and mortgages usually aren't. When you're self-employed, keeping your fixed expenses as low as possible gives you the financial flexibility to survive lean times and to thrive in good times. If your obligations are set so that you can meet them even in your business's slowest month, you won't have to worry about losing personal assets to business challenges. This requires the discipline to live below your means -- to wait until you can pay fully or partially in cash for some purchases -- but it can pay off in greater peace of mind as your company, and your personal income, rides the waves of the business cycle.
Maximize Long-Term Savings
Saving for retirement is almost always a good idea, but it's a great idea when you're self-employed. You can't count on an employer to provide you with a pension or even to match contributions to your retirement plan, so it's that much more important that you take care of yourself. This challenge, however, doesn't come without certain rewards as well. Because money you contribute to your retirement plan is often considered a business expense, it is not therefore subject to self-employment tax, meaning that you get a financial benefit for contributing. Because you're both the employer and the employee, you also have the benefit of contributing "twice" for certain plans. For example, depending on how a Simplified Employee Pension (SEP)-IRA is set up, you can contribute as an employer as well as contribute additional money as if it were your own personal IRA as an employee.
Spending vs. Investing Decisions
The ability to write off legitimate business expenses can be a powerful inducement to invest in travel to faraway conferences or buy yourself the latest business technology tools; after all, such legitimate expenses are tax write-offs. However, if you're looking to build value in a business that you can sell someday, this spending could come back to haunt you. As Ben Brickweg points out, "Gross sales, net profits, and real-world asset values define the value of your business. Anything you spend that doesn't increase one of those factors doesn't do anything for you in the long run." With this in mind, some business owners aggressively manage their business's spending as much as their personal spending to ensure that they're wringing the maximum value out of every dollar.