Financial Planning for the Self-Employed - Brief Article

USA Today (Society for the Advancement of Education), August, 1999

Have you already joined the growing ranks of the independent worker? Are you thinking of becoming self-employed, lured by the idea of working just for yourself? Or are you being pushed out the company door and joining the ranks of the self-employed out of necessity? Whatever the reason, you will have some unique financial planning issues to wrestle with, indicates the Institute of Certified Financial Planners, Denver, Colo.

Incorporate or not? One of the first decisions you will need to make is whether to be a sole proprietor or choose some form of incorporation. Most self-employed operate as sole proprietors. It is simpler and less expensive than incorporating. However, incorporation may be attractive if you have some concerns about legal liabilities, since various forms of incorporation can offer limited-liability protection.

Managing cash flow. Independent contractors are more likely to experience uneven cash flow than company employees. There will be no regular Friday afternoon check to pick up at work. You might be flush one month and penniless the next. Thus, it is especially critical that you budget for wide swings in income. Try to determine how much you can count on as an average. Use that as your base and work from there. In flush times, bank the extra money and draw on it for those times when income falls below average.

Managing taxes. Perhaps nothing is more complicated financially for the self-employed than taxes. Unlike employee paychecks, they aren't taken out of income you receive. You are responsible for paying income and Social Security taxes. It is vital that you take the right amount for taxes off the top, before you start spending the income. Otherwise, you may not have the money on hand to pay any taxes due when it is time to file your quarterly estimated or annual return.

Tax deductions and credits are more complicated for the self-employed, too. If you work out of your home and wish to take the home office deduction, you will need to track expenses you probably never worried about as an employee--office supplies, phone calls, mileage, dues, postage, publications, business equipment, etc. You will have to keep detailed records and receipts for the Internal Revenue Service.

Benefits. Bluntly put, you don't get any. If you can't piggyback on your spouse's benefit plan, you must provide your own health, life, disability, and liability insurance. You won't have access to tax-saving flexible spending accounts or company benefits such as paid vacations, sick leave, stock options, and/or adoption benefits. You won't be eligible for unemployment, either, if self-employment work disappears.

Getting life insurance on your own might be a problem if you have medical issues that usually aren't questioned under a group plan. Finding a good, affordable disability policy to replace lost income also can be tough for the self-employed. Disability insurers generally prefer to work with groups. One possibility is to join an association that offers access to disability insurance.

Retirement. You will get no employer to match your 401(k) if you are self-employed. You won't even have a 401 (k)--they are too complicated and expensive for the self-employed. Instead, you will need to learn about tax-deductible vehicles such as Keogh plans and simplified employee pension plans, as well as the traditional individual retirement accounts. You may want to consider nondeductible alternatives such as the Roth IRA and annuities.