How to Create a Self-Employed Budget

As a self-employed worker, you can still order lattes – you just need to tackle finances differently.

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Rebecca Thorman
Rebecca Thorman
Employees in today's job market are increasingly opting out of traditional workplaces to join the fast-growing ranks of the self-employed.

About 40 percent of adults in the U.S. workforce either currently works or has worked as an independent at one time, and by 2020, that number is estimated to reach 50 percent, according to MBO Partners 2013 State of Independence in America report.

The majority of self-employed workers seek independence to be their own boss, retain a flexible schedule and build unique career paths. Still, many find that with increased control comes increased responsibility, and economic viability is harder than anticipated. Financial stressors, including difficult tax and accounting procedures, a lack of benefits and trouble budgeting for irregular income, all rank as the top disadvantages of independent work.

Before you decide how many lattes you can afford as a self-employed worker, you need to take control of your finances. Here are some ways to understand your budget.

Set aside 30 percent for taxes. As an independent, there is no one to withhold your taxes; it's up to you to complete quarterly estimated tax payments to the internal revenue service. Estimated tax payments should include federal and state income tax as well as self-employment tax. Self-employment tax consists of the same Social Security and Medicare taxes all wage earners must pay, but at different rates. If you're employed, your employer pays for part of your Social Security and Medicare taxes, but as your own boss, you pay it all. In 2013, the IRS reports the rate is 12.4 percent for Social Security and 2.9 percent for Medicare, making a total of 15.3 percent self-employment tax.

Since the IRS requires taxes to be paid at the time the income is earned, you may be subject to a penalty if you do not pay enough by the due date each quarter. Don't forget, the self-employment tax is in addition to income tax. So plan to set aside 30 percent of your income minus expenses into a short-term savings account, and set aside money each time you are paid.

Allocate for health insurance. As a self-employed worker, you can often deduct health care premiums, and if you elect to use a state health insurance exchange, you may qualify for additional tax credit subsidies. Regardless of tax benefits, health care premiums are a large monthly expense you wouldn't have if you worked for a traditional employer. Health care policies vary depending on your age, location, type of plan and deductible. Keep in mind that the cost of health insurance usually does not include deductibles, dental, vision or prescription coverage.

Allocate for life insurance. Many employers provide low-cost life insurance to their employees, so add another line item to your self-employed budget. It's often more important for independent workers to retain life insurance, and the cost will depend on your age and health. As a sole proprietor, you are responsible for any debt your business incurs, and as a result, any losses or financial obligations at your death become the responsibility of your estate. Life insurance can be used to pay that debt in the event of your death and also to provide for the needs of your family.

Build a short-term savings fund. While it's important for all workers to have a six- to nine-month emergency fund, self-employed workers may find it necessary to build additional savings into their accounts. A healthy short-term emergency fund allows you to cover expenses from your savings account instead of your credit card, despite unpredictable income.

Take advantage of self-employment plans. One of the greatest benefits independent workers lose is the ability to contribute to a 401(k) and participate in matching programs employers often offer. But when you work for yourself, you still have many of the same tax-deferred options to prepare for your retirement:

  • Simplified Employee Plan IRAs are a good option for freelancers, consultants and moonlighters who do not plan to hire employees. You can contribute 25 percent of your income, up to $51,000 in 2013, and you can fund the plan until you file your taxes. So if you have irregular income, you can decide whether to make a large or small contribution at tax time.
  • Individual 401(k)s allow you to contribute both as an employer ($17,500 or $23,000 if age 50 or older in 2013) and an employee (an additional 25 percent, up to $51,000 in 2013). The individual 401(k) is also flexible and can be tailored in the event you want to take out a loan against your savings.
  • Savings Incentive Match Plan IRAs only allow you to contribute $12,000 in 2013, but are the best option for self-employed workers who plan to hire no more than 100 employees. While the SIMPLE IRA requires you to match up to 3 percent of your employee's contributions, it avoids many of the complex rules and conversions the other options require when additional employees join.
  • Self-employment gives you the freedom to choose your work, but it can be burdensome financially. If you plan your budget with the line-items self-employed workers require, you won't encounter any surprises when it's time to pay bills, taxes or prepare for your financial future.

    Rebecca Thorman's weekly blog Kontrary offers tips to create the career, bank account and life you love, and is a popular destination for young professionals. Her goal is to help you find meaningful work, enjoy the heck out of it and earn more money. She writes from Washington, D.C.