Have you considered becoming self-employed?
It is getting easier to start your own business given rapid technological advances, increased ability to buy your own health insurance through the Affordable Care Act, ability to outsource your needs, growth in the sharing economy and innovative financing choices.
There are noteworthy advantages to starting your own business such as being your own boss and having control, flexibility, work as hard as you want and own your successes. If you are a disciplined self-starter, have a vision and a plan you want to carry out, this may be a great path for you. The high risk/high reward opportunity is attractive.
The disadvantages are risks associated with potentially high upfront costs, a poor business plan, lack of provided benefits, taking care of taxes, raising money, need for support and the difficulties associated with handling the business.
We will go review the benefits and drawbacks of being self-employed but let’s define the term first.
What does being self-employed mean these days?
It generally is defined as working for oneself as a freelancer, independent contractor or the owner of a business rather than getting wages (and taxes withheld) from an employer. The exact definition of self-employment may vary between the Bureau of Labor Statistics (BLS) and IRS. As more people take on side jobs in addition to working for someone else, it is confusing as to how many people are truly self-employed.
How Many Self-Employed Workers Are There? It Depends
In 2015, the Bureau of Labor Statistics (BLS) reported 15 million workers were self-employed, or 10.1% of the total US workforce. The BLS did a survey in May 2017 to estimate workers in contingent or alternative worker arrangements, or both. Government data sources have had difficulty counting the number of gig workers as they may be working at more than one job.
Contingent workers are those who do not have an explicit or implicit contracts for continuing employment. These constituted an estimated 5.9 million workers in May 2017. Workers in alternative employment arrangements, include independent contractors, freelancers, independent consultants, on-call and temporary jobs amounted to 10.6 million workers but may also be included in contingent category.
The IRS says you are self employed if you carry on a trade or business as sole proprietor or as independent contractor, member of a partnership or otherwise in business for yourself, including part-time work.
Therefore, if you are generating supplemental income, it is taxable and you may be deemed self-employed. You are responsible for paying your own taxes. Some people are earning full-time wages from employers but may be earning part-time income as contractors or freelancers.
Numbers Vary By Study
The Fifth Annual “Freelancing in America” study by the Freelancer Union and Upwork was released in October 2018. It estimates there were 56.7 million freelancers in what is touted as the most comprehensive study of the US independent workforce. They believe a majority of US workers will be freelancers by 2027.
MBO Partners recently released “2019 State of Independence in America” report. Their study showed 41 million independent Americans workings as consultants, solopreneurs, freelancers, contractors, temporary or on-call workers. I found their study reflects the reality of the current workplace with many workers adding supplemental income.
However, the number of workers that working as full-time independents by choice are roughly 12.4 million people. Of the nearly 29 million remaining independent workers:
- 2.9 million workers are “Reluctant independents” meaning they are currently working independently but would have happily move onto someone else’s payroll if they find a traditional job;
- 15 million workers are “Occasional Independents” working at least one time per month as such, and
- 10.8 million workers are “Part-Time Independents” adding supplemental income from being a driver for Uber or Lyft.
Benefits of Being Self-Employed:
1. You Have More Control Over Your Life
It often gets frustrating to work for others. Your ideas are listened to but sometimes abandoned, your schedule is rigid with a lot of inefficiencies and you don’t see the upside potential you hoped for. We have all been there.
According to a TD Ameritrade Self-Employment survey, 76% of respondents had traditional employment before venturing out on their own.
Often a switch to working for yourself stems from a negative experience at your job. In an Intuit-Quickbook survey, 68% of respondents affirmed that they had an experience that pushed them to start working for themselves.
Having the ability to set your own goals, make your own decisions and carry them out can be exhilarating. You can work your own hours from home in sweatpants if you want.
Although working for yourself means you should be a self-starter, it doesn’t necessarily mean longer hours. Of those surveyed for Quickbooks-Intuit study on Work/ Life Balance, 38% worked shorter hours, 35% worked longer hours and the remainder worked similar hours as before.
True, many companies offer flex-time as a perk. Having your own business allows you to have maximum pliability over your schedule and how you work. As long you have access to the internet, you can work from anywhere. Starting a home-based business may be more cost-efficient with lower fixed costs. It can be a great option as long as you aren’t easily distracted.
Know when to take breaks and vacations and avoid burn-out. My parents had a family-run retail business. They didn’t have the option of a website. No one would have distinguished their store as a “brick and mortar” then. Their shop was open 7 days a week except for a handful of days off for national holidays. It was a rigid schedule for them.
With technology, you are only limited by your desire to make money as you don’t have a guaranteed paycheck.
3. Improved Work/Life Balance
Surveys have shown that having extra time for you and your family is a great benefit of being self-employed. Depending on your choice of business you may eliminate a long commute, travel to meetings, the need for more formal clothing and unwanted meals out with clients.
