You, Inc.: The Leap Into Self-Employment
After working for someone else, self-employment can be an exhilarating change. But it’s also fraught with potential pitfalls, including the possibility of running out of money before your new venture even gets off the ground.
"The more planning you can do beforehand, the more you’ll increase your chances of growth and success," says Raj Tumber, a Las Vegas–based small-business advisor with SCORE, a nonprofit organization that provides guidance to entrepreneurs.
Tumber, who has plenty of experience watching business owners meet the challenges of getting a venture started, offers four steps all entrepreneurs should consider to help prepare financially for self-employment.
4 steps all entrepreneurs should consider to help financially prepare for self-employment
- Create a thorough business plan. Perhaps you’ve figured out where you add value in your core profession for a specific clientele, and you’re ready to begin offering that service. Before you start seeing clients, write out a detailed business plan. That way you can get a firm handle on startup expenses such as legal fees and a marketing budget, as well as ongoing costs such as office space and supplies.
- Budget your transition. Even if your business reaches all your revenue targets during its first year, you’ll probably still see a drop in your income as you work toward generating a consistent profit and reinvest in your new venture. Tumber suggests saving consistently for one year before leaving your full-time job to build a cash buffer that can help sustain your household through the transition. To prepare, ask your Financial Advisor to help you anticipate costs and map out strategies for potentially boosting your savings and building that financial cushion. In particular, make sure you budget for:
- Your tax bill. The estimated quarterly federal taxes you’ll need to pay for your business should top your list of business expenses. This obligation covers income and self-employment taxes. You could face penalties if pay them late, even if you expect a tax refund.1
- Health insurance costs. If you have a spouse or partner, the most cost-effective way to obtain health insurance might be through his or her employer. But if that isn’t possible, an insurance broker can help you search for appropriate coverage for individuals and small businesses. Just be prepared for a step-up in costs.
- Retirement investing. If retirement is still in the future, you’ll need to keep saving for it. Self-employed workers can contribute to traditional IRAs called simplified employee pension (SEP) plans.2 Check contribution limits and investment options with your Financial Advisor, and discuss other options for saving more if you determine that it’s part of your retirement strategy.
- Make your office space work for you. If you plan to work from a home office when you launch your business, you might qualify for a tax deduction. To apply for that claim, your residence’s work area must be either the principal place of business or a space to meet with clients, patients or customers. You might also qualify if you use a detached structure that is part of your home, such as a garage or studio, in connection with your line of work.3
- Line up credit early. It's always smart to line up access to credit before you need it, and that’s especially true when you’re considering a switch to self-employment. Qualifying for a loan is likely to be much smoother while you still have a stable income. Otherwise, you are likely to face stricter underwriting standards as a self-employed borrower. "As a businessperson, you will probably need to show your last couple years of profit-and-loss statements, which isn’t possible for a brand-new business," Tumber says.
Wells Fargo Advisors does not provide legal or tax advice.
1 Internal Revenue Service, "Estimated Taxes," http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Estimated-Taxes.
2 Internal Revenue Service, "Simplified Employee Pension Plan," http://www.irs.gov/Retirement-Plans/Plan-Sponsor/Simplified-Employee-Pension-Plan-%28SEP%29.
3 Internal Revenue Service, Tax Tip 2011-53, "Work From Home? Consider the Home Office Deduction," http://www.irs.gov/uac/Work-From-Home%3F-Consider-the-Home-Office-Deduction.