By Theo Thimou, clarkhoward.com
Ready to give up on corporate America yet? Maybe you’ve thought about striking out on your own as an entrepreneur and becoming your own boss. But before you do that, heed this advice to prepare…
How to get ready for self-employment before you make the leap
The latest data available from the Census Bureau tells us that the number of self-employed workers grew to nearly 24 million people. That’s up 10% over a period from 2007 to 2014. So this is a clearly a growing trend.
We know there’s a lot to think about when considering self-employment, but here a few financial concerns you want to be sure that you address.
Emergency fund: How much do you need?
Before making the leap to becoming self-employed, you should build up a nice rainy day savings account to survive the lean times that come with running any business yourself.
While most financial experts recommend an emergency fund equal to at least six months of your income, that’s a rule geared toward those who have a steady and reliable income from an employer. Consumer Reports goes as far as recommending 12 months of money in reserve if you’re going to be self-employed. That will help you avoid tapping your existing retirement savings in a pinch.
Health insurance: How will you get it?
When you no longer have an employer to rely on for insurance, you basically have three options: Get it through your spouse’s employer, buy COBRA or get an Affordable Care Act plan.
Going on a spouse’s plan is like hitting the “easy” button and can save you a lot of money if that’s an option. Meanwhile, COBRA is costly — up to 102% of the premium you paid through your employer’s plan — and only lasts 18 months.
The Affordable Care Act option is viable, but if continuity of care is an important consideration for you, then be sure to check with your doctors to make sure they accept the level of plan you’re considering buying.
Other insurance: What kinds and how much?
Throughout your working lifetime, you are three times more likely to become disabled than you are to die before age 65. Makes a convincing case for having disability insurance, right?
There are a lot of considerations to think about with disability insurance, such as making sure the insurer is financially strong for the long haul, making sure your policy covers your specialty and more. Get a full rundown of what you need to know here.
Retirement: Don’t forget to save!
Nearly a third of all entrepreneurs aren’t saving anything at all for their retirement, according to a new survey from non-profit The American College. They’re too busy pouring every penny back into their business, thinking that will be their big score. Maybe, but maybe not.
Fortunately, there’s an alternative that’s a great idea. As a self-employed person, you have access to a simplified employee pension (SEP). The paperwork to set up a SEP is simple, and you can even open one at a low-cost investment house like Vanguard, Fidelity or T Rowe Price at no cost.
SEPs work like a traditional IRA or 401(k), with a current year tax deduction. Withdrawals are taxed at retirement. SEPs also offer flexibility because you can put in from zero in a year to as much as $51,000. That’s helpful during the feast or famine startup years. Don’t miss this opportunity to save for your future!
Taxes: Handling your new situation
When you work for yourself or as an independent contractor, it’s very rare that taxes are withheld from your paycheck. So it’s up to you to plan for tax time.
As a self-employed person, you’re required to send quarterly estimated tax payments to the IRS. One suggestion that Consumer Reports offers is to set up a separate bank account for tax stuff. That way you always have a stash of money that’s dedicated to taxes.
Plan on saving 25% of everything you earn for taxes so you’re not left scrambling when it’s time to pay Uncle Sam.
Audits: How to survive a potential one
Here’s something to note well: The self-employed have a bull’s-eye target on their returns. That’s because past audits have shown a meaningful percent of the self-employed who don’t report income properly.
Unfortunately, this is one case where you’re guilty until proven innocent with the documentation you can produce to back up your claims in a correspondence audit (via the mail) or a field audit (face-to-face interview).
Some big problem areas are the way you claim a home office deduction and how you deduct unreimbursed business expenses, among others.
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