Making the leap to a freelance career? Do these 4 things first

More people than ever are making the transition from working for an employer to working freelance. The 5th Annual “Freelancing in America Study” estimates 56.7 million Americans freelance. That’s an increase of 3.7 million people in five years. 

People who decide on a freelance career cite various reasons for doing so. They mention everything from the desire to improve their work-life balance, make their own schedule, travel and work anywhere in the world, take on interesting projects from different clients, and avoid the headaches of rush-hour traffic.

It’s a decision I made 17 years ago when I decided to transition from working as a full-time technical writer employed by a company to working as a self-employed freelance writer.

Fortunately, I didn’t go into it blindly. I was lucky enough to have a few good friends who were freelancers and who were willing to give me some hard-won advice. We sat down and had an honest discussion about the good, bad, and ugly of the freelance lifestyle. It was a sobering conversation, but one I needed to have.

I soon realized before quitting my full-time job I needed to get my financial ducks in a row. Before talking to my friends, I had no idea about some of the financial trade-offs I would encounter going from working for a big company to being self-employed.

If you’re thinking of making the leap to freelance work, then I highly suggest you slow down and take a few important financial things into consideration before quitting your job. No, I’m not saying or implying that you shouldn’t become a freelancer. You’re the only one who can make that decision for you based on your goals and career aspirations.

But what I am saying is you should go into the lifestyle with a clear understanding of some of the financial landmines you could encounter on the road ahead. Take a little time to do some research and planning first and you’ll boost your odds of having a safe landing.

Here are the top 4 things I recommend you do before making the freelance leap.

Plan for taxes

When working for an employer, your federal and state income taxes are more or less on automatic pilot. Your employer deducts your taxes from each paycheck. You never actually see this money that goes toward paying your taxes. It never ends up in your bank account.

But all that changes when you’re a freelancer. Instead, you have clients or customers. This relationship is much different than an employer-employee relationship. 

If you have clients, they will probably refer to you as an independent contractor. They may even ask you to sign a contract that clearly defines your role as a contractor. You will bill for your work and, if all goes well, your clients will pay you the agreed-upon amount. You get the full amount without any deductions for taxes.

Now the first time you get a check as a freelancer, it might seem like a pretty heady experience. “Wow,” you might think, “Look at all this extra money!” It may seem like a whole lot more than you ever earned as an employee.

But don’t let that fool you. Your obligation for paying taxes does not go away. It is now your responsibility to set aside enough money to pay your taxes and to ensure your taxes get paid on time. 

You’ll now have self-employed tax obligations, which are different than the tax obligations you had as an employee. The amount you pay each year could change drastically. If you don’t plan for this in advance, you could be surprised by a higher than expected tax bill.

In addition, the tax forms you file will change and a whole host of other tax-related things could change once you become self-employed. For example, you might need to account for various expenses or itemize deductions. You might need to set up quarterly estimated tax payments. 

While you might be tempted to go it alone and figure out your taxes on your own, I strongly suggest you consult a licensed tax expert such as a Certified Public Accountant (CPA) before you make the leap from full-time employee to freelancer. Tax laws change frequently and trying to figure out your taxes on top of launching a new freelance business could be a costly mistake.

A qualified tax expert will be able to give you advice on how much tax you might owe once you become a freelancer, how to plan for your taxes, and when to pay your taxes to ensure you aren’t ever delinquent. An added benefit: if you do a good job planning for your taxes upfront, you’ll sleep better at night knowing you won’t be caught off guard by an unexpected tax bill.

Research health insurance options

The loss of employer-paid health insurance is one reason why some people decide not to become freelancers. That’s because the dollar value of this employee benefit can be huge, especially if you have a spouse or children to provide for.

You could easily experience sticker shock once you go shopping for your own health insurance plan. Even with the Affordable Care Act (ACA), you could still end up paying far more than you anticipated for healthcare coverage. Depending upon how much you earn as a freelancer, you may not receive much of a financial benefit (or none at all) from ACA.

And, of course, health insurance is a very personal thing. Some freelancers decide to purchase a very basic plan that only covers the minimum mandated coverage. Other folks, however, want comprehensive coverage. 

For a price, you’ll likely find a plan that meets your requirements. But is that health plan and price an acceptable trade-off for becoming a full-time freelancer? Only you can answer that question, and that’s why it’s important you do your research before you leave your job.

Fund your own retirement

Making the leap into the freelance world means you’re now responsible for setting up and funding your own retirement plan (if you choose to do so) instead of relying on an employer-sponsored retirement plan such as a 401(k). If your employer offers matching funds, then this is something you’ll be losing if you go freelance.

In the excitement of setting up your freelance business, it’s easy to overlook funding a retirement account. Especially during the first few years of your new business, it might be tempting to use the money you’d normally set aside for retirement for business expenses instead. But this might be a financial mistake you’ll regret later on.

Fortunately, you have plenty of good options for funding a retirement plan as a freelancer. You could set up an Individual Retirement Account (IRA) with the help of a brokerage firm, bank, or financial advisor. If you have a 401(k) you want to roll over into an IRA, you might want to interview a few Certified Financial Planners (CFPs) to get a clear understanding of your rollover options. 

Ask trusted friends and family members for CFP recommendations and be sure to research their credentials yourself before scheduling an appointment. Most CFPs will give you a free initial consultation. Take them up on this and get a wide variety of retirement planning ideas that will help you make a good decision. 

Factor in your time off

Paid time off is a benefit you might take for granted as an employee. You might receive paid vacation time, sick leave, and holidays. Add it all up and this could amount to several weeks each year that you get paid even though you’re not working.

As an independent contractor, there is no such thing as paid time off in the traditional sense. In essence, you’ll “self-fund” your time off by factoring this into the cost of the services or products you provide your customers.

You’ll want to make sure you always have money set aside for those unexpected days when you simply can’t work due to illness or when it’s time for you to take some much needed rest and relaxation. 

The Bottom Line

As you’ve probably surmised after reviewing the items on this list, your ability to budget your money will be crucial for you to make a successful leap into the world of freelancing. Initially, it may be challenging to come up with a realistic budget to cover all the different financial responsibilities you’ll have as a freelancer. 

The best advice I can give you is to go into your career transition with your eyes wide open. Take the time needed to research your various options so that you aren’t blindsided by the financial landmines I’ve discussed in this article.

I would also suggest you make a list of all the reasons why you want to become a freelancer. Ask yourself if the potential benefits of freelancing outweigh the financial challenges you might face.

For me, when I started freelancing 17 years ago, the answer was yes, the benefits did outweigh the challenges. I started freelancing because I wanted the flexibility in my schedule to do caregiving for several disabled family members who needed my assistance. I wanted to be there for them during medical appointments and during those rough times when they needed a helping hand. 

Have I given up some monetary wealth to achieve my goal? Probably. But for me that trade-off was acceptable because I’ve gained a different kind of wealth that I find more valuable.

Have you made the leap into freelancing? What financial challenges did you face and how did you handle them? We’d love to hear your story in the comments below!