I read an interesting article this morning about the unique financial challenges that face self-employed persons these days. According to data in the article, there are approximately 17.7 million indepedent workers in the U.S., up 10% from 2011. I found this statistic interesting for two reasons: (1) the number of people striking out on their own has gone up on the tail of the economic downturn; and (2) according to the latest SBA Weekly Lending Report, the SBA loan approval amounts have not changed much (Click here for full report). There are a plethora of conclusions one might draw from the data (and I am no economist) but it appears that those who have decided to go out on their own are doing so despite the shaky economic data and bear market reports (myself included).
Since entrepreneurs tend to be a bit more risk tolerant than the average worker I thought this Financial Planning article would bring to mind some planning ideas meant to decrease our exposure to financial turmoil. Here they are:
(1) Smooth Out Income Volatility - Financial advisors suggest that the typical employee keep 6 months to a year's worth of living expenses set aside in an emergency fund. However, the self-employed should try to keep 18 to 24 months set aside to "backstop cashflow." This money should be kept in a liquid account, such as a money market account.
(2) Retirement Planning - The only person in charge of our retirement is us. There are no employer sponsored pension plans or matching 401(k)s. However, because the self-employed person wears both hats we can contribute to a solo 401(k) through individual contributions and then 20% of net adjusted profits on the "employer" side... up to an annual limit of $52,000 for people under 50.
(3) Rollover Options - Many people start their careers employed by someone else and then either by design or default end up going out on their own. If you fall into this category, talk to your financial advisor about the various rollover options to decrease your costs while maintaining the best benefit you can.
(4) Insurance Issues - We are also in charge of all our own healthcare insurance. Obamacare might make it easier for the self-employed to get private health insurance, especially those with pre-existing conditions. One option, according to the article, might be to look at a high deductible plan and a health savings account. The HSA allows you to put in pre-tax dollars, it compounds on a tax-deferred basis, and is not taxed upon withdrawal. We also need to be thinking about disability insurance; if something happens to us our income stream vanishes.
(5) Tax Planning - Self-employed people are in charge of all their own employment taxes, which means that we have to contribute our normal employee amount (the amount that is taken out of your paycheck when someone else pays you) PLUS the employer amount. This adds up to 12.9% in federal withholding and an additional 2.9% for hospital insurance. As if that is not bad enough, if you make over $200,000 as a single taxpayer or $250,000 as a married taxpayer filing a joint return you are subject to an additional 0.9% of the self-employment income as an "additional" tax. The "employer" part of the self-employment tax is deductible as a business expense, so that cushions the blow a little, but the important point is to make sure you are setting aside enough to cover all your taxes.
In the near future I will be offering tax planning services in addition to my small business and estate planning services but the Internal Revenue Code is complicated and nuanced so please make sure you talk to your tax planning professional before making any decisions regarding your business (or personal) taxes. One of the first things I ask my clients for is written authorization to discuss their small business matters with their tax planner and/or CPA. Having all the members of the advisory team on the same page is invaluable because it saves both time and money from the outset.
As always, I can be reached at firstname.lastname@example.org for questions or comments. If you have a small business that needs planning advice or you have small business compliance concerns please email me or call me at 844-235-4766.