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Financial Planning for the Self-Employed

Real estate agents, carpenters, writers, plumbers and other independent contractors have cut the corporate umbilical cord in exchange for more flexible hours and the independence to pursue their own dreams.  

According to the U.S. Census Bureau, businesses without paid employees grew 2.3% between 1999 and 2000, from 16.2 million to 16.5 million.  However, if you’ve been thinking about joining the ranks of the self-employed, you’d better have a financial plan.  While working for yourself affords some new freedoms, it also presents unique financial challenges.  Here are some important things to consider:

Setting up your business.  One of the first decisions you'll need to make is whether to be a sole proprietor or choose some form of incorporation, such as a C corporation, subchapter S or limited liability company. Most self-employed individuals operate as sole proprietors, because it's less complicated and less expensive than incorporating. However, incorporation may be attractive if you have concerns about legal liabilities, since the various forms of incorporation can offer limited liability protection.  Through your decision-making process, be sure to consult with professional advisors who can help you choose what’s best for you. 

Managing cash flow.  As an independent contractor, you may face periods of uneven cash flow. Without scheduled paychecks from an employer, you could end up flush one month and penniless the next.  To ensure that you always have cash at hand, develop a budget and a financial plan that allow for your swings in income.  Determine an average of how much revenue you can count on, and use that as a base for monthly expenses.  During months that you make more, stash the extra cash in an interest-earning savings account or money market account and draw from it during months you have little or no income.  Also, you should consider paying yourself a salary and keeping your personal and business cash in separate accounts.  Combining them can complicate tax deductions and potential reimbursements.

Obtaining insurance.   First, do some research and see if you can piggyback on your spouse's benefit plan. Otherwise, you must make plans to provide your own health, disability and life insurance.

Health: Unfortunately, many self-employed individuals ignore this need once they leave their companies.  According to the National Association for the Self-Employed, more than 60% of America’s 41 million uninsured are from households headed by a self-employed individual.  If you can't get health insurance through a working spouse, consider a medical savings account (MSA). An MSA allows you to take a tax deduction for the money you put into the account to pay for out-of-pocket medical expenses associated with a high-deductible healthcare policy. If you don't spend all the money you put into the account, it can stay there and earn interest tax-deferred. 

Disability:   Finding a good, affordable disability policy to replace lost income can be tough for the self-employed because as disability insurers generally work with groups. One possibility is to join an industry trade association or alumni organization that offers access to disability insurance.

Life: Life insurance can help provide money to pay off your mortgage or send your kids to college if you die.  There are many types of life insurance, ranging from term insurance (death benefit only) to cash value (cash accumulation and death benefit) to combinations of the two.  However, be aware that getting life insurance on your own might be a problem if you have medical issues that sometimes aren't questioned under a group plan.

Saving for retirement.  If you’re self-employed, you can forget about 401(k)s.  They're too complicated and expensive for your purposes. Instead, research tax-deductible vehicles, such as Keogh plans and simplified employee pension plans SEPS, as well as traditional individual retirement accounts (IRAS). You also may want to consider nondeductible alternatives, such as a Roth IRA and annuities.  If you choose to incorporate as a small business, consider getting a savings incentive match plans for employees (SIMPLE) IRA.  Designed for companies with fewer than 100 employees (including self-employed workers) with no other qualified plan, SIMPLE IRAs offer income tax-deferred savings and employer-matching flexibility. 

Managing taxes. The bad news is that, unlike employee paychecks, taxes aren't taken out of income received by an independent contractor. You're responsible for paying income and Social Security taxes. As a result, it's important that you save for taxes from each payment you receive, before you start spending the income. Otherwise, you may not have the money on hand to pay any taxes due when it's time to file your quarterly estimated or annual return.  On the other hand, the self-employed may be eligible for certain tax breaks.  Contributions to retirement plans, health insurance premiums, auto expenses, travel costs, meals, entertainment and office-related expenses all may be deductible.  Make sure to keep all of your receipts so you can save during tax time.

Working on your own can be both intimidating and exciting.  Whether you are planning for your new opportunities as a freelancer or growing a small business, meet with a certified financial advisor so he or she can help you manage your finances during your pursuit of independent success. 


Hypothetical example provided for illustrative purposes only.  Does not take into account transactions fee's or expenses.  Past performance does not guarantee future results.  This information is provided for informational purposes only.  The information is intended to be generic in nature and should not be applied or relied upon in any particular situation without the advice of your tax, legal and/or your financial advisor.  The views expressed may not be suitable for every situation.

American Express Financial Advisors Inc. Member NASD. American Express Company is separate from American Express Financial Advisors Inc. and is not a broker-dealer.

This communication is published in the United States for residents of  North and South Carolina only; and this advisor is licensed only in  the states of North and South Carolina." 
Roy P. Janse 
Financial Advisor 
American Express 
Financial Advisors, Inc. 
IDS Life Insurance Company 
1150 Haywood Road 
Greenville, SC 29615 
Phone: (800) 554-0805 x141 
Fax: (864) 234-7139 

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