Personal Finances as an Independent Contractor
It's harder to manage than with steady employment
It’s challenging to stay on top of your finances when you’re an independent contractor — aka, gig worker, self-employed, 1099’er. Your income is more unpredictable; taxes are not withheld and can amount to more than you think; and, unless you have a spouse with employer-sponsored health care, you’re on your own to obtain health insurance.
That’s a lot to manage. To be successful, you must have a well-organized, structured, and sustainable approach. I’ll offer a few suggestions:
1a. Track actual spending.
I tell all my clients to do this but having clarity on your total monthly spending is even more important when your income is variable and you owe state and federal tax payments every quarter. This also helps with #5 (below).
1b. Categorize expenses as mandatory or discretionary.
If you’re currently facing lean times, you must understand what is discretionary spending so you can cut it out until the fat times. Similarly, understand how your expenses break down into variable versus fixed and regularly re-assess the variable expenses to see if you can reduce or eliminate any of them.
2a. Use mental accounting buckets to set aside taxes.
Pay estimated taxes on-time every quarter. To ensure you have the funds available, set aside the necessary amount each time you are paid. These easiest way to do this is to have a TAXES mental accounting savings bucket inside of your checking/savings account.
How much? More than you think. When self-employed, you owe both sides of FICA taxes and that alone is ~15%. Add in state and federal income taxes and it can easily be 35% of your net income, depending on your income and your state of residence. So, every time you get paid, transfer at least 1/3 of it into your TAXES mental accounting bucket.
2b. Use mental accounting buckets to set aside retirement savings for a Roth IRA and/or a SEP IRA.
Use a RETIREMENT mental accounting bucket for IRA contributions as you won’t know the precise amount you can contribute until the end of the year. Until then, accumulate them in a manner that’s partially hidden from you so you won’t spend these funds on something else.
A SEP-IRA can be beneficial for the self-employed as it reduces your taxable income and potentially make you eligible for other benefits such as contributing to a Roth IRA, health insurance subsidies, etc. A Roth IRA is always a good idea.
Roughly, you can contribute ~25% of your net taxable income to a SEP-IRA and that’s unrelated to Roth IRA contributions.
3. Document tax-deductible expenses.
Record tax-deductible expenses you incur throughout the year. Be organized and systematic about this as you’ll pay unnecessary taxes if you don’t keep careful track of these.
Use a simple 3-column spreadsheet — date, expense, amount. Pen and pad is fine; a shoebox filled with paper receipts is not. Pay everything with the same credit card and you’ll have a record, if you need it.
4. Shop carefully for health insurance.
Health insurance may be the second largest personal expense (after housing) for those self-employed. Good luck purchasing your health insurance off a state exchange, but if that’s your fate, invest the necessary time and effort to ensure you choose what’s best for your circumstances. Health insurance premiums can vary greatly based on choices you make:
HMO or PPO
restrictions of the provider network
co-insurance, deductible, and out-of-pocket amounts
There’s no single right answer for everyone. Factor in your personal health status and be mindful about the selection you make as the differences can be thousands of dollars per year. And, consider a high deductible health plan and if you opt for that, open up a health savings account for yourself to get another tax savings. Lastly, know that you can make a new choice each year.
5. Forecast upcoming income and expenses.
This isn’t easy to do but forecast both income and expenses for the near- and mid-term future. The goal is not to be precise but instead to have some insight to allow you to reasonably plan your financial life going forward.
Being financially organized and diligent won’t eliminate all the stress and unpredictability of life as an independent contractor but it can help and save you money. Now go find some new business.