Autonomy, flexible hours and the ability to earn more without jumping through hoops: Given these perks, it’s no surprise that over 9 million Americans have chosen to start their own businesses, according to the latest data available from the Bureau of Labor Statistics. Of course, this is much harder to accomplish than simply deciding to strike out on your own. You’ll have to be mindful of the financial steps needed to get it right.
Here are six steps to help you transition and prepare for self-employment:
1. Create a solid business plan
Becoming your own boss can be exhilarating and terrifying. But if you don’t have a specific plan for how things will work, you’ll be setting yourself up for failure. You’ll need to have one in place if you plan on seeking investors, too.
A good business plan should include things like:
- Details about the products or services you plan to offer
- Profit margins and financial projections
- Market and competitor analysis
- Marketing and sales strategies
The Small Business Administration has resources that can help you run your business, including making a business plan and financial resources.
2. Build a healthy financial cushion
While the average person should have a three- to six-month emergency fund, self-employed people need to be even more conservative because they don’t have a guaranteed income from an employer. It’s generally best to aim for a six to 12 month emergency fund to be safe.
If you’re not yet self-employed, building that fund up before taking the plunge is a good strategy. That way you’ll have cash reserves to fall back on while you’re getting things going with your new business, and you’ll be less likely to have to take on debt if you have a slow month or something unexpected comes up.
3. Look into your health insurance options
You can get health plans through the Health Insurance Marketplace. Make sure the plan you pick covers all your medical needs — this may mean paying higher premiums than you currently do with your employer-sponsored plan. Another consideration is how you’ll save up for medical expenses and prescriptions. A health savings account (HSA) can be helpful because every dollar you contribute to it is triple tax-advantaged:
- Contributions reduce your taxable income.
- That cash isn’t taxable if you use it on qualified medical expenses.
- You can invest your HSA funds and the growth isn’t taxable as long as it’s used on qualified medical expenses.
The catch, however, is that you can only get an HSA if you have a high-deductible health plan (HDHP). You can search for HSA-approved plans on the Marketplace website. But you should do the math to ensure those perks are worth the high deductible.
4. Plan for financial peaks
Being self-employed isn’t always about planning for the worst — you should also consider how you’ll handle windfalls that may come your way. After all, depending on your business, it may not be wise to simply use those funds on fun things, like a vacation or new TV.
You may find that your business income is somewhat unpredictable, particularly at the start. So extra cash may be best used to pay for necessities during leaner months. Or if you sell a physical product, you may want to invest that cash back into the business to boost your inventory so that you can make more money.
5. Make sure to account for taxes
Taxes can be especially painful for a self-employed person. After all, you may have to set aside thousands of dollars each quarter for taxes instead of having that money taken out of your paycheck. You need to account for quarterly tax payments by projecting your annual income based on how things are going with your business every few months. That way, you’ll know how much money to put aside for both federal and state taxes.
A tax program aimed at self-employed people can help you understand what you need to pay to avoid a big tax bill come Tax Day in April. You should have a dedicated tax savings account to keep that money separate from your everyday funds. And if it feels better to make smaller payments, you may consider making tax payments consistently throughout the year.
6. Get a business checking account
A business checking account can help you separate your business’ profits from your personal finances. This can help make your finances easier to manage, allowing you to pay yourself a regular salary. A business checking account can also protect you if your business ever gets sued. In that event, any such lawsuit would only be able to access the funds in your business accounts.
You’ll need an Employer Identification Number (EIN) or your Social Security Number, as well as a business license, to open a business checking account.