Having a better balance should reduce some of the work stresses of a traditional job. Those who are self-employed often say they experience greater satisfaction and a higher quality of life working for themselves for these reasons.
4. Higher Earnings Potential
Initially, you will have start-up costs to absorb on low revenues, if any sales at all. Longer term, your outlook is more promising. According to ZipRecruiter, the national salary average for self employed workers is $88,400/year as of July 2019. Freshbooks reports that 24% of survey participants earned over $100,000.
The US Small Business Administration (SBA) reports that on average, self-employed earn higher incomes than employees. Keep in mind that at least at the start there may be a long learning curve before you break even and generate positive earnings.
It is important for those who are self-employed to make sure to do their own proper accounting of revenues and costs. There are software packages for accounting, budgeting, expense tracker, billing, invoicing system and tax preparation.
5. Tax Deductions For Your Business
You are required to file taxes annually and pay estimated taxes on a quarterly basis and pay the self-employment tax.
As a self-employed owner, you are entitled to deduct certain expenses. However, the recent 2017 Tax Cuts and Jobs Act eliminated some of those deductions. You can still deduct costs associated with your home office, use of a car for business, meals and health insurance premiums. You should review the specific IRS rules and consult with a tax professional.
Most importantly, you need to keep stellar records of your costs related to your business.
Home Office Costs
Deductions for your home office costs are among the more complex rules. You may deduct workspace costs you use regularly and exclusively for your business. Determine your office space at home by measuring specific square footage allocated for your business’s purpose.
Other costs associated with your home office may provide tax benefits are proportionate to your space are: mortgage interest, homeowners insurance, property taxes and utilities
There are two methods you can choose: standard method and simplified method. The standard option can be a pain as you have to diligently calculate your costs on an allocated basis. On the other hand, the simplified method is easier but may be capped in terms of home space used.
The costs associated with your workspace in your home that may be deductible are the office portions related to your mortgage interest, property taxes, insurance, and maintenance. Business communications expenses like phone bills, internet and faxing may also be deductible.
Health Insurance Premiums
If you purchase your own health insurance and cannot be part of your spouse’s plan provided by his or her employer, you may deduct premiums for vision, dental, health and long term care.
Business Meals, Cars, and Overnight Travel
You may deduct 50% of business-related meals based on receipts or records you keep. Travel-related expenses may be deductible if overnight for specific business activites. Your travel must be away from your home base. Keep good records of your purposeful trip as meals, car rentals or Uber may be deductible.
Car costs associated with business use are tax deductible overall.
Employer-Related Part of Self-Employment Tax
If you are paying the self-employment tax, you may be able deduct part of the FICA taxes that cover Medicare and Social Security that is the employer-related.
6. Retirement Planning
As you are accountable for doing your own taxes, you are also responsible for your retirement planning. You won’t be entitled to an employer match as you are now self-employed. On the positive side, you may have the ability to contribution higher tax-deferred dollars to your plan.
You have a few good options:
Traditional IRA or Roth IRA
These are the simplest plans you can set up yourself but they also have the lowest contribution limits. Contributions are up to $6,000 in 2019, up to $7000 as a catch up contribution for those 50 and above. There is a tax deduction for the traditional IRA and no immediate deduction for Roth IRA.
If you contributed to your IRA plan in your previous job, you can roll over the plans.
This plan is for a business owner or self-employed person with no other employees, except your spouse. The solo 401K plan has a special benefit as the participants are both employer and employee. This means the self-employed person is able to contribute in two ways. as “employee” you can contribute $19,000 in 2019, or $25,000, or $6,000 more, if you are 50 years or older.
Then as “employer,” you can make a contribution of up to 25% of your compensation each year, up to a maximum of $56,000 in 2019 on an annual basis. If you are 50 years or older, your combined employee and employer annual contributions can’t exceed $62,000 as of 2019.
Owner’s spouse may also be able to make contributions if he or she is working for the business, thereby potentially doubling the contribution.
The Simplified Employee Pension or SEP IRA is good for business owners or self-employed with no or few employees. Annual contributions must be set at the same percentage of compensation for all employees, including the business owner. Annual contributions are limited to $56,000 as of 2019. Employee contributions are treated as a business expense.
There is no Roth IRA option.
Savings Incentive Match For Employees or SIMPLE IRA plan is for larger businesses with up to 100 employees. Contribution limits are up to $13,000 in 2019, with an additional $3,000 in the employee is age 50 or older. These amounts are a deductible expense but distributions in retirement are taxed. Employers must make some kind of contribution annually so this is a less flexible plan.
Defined Benefit Plan or Pension
This plan is best for a self-employed with no employees. It is more complex and generally an option when the business has a high income and wants to save a lot for retirement on an ongoing basis. Contributions are calculated by an actuary using the business owner’s age, expected return on investment and expected annual benefit.
The maximum annual retirement benefit is at $225,000 and is tax deductible generally.
