Being self-employed offers independence, flexibility, and control over your income, but it also comes with unique financial challenges. Without the steady paycheck, benefits, or safety nets that traditional employees have, it's crucial to establish your own financial safety net to protect against income fluctuations and unexpected expenses.
In this blog, we’ll walk through practical steps to help you build a robust financial safety net, ensuring both short-term stability and long-term success.
1. Start with an Emergency Fund
An emergency fund is the foundation of any financial safety net. As a self-employed professional, it’s essential to have a cushion for both personal and business expenses in case of slow income periods or unexpected costs.
How Much to Save: Aim for 6 to 12 months of living expenses. If your income is highly variable, aim for closer to 12 months.
Separate Funds for Business and Personal: Consider keeping separate emergency funds for your business and personal expenses. This helps ensure both areas are covered if you face a downturn or an emergency.
2. Establish Consistent Cash Flow Management
Without a regular paycheck, managing your cash flow is critical. Here are a few strategies to maintain a consistent income stream:
Budget for Variability: Base your budget on your lowest earning months to ensure your lifestyle remains sustainable year-round.
Pay Yourself a Salary: Set up a regular "salary" from your business income. Transfer a consistent amount from your business to your personal account each month, creating stability in your finances.
Set Aside Taxes: Don’t forget about taxes! Set aside 25-30% of your income in a separate account to cover quarterly tax payments and avoid surprises.
3. Prioritize Health and Disability Insurance
Without employer-provided benefits, you’ll need to take charge of your own health and income protection.
Health Insurance: Purchase a health insurance plan that fits your needs and budget. A high-deductible health plan (HDHP) paired with a Health Savings Account (HSA) offers lower premiums and tax-free savings for medical expenses.
Disability Insurance: As your income depends on your ability to work, disability insurance is a must. Choose a policy that covers at least 60% of your income, with adequate coverage periods and an elimination period that fits your needs.
4. Save for Retirement (Even Without a 401(k))
Since you don’t have access to an employer-sponsored retirement plan, it’s up to you to create your own. Luckily, there are several tax-advantaged retirement accounts designed for the self-employed:
Solo 401(k): This is my favorite option for self-employed professionals, allowing you to contribute both as an employee and employer. In 2024, you can contribute up to $23,000 as an employee, plus up to 25% of business wages(W-2), for a total of $69,000 (or $76,500 for those 50+).
SEP IRA: A Simplified Employee Pension (SEP) IRA allows for contributions of up to 25% of your business income(W-2), with a limit of $66,000 in 2024.
Roth IRA: If you qualify based on income, a Roth IRA provides tax-free withdrawals in retirement, offering flexibility in managing your future tax burden.
5. Focus on Building Income
For many, starting out as a solopreneur is a bet on yourself and an investment in yourself. The first couple of years should be spent investing in yourself and your business in order to build your income. The only way you can do that is by having a safety net that allows you to go all in.
6. Plan for Business Continuity
Your business is a significant part of your livelihood, so it’s crucial to plan for any disruptions that might affect its operations.
Business Insurance: Look into general liability, professional liability, and E&O policies depending on your services/industry.
Automate and Delegate: Automating routine tasks and delegating responsibilities to trusted freelancers or employees ensures that your business continues to run smoothly if you’re unavailable. It also allows you to hire and scale since you have repeatable processes.
7. Tax Strategies for Self-Employed Professionals
Taxes can be one of the biggest expenses for self-employed individuals, but there are strategies you can implement to minimize your tax burden.
Deduct Business Expenses: Ensure you’re taking full advantage of deductions for business expenses like home office costs, travel, and equipment. Keeping detailed records is key to maximizing these deductions and protecting yourself in the case of an audit.
S-Corp Election: If your income is high enough, consider electing S-Corp status. This allows you to pay yourself a reasonable salary and take additional income as dividends, which aren’t subject to self-employment taxes.
Retirement Contributions: Retirement plans are a great way to lower your current year taxable income but it's important to strike the right balance between long term accounts and short-term accounts to maintain liquidity.
8. Prepare for Retirement by Diversifying Investments
While your retirement accounts provide tax-deferred savings, it’s equally important to diversify your investments outside of these accounts.
Taxable Brokerage Accounts: A taxable brokerage account offers flexibility since you can access funds before retirement without penalties. This provides an additional layer of financial security.
Real Estate Investments: Real estate, whether through rental properties or Real Estate Investment Trusts (REITs), can provide additional income and long-term growth.
Balance Your Portfolio: Make sure your investment portfolio is diversified across asset classes, such as stocks, bonds, and alternatives, to help balance risk and reward.
9. Establish a Business Succession Plan
Thinking ahead about what happens to your business if you're unable to work or when you retire is crucial for long-term security.
Buy-Sell Agreements: If you have business partners, establish a buy-sell agreement to outline what happens if one partner leaves or passes away. This ensures continuity for the business and financial protection for your loved ones.
Estate Planning: Incorporate your business into your estate plan by setting up a revocable living trust. This helps streamline the transfer of business assets without the delays and costs associated with probate.
10. Build a Support Network
Building a financial safety net also means having the right people in your corner. Assemble a team of professionals who can provide advice and support.
Accountant or Tax Advisor: A tax professional can help ensure you’re staying compliant, making the right deductions, and minimizing your tax bill.
Financial Planner: A financial planner can help you build a comprehensive strategy to cover personal and business finances, retirement, and investments.
Legal Advisor: A legal advisor can assist with contracts, intellectual property, and other legal matters, ensuring you’re protecting both your business and personal assets.
Final Thoughts
Being self-employed means embracing both the freedom and the financial responsibility that comes with it. Building a strong financial safety net—through emergency savings, diversified income streams, insurance, and tax strategies—provides the protection you need to manage life’s unexpected twists and turns.
If you're ready to take control of your financial future, WealthBound Advisors is here to help. We specialize in guiding self-employed professionals through their unique financial challenges, so you can focus on the things you're best at.
Disclaimer: None of this should be seen as advice. This is all for informational purposes. Consult your legal, tax, and financial team before making any changes to your financial plan.