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By Suze Orman
At the heart of the great resignation trend that has seen so many people leave jobs, is the decision to stop work that extracted too high a personal cost. Amen to that.
Yet for many who have left a job, or are ready to move on, the quitting isn’t really the point. Right? Rather, you are focused on building a new approach to work that fits better with what you want from life.
If your great reassessment leads you to become self-employed—gig worker, independent contractor, entrepreneur—I want to make sure that you have all the financial steps taken care of.
And there’s a lot to do. For all the upside of being the boss of you, there is also the challenge of having to be your own benefits manager as well.
Here are four key must-do’s when you launch into self-employment.
I don’t care how young and how healthy you are, I have no budge on this. Stuff happens.
When you leave a job that provided health insurance, and the company has at least 20 employees, you might be eligible to continue coverage for up to 18 months. This is referred to as COBRA coverage, after the federal regulation that mandates employers continue to carry former employees on the plan. But there is a huge catch here. When you were working at your job, your employer likely covered a huge portion of the total premium for your coverage; whatever you may have paid each paycheck typically was a small percentage of the total cost.
If you continue coverage through COBRA you will pay 100% of the total premium. Actually, you might be charged 102%, as insurers are allowed to tack on another 2% to cover administrative costs.
My advice is compare COBRA coverage to what a policy you can buy directly on the ACA (Affordable Care Act) marketplace. Everyone is eligible for an ACA plan, and you may qualify for subsidies that will reduce your premium costs.
In a better world health insurance would not be such a big monthly cost. But here we are. Please don’t go without this vital protection.
And there’s a bit of a silver lining: Most self-employed people who pay for their own health insurance are allowed to deduct 100% of their annual premiums on their federal tax return if you meet the requirements. That effectively reduces the real cost of being protected.
You know my advice is to have one year’s worth of living costs saved up. And you know I am 100% behind the fact that it can take time to get to that point. But if you are going to launch into self-employment, I sure hope you have at least six months saved up.
My big concern here is that you may find cash flow is anything but steady. For starters, even if you have work lined up quickly, you aren’t going to get paid automatically every two weeks. The way it often works is you need to invoice a client, and then wait for payment. Some clients will take as long as a month to cut the check. It’s also wise to expect hiccups with new clients, as it’s all too common for their payroll folks to take their time getting you into the system.
And the reality for anyone who goes the freelancer/independent contractor/gig worker route is that income can vary from month-to-month. Especially in the early going.
I want you to be ready for that.
Ready to get super serious about building your emergency savings? Check out Alliant’s Ultimate Opportunity Savings Account.
When you are self-employed you are responsible for paying all your taxes. Nothing will be deducted from the fee clients pay you. You are responsible for your income tax, as well as your payments for Social Security and Medicare (this was the FICA deduction when you worked for an employer.)*
Social Security and Medicare tax payments are referred to as the Self Employment (SE) tax. You will pay that and your income tax in one Estimated Tax payment each quarter. If you live in a state that levies income tax, you are also in charge of making those payments. You can pay all estimated taxes online.
Federal Estimated Tax payments are due on April 15 (for the first quarter of a calendar year), June 15, September 15 and January 15 (for the fourth quarter of the previous calendar year.)
Estimated tax payments trip up so many new self-employed folks. You aren’t allowed to wait until tax season and pay everything then. There can be penalties for doing that. Besides, it’s going to be easier cash-flow wise to pay quarterly.
To be honest, the first year may be the hardest, because you aren’t sure of your income. You can look up federal tax brackets to get a sense of where you might fall; just remember those tables are for taxable income, which will be less than your earned income after you take various deductions.
There are free online calculators that can estimate your self employment tax. You can find calculators that will estimate both your self-employment tax and your income tax. Search for “1099 tax calculator.” (The 1099 refers to IRS form 1099-MISC, which is how your clients will report payments they made to you to the IRS. During tax season, your clients will mail you copies of your 1099-MISC, which you will use to file your federal tax return.)
My advice is to set up a separate savings account labeled Tax Payment, and each time you are paid move some of the money into that account so you will be ready to make your quarterly estimated tax payments.
I know how tempting it may seem to think you can wait a while until you tackle this. I hope you will reconsider. There will never be a good or easy time to set this up. And the sooner you do it, the more time your money will have to grow.
While there is a way to set up your own 401(k) when you are self-employed—called a Solo 401(k)— I am going to suggest you start with the far simpler way to save for retirement on your own: an Individual Retirement Account (IRA).
You can open an IRA at any discount brokerage.
You know I am a big fan of saving in a Roth IRA. This year you can contribute $6,000 to a Roth IRA if you are younger than 50 years old. Anyone at least 50 can contribute $7,000.
There is an income limit to be able to contribute those maximums, but it’s pretty high. In 2022, individuals with modified gross income below $129,000 are eligible. For married couples filing a joint tax return, your income must be below $204,000.
If you anticipate that $6,000 or $7,000 is the most you can manage to save right now, then a Roth IRA is a great way to get saving for retirement.
But if you can manage to save more, I want you to know about a special type of IRA that is for self-employed workers. With a SEP-IRA (Simplified Employee Pension Plan) you may be allowed to save even more. In 2022, a sole proprietor—that’s you if you are self-employed with no employees—can save 20% of net earnings for the year, up to a maximum limit of $61,000. You can set up a SEP-IRA at a discount brokerage.
That said, there is no such thing as a Roth SEP-IRA. A SEP-IRA is only offered as a traditional IRA. That means what you contribute is deducted from your income for that year, but in retirement when you make withdrawals every dollar will be taxed at your ordinary income tax rate. (With Roth IRAs, you have no upfront tax break on what you contribute, but 100% of withdrawals in retirement are tax free.)
I want to be clear: any and all saving for retirement is a good thing. In years when business is great, maybe consider a SEP-IRA. In years when $6,000 or $7,000 is the max you can afford to save, use a Roth IRA.
Alliant has partnered with Suze Orman to offer a high-rate savings account and bonus for new members. Start your savings journey today!
Suze Orman is the author of 10 consecutive New York Times bestsellers, a two-time Emmy award winner, and your go-to for honest answers on everything finance. She is the most recognized personal finance expert in America today and host of the Women & Money (and Everyone Smart Enough to Listen) podcast. Suze is excited to be a contributor for Money Mentor.
Suze and Alliant teamed up to help Alliant members make the most of their life by teaching them to make the most of their money. New Alliant members are also eligible for The Ultimate Opportunity Savings Account.
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