If you dream of leaving the 9 to 5 behind and making it big as a freelancer, it may be time for a reality check. While there are some definite perks to working for yourself, it’s not something you can afford to do without proper planning. Building a solid freelance career takes time and you need to make sure you can cover your bills until those steady gigs start rolling in. Before you strike out on your own, there are some things you can and should do to make sure your finances are on solid ground.
1. Build Up Your Savings
Unless you just won the lottery, quitting your job without having a cushion of cash in the bank doesn’t make much sense. If you’re planning to go freelance, you need to make sure that you have enough savings to stay afloat until your income is more consistent. Ideally, you shouldn’t hand in your resignation until you’ve saved up a sizable emergency fund.
How much money you need to have on hand really depends on your expenses and your comfort level. Financial experts typically recommend saving enough cover anywhere from three to nine months’ worth of expenses. This figure might be higher if you have kids or lower if you’re planning to work part-time while you’re freelancing.
You should also think about setting up a separate short-term fund for basic expenses. This is money that you can use to cover the bills when you’re making the move from full-time employment to freelance work. The money you make from freelancing would go into this account and you can use it to pay your personal bills or cover business expenses. Having an extra buffer of cash in the bank can help you avoid tapping into your emergency fund unless you absolutely have to.
2. Be Realistic About Your Budget
If you want to get your freelancing career off to the best start possible, you have to have a budget. This means making sure you have more money coming in than going out. Unfortunately, budgeting is a little trickier when your income varies from one month to the next.
Leaving your job for good won’t have much of an impact on your fixed expenses but you may need to make some adjustments with regard to your variable spending. For example, you may not be spending as much on travel since you’re not driving to work every day but your utility bills may creep up if you’re spending more time at home. You need to go over each item in your budget carefully to look for things you can cut and expenses that may increase.
Aside from your household bills you also need to think about what goes into running a freelance business cost-wise. This may include things like office supplies, Internet access, computer equipment, marketing materials and advertising. You need to be aware of what the initial financial impact will be and how these costs will affect your bottom line over the long term.
3. Plan Ahead for Taxes
Freelancing is a form of self-employment, which means you’re responsible for making sure Uncle Sam gets his due at tax time. Generally, freelancers are required to make estimated quarterly tax payments throughout the year. For the 2013 tax year, the self-employment tax rate was 15.3%. If you’re not filing your taxes properly or you underpay the estimated tax due, you could end up getting hit with a penalty when April rolls around.
In addition to keeping track of your income, you also need to maintain careful records of your expenses throughout the year. There are a number of things you may be able to write off as a tax deduction but you’ll need to have appropriate documents to support your claim. Claiming the home office deduction can shave a few bucks off your tax bill but it could also get you in hot water with the IRS if you can’t prove your expenses.
4. Don’t Forget About Retirement
Working for yourself means you don’t have the luxury of participating in an employer’s retirement plan so you need to be proactive about saving for your golden years. Self-employed workers have several savings options available, including traditional, Roth and SIMPLE IRAs or a Simplified Employee Pension plan. Setting aside money in one of these accounts can help you build your nest egg while enjoying some tax benefits.
If you have a retirement plan at your current employer, you’ll want to make sure you take it with you when you leave. Generally, you can roll the money over into another qualified retirement account without penalty. Just make sure you’re aware of any restrictions your employer may have before you try to move money out of your account.
Freelancing is often a feast or famine pursuit but it is possible to build a successful and financially rewarding career. The more planning you do ahead of time, the easier the transition will be when you’re finally ready to make the leap.
Photo Credit: Kiva Dang