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Budgeting for the Financial Ups & Downs of Self Employment

More people today are choosing to be their own boss, with the number of self-employed Americans expected to continue rising. Making the leap to being your own boss is exciting, but it also requires proper budgeting and planning in order to be lucrative. Since self-employed income is often less predictable than the salary you'd expect working somewhere full-time, here's what you'll need to know about benefits, budgeting and staying in the black.

What to Plan For

In addition to allocating part of your self-employed income for taxes, you should also adjust your budget to cover the following benefits:

  • Health Insurance: Purchase individual and family plans through the national Health Insurance Marketplace or by contacting insurers directly. Ask about options for entrepreneurs or independent contractors.

  • Retirement Plan: Save for retirement with a Solo 401(k) plan. You may also consider an IRA or Roth IRA account.

  • Office Space & Supplies: Many office supplies are tax-deductible business expenses, but you'll need to keep thorough records in order to receive tax deductions. If you rent a separate business space, that will also be tax deductible.

  • Time Off: Most companies offer employees paid sick and vacation time. Self-employed persons will need to budget well in advance to prepare for time off. This is just one reason why freelance hourly rates tend to be higher than typical wages for full-time employees; another is because the flux of available work can cause irregular income.

The Self-Employed Budget:

As a self-employed individual, you'll typically have good months and bad months — financially and emotionally. Your budget should estimate your monthly income conservatively so that you avoid overspending. To create a personal finance budget, follow these steps:

  1. Start with fixed expenses: These will include a house or rent payment, utility bills, groceries, cell phone bills, software fees, taxes and insurance. You can also include an estimated cost of office supplies. You can estimate how much you expect to spend a year on them and divide the annual amount into a monthly amount.
  2. Identify other important expenses: Some non-fixed expenses should still be anticipated and accounted for in your budget. These include car maintenance, medical bills and home repairs. In the good months, these will be easier to pay for.
  3. Prepare for your tax bill: Now that you're in business for yourself, you'll be filing your tax return under self-employed status. When creating a budget, don't forget to set aside the part of your income that would normally go to taxes. Remember that self-employment tax is higher than what you'd pay working for someone else. Aim to save around 30% of your self-employed income for quarterly or annual tax payments.
  4. Write down savings goals: Will you be buying a car soon? Are you hoping to purchase a home or pay off student loans early? Whatever your goals are, add them to your short- and long-term goal lists. Savings for retirement should be at least 12-15% of your income, if possible. To identify financial goals, look at your take-home pay from last year, and aim to save at least 12% of that amount this year. Divide by 12 for a monthly savings goal.

When you create an annual budget, use your worst month from the year before as a guideline for a conservative earnings estimate. This gives you an idea of how much you'll have left over from other expenses. As income comes in, be sure to pay your fixed expenses first. Then, add to your savings and emergency funds. If your financial situation is veering into the red, look for extra gigs to increase your cash flow.

Preparing for the Future

Just like a multi-million-dollar corporation strategizes every new product launch and campaign to avoid overspending, you should also thoughtfully consider how you spend your profits. Here are a few tips to get you started:

Set money aside in an emergency fund

An emergency fund is vital to have in case you are unable to work for a certain amount of time, or if your client roster slows down for a couple months. Your goal should be a dollar amount that's equal to six months of pay. Don't be intimidated by that number. Dedicate what you can, and keep contributing to the fund in a savings account to keep it separate from your personal and business accounts.

Open a business bank account

Opening a business checking account can help you maximize your savings come tax time. You'll be able to see your exact income and what purchases you made for your business that are tax-deductible. A business account can also increase the professionalism of your business and enable you to accept credit cards. A business account can also be a positive first step toward building a financial relationship that leads to a small business loan, if you decide to grow.

Use cash before credit

Numerous research studies show people are more likely to spend more when using plastic. When you use a credit card, all it takes is a swipe or dip for your money to be transacted instantly. That simple action makes spending hundreds of dollars on a frivolous purchase seem less severe than if you actually had to withdraw a large amount for spending.

Determine how much cash you will budget for purchases each week. Withdraw that amount at the beginning of the week to keep your spending regulated, save money and avoid heavy credit card debt.

Live Lean — At Least in the Beginning

Self-employment can be one of the most fulfilling career paths for many people. It's important to remember, though, that income is rarely guaranteed and can fluctuate wildly. In the first six months to first year of founding your own business, you can get a more solid footing in the self-employed world by working hard and living lean. Start by tracking your spending, and use the tips we've provided to work out your new life as a business owner!

Living lean means saving more. Are you up for the challenge to set a savings goal and crush it?


The material presented here is for educational purposes only and is not intended to be used as financial, investment or legal advice.