There are many options that provide greater contribution limits to the self-employed person.
Drawbacks of Being Self-Employed
1. Sole Proprietor (SP)
Most small business owners may set themselves up in the form of sole proprietorship. Although SPs have some benefits, you may be exposed to personal liability. This means if you are sued and lose the case, your personal assets like your car and house could be taken to settle a case. Being an sole proprietor carries higher risk than other forms like incorporation or an LLC.
2. You Are On Your Own
You are probably going handle a lot of the business aspects on your own. Consider outsourcing at least some of the functions. Many people have a strong vision, motivation, hard work ethic, are decisive and have strong skills.
However, you are running a business on your own. Your management abilities will be just as important, if not more so. You need to deal with a lot more than when you were working for an employer.
When you are not yet generating much in the way of revenues, seeing losses pile up can be unnerving and stressful. You may also feel isolated at times. Make sure to make contacts, find mentors who could be helpful, join associations and network with people important to your business or are in similar situations.
3. Unpredictable Income
Depending on the type of business you are running, you may always be subject to sporadic earnings unless you have a subscriber business. At a minimum, you need to create a budget for your business, understand your revenue inflows, fixed expenses and variable expenses. Track your costs for potential reduction opportunities.
More than one-third of US households experienced a 25% change in income year-to-year according to Pew Research.
Make sure that you pay yourself a salary and save as much as possible for those times your monthly income is lower. You need to have an ample emergency fund for six months or more to pay for your living expenses. Arguably, your emergency fund should be for as much as a full year if your earnings are volatile. You do not want to borrow money to pay your basic expenses.
In the TD Ameritrade survey of self-employed people, 59% say they are more anxious about earning a steady income.
Related Post: Why You Need An Emergency Fund (And How To Invest It)
4. Raising Money For Your Business
It is harder to get loans as a new business owner in its start-up phase. While you may have had a proven track record at your previous employer, banks will be looking at you in a new light. They will review your business plan, your budget and balance sheet. Importantly, they will be reviewing your credit report and credit score in great detail.
Before you even form your business, it is important to review your credit report for possible errors. Fix them ahead of approaching the lenders for a loan. There may be hits to your credit report that you can explain.
Most importantly, you need to prepare for the possibility of needing funds in the future for a variety of reasons. It could be that you underestimated the costs of your business, you want to seize an opportunity that has presented itself or demand is growing faster than anticipated. According to the SBA, 50% of small businesses fail within the first five years.
Insufficient capital is often one of the major reasons that some businesses fail.
Many self-employed take financial risks to start their business with 27% relying on personal borrowing. Very few look to small business loans/credits (8%) or even federal loans or grants(2%) which may be available to them. It is worth checking the Small Business Administration’s (SBA’s) website to see if you qualify for a low cost loan or grant.
Innovative financing is available to you to pursue. Consider crowdfunding as a financing source that works for small business owners, particularly women.
Related Post: Challenges Women Entrepreneurs Face (And Overcome)
5. No More Company Benefits
Being self-employed hits you with the realization that you no longer have paid benefits you may have enjoyed at your previous employer. You still need to have access to some of the key benefits and purchase them on your own.
Thanks to the Affordable Care Act, you may be able to buy cheaper health insurance. Health plans can be obtained by HealthCare.gov though they may expensive. Positively, you can deduct the premiums for you and your dependents. If you are a freelancer, you can join the Freelancer’s Union for free. You can purchase different types of insurance and retirement plans as a member.
With respect to all kinds of insurance–dental,vision and disability–you can try a few places. Freelancers Union may provide some of these benefits.
Some benefits are less replaceable like paid leave or vacation pay. It will up to you to take off regularly. It is important for you and your family.
The benefits of being self-employed outweigh its drawbacks for many people. The key is knowing if it is right for you. Hating your job and your boss is not necessarily a sign of your potential success in starting your own business. Changing jobs first may the better decision.
Having your own business is a high risk/ high reward decision to make. Some people have begun their own business as a part-time side job, retaining their full-time job as a way of trying out the business. Others have gone out on their own after a considerable amount of planning and saving.
Essential Characteristics For A Self-Employed Person:
- Not A 9-5 person
- Lifelong learner
- Determined and have been obsessively planning
- Have many skills, including communicating with others and problem-solving
- Need good financial habits, financially prepared and disciplined
- Strong work ethic and ethical
- Can be patient
Being on your own is a big decision to make. Talk to others, especially your family. At the very least, listen to your inner self. The answer is there.
Are you self-employed or considering such a move? Wishing you the best in the decision and realizing success. Please share with us any thoughts or comments you have. We would like to hear from you!
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Pros And Cons of Being Self-Employment
With a passion for investing and personal finance, I began The Cents of Money to help and teach others. My experience as an equity analyst, professor, and mom provide me with unique insights about money and wealth creation and a desire to share with you.