You’ve most likely come across those idealized depictions of the freelance life: Working out of a hammock on the pristine, white sands of a beach in Bali. Typing away on an assignment while balancing a small child on your knee. Taking a month off from client work to focus on a passion project. It’s true: When you work for yourself by freelancing, you aren’t tied to an office job and can enjoy greater freedom.
That’s the power of being a solopreneur. You can decide to work from wherever you wish, on whatever projects you wish, and on your own time. But that freedom comes with a price. Specifically, it can create a lot of money stress.
The issues that come with forgoing a steady paycheck are many. Having freelanced for over four years, I’ve experienced a myriad of money issues as a self-employed writer. And while enduring these financial stressors, I’ve developed some ways to minimize money woes.
Here are some common money issues freelancers face, and how to best handle them:
Budgeting on Variable Income
The majority of existing money advice is based on having steady cash flow. Don’t have a reliable income? Might as well toss that advice out the window. As you might expect, it’s incredibly challenging to create a spending plan when your income can wildly fluctuate.
How to solve it: Because my income changes each month, I don’t create a spending plan based on how money I earn. I create a budget based on my living expenses. To gauge how much I can reasonably afford on rent, food, and car payments, I base my living expenses on how much I earned as a freelancer in years prior.
If you’re a newbie, budgeting can be tricky. Try basing it off your first six months of income foraying into self-employment. Or if you’re relying on your savings, budget based on how much you have in your savings. That way any income you earn starting out can serve as a “bonus” money.
Suffering from Freelancer Income Distortion
With cash flow that fluctuates so drastically, one might suffer from what I call Freelancer Income Distortion. My income has certainly exhibited mercurial ups and downs. It’s hard to pin down your true income. Are you earning $24,000 a year, or are you a six-figure freelancer?
When you don’t know what your “true income” is, it’s tough to know what you can realistically afford. Not knowing how much you are really making could lead to some poor spending choices. If you’re having an awesome few months, you might be inclined to spend your money on an amazing trip, and neglect to save any for a rainy day. Conversely, if you’re enjoying a streak, and have been consecutively netting X a month, is it okay to undergo lifestyle inflation? It’s a bit maddening.
How to solve it: To gauge your “true income,” consider taking the long view and base it on how much you rake in annually. That way, you won’t freak out if you’re having a lower-than-usual earning month, or experiencing a work lull. On the flip side, if you’re making bank for a period of time, you don’t go out and make fancy purchases.
No matter how much you earn, you’ll want to save for your emergency fund. Whereas the general rule of thumb with saving for a rainy day is anywhere from three to six months, if you’re dealing with freelancer income, try to save at least six months.
Once your emergency fund is established, you can focus on saving for your other money goals. I currently keep separate savings accounts for a trip to Vietnam in 2020 and a “splurge fund” to spend on whatever I please. I can feel good spending my money on fun purchases because that is money I saved beforehand.
I save based on percentages. After I pay myself a set salary each month, I divvy up whatever remains into different money goals. For instance, I’ll split my money equally into four different pots: savings, retirement, investing, and vacation.
Setting Enough Aside for Taxes
Because you don’t have taxes automatically taken out of each paycheck, saving for self-employment tax is on you. While it’s common advice that freelancers should save 30 percent — if not more — of their total income for taxes, you want to come up with a tax strategy to save on how much you owe Uncle Sam, explains Katherine Pomerantz, founder of The Bookkeeping Artist.
Don’t forget to save for your federal and state taxes. People always concentrate on the “self-employment” portion of the taxes but they stop there, says Eric J. Nisall, freelance business and tax expert. “Federal taxes can account for a larger amount, especially considering the fact that the business income gets added to all of the other household income to determine the taxable amount,” says Nisall. “That’s one of the biggest reasons people come up well short when they file their returns.”
How to solve it: Set aside a percentage of each paycheck for taxes, first and foremost. I aim to save more than I anticipate needing. Whatever remains is what I can spend. That way you aren’t falling behind on your taxes. And trust me, it’s really hard to catch up on your savings for taxes.
Saving for Retirement
Saving for retirement can seem like a pipe dream when you’re a freelancer, but this is the biggest tax deduction Pomerantz sees freelancers missing out on. Any contribution to a Traditional IRA or SEP IRA is tax deductible.
Pomerantz recommends saving the full 30 percent for taxes. “Rather than send that to the government, stash it in a retirement account and pay no tax,” says Pomerantz. “In 2019, you can save $6,000 in a Traditional IRA and whopping $56,000 in a SEP IRA! You can contribute to both, and take up to $62,000 off your taxes!”
How to solve it: Set up an automatic transfer that deducts a portion of every paycheck. Set up a dollar amount to transfer every week. Start with $20 a week, which equals $1,040 a year. Then, as you adapt to living on less, bump it up by $5 or $10 a month.
“Smaller, frequent transfers are easier on cash flow and less likely to be missed,” says Pomerantz. “Soon, saving becomes addicting as your retirement account starts gaining through compound interest as well as your own transfers. The tax savings is really just a bonus!”
Staying on Top on Financial Housekeeping
Freelancers and gig economy workers are notorious for depending on 1099-MISC forms to serve as their income tracking method, explains Nisall. “I hear things like ‘I have a contractor who wants a 1099-MISC to calculate their income for their tax return,’ and it just makes me cringe,” says Nisall. “As a business owner, you are responsible for tracking your own income and expenses, and using 1099s for that purpose is not smart because you are never guaranteed to qualify to receive one.”
How to solve it: I am guilty as charged on this one. For several years I relied on my 1099s to figure out how much income I earned in a given year. I learned the hard way that it’s when you receive the money that counts. Come tax time, I had a rough time trying to figure out which year I got paid for certain work.
The best way to avoid falling into this trap? Nisall recommends simply starting a spreadsheet or getting accounting software to track everything as it comes in and goes out. After four years of relying on 1099 forms to track income, I’ve finally hopped on cloud accounting software. I check my financial transactions about once a week. And it’s saved me tremendous time and headache.
Being aware of the money issues freelancers commonly face and doing your part to practice good habits will help you avoid financial anxiety that often comes with the territory of solopreneurship. There’s a lot to manage, but once you make these concerns a priority, it turns into a habit. Otherwise, you’ll find yourself stuck in a quagmire of financial stress.