Starting a business comes with a lot of considerations. If you have the luxury of having another job while you prepare to join the gig economy, you can – and should - take care of some important items while still collecting a paycheck.
Preparing to Take the Leap
First, building up a cash cushion is critical to get you through those first months of getting your business off the ground. The alternative is to start off your newfound independent life by incurring debt for your basic needs. Also important: creating a website and other marketing materials, arranging physical space if necessary, setting up a business bank account and credit card, and figuring out your health insurance.
Make sure you have a good sense of what your personal monthly cash needs are. It can be as simple as going through your bank statements and making a list of everything you’ve spent money on for the past few months (maybe going back to your pre-pandemic spending habits). Understand how you can realistically make enough money through your business to cover at least those basic expenses, and a timeline for when that might happen. Forecasting your business income in this way can help you to gauge whether you’re on track to meet your goals and help you to estimate how long your savings will last.
Managing Unpredictable Income
Once you begin your business, you may be living off of your savings for a while, but at some point you will be making more than you need to cover your living expenses. If your income fluctuates from month to month, it can be difficult to manage your personal finances. A simple way to handle this is to set up your finances so that you’re paying yourself a salary. Figure out how much it costs you to live (for easy math, we’ll say $2,000 per month). Set up a regular transfer – maybe weekly of $500 or bi-weekly of $1,000 – from your business account into your personal checking. If you don’t use a separate business bank account, you can deposit your gig earnings into a traditional savings account. Over time, as long as you’re making more than you need to live on, you will gradually build up a cushion that you can dip into during slow times to keep your personal income smooth and predictable.
Income taxes are tricky for gig workers. Often it takes a few years to make positive taxable income, so during those first years you don’t have to worry too much about putting money aside to pay Uncle Sam. However, once you are making money, make sure that you’re putting enough aside every month to cover your tax liability. Often a separate bank account specific to taxes is a really good idea, so that money stays safe.
It may take a while to perfect the percentage of your gross income that needs to be put aside every month. You might start with 25-30%, which should cover federal and state taxes. Depending on your personal situation, including your spouse’s income and withholding, as well as number of children and other income or deductions, the right number for you might be more or less than that.
Once you’re making taxable income, you’ll owe self-employment tax of 15.3% - although you can take a deduction of 50% of that.
Taxes are a moving target: if you get yourself into a situation where you owe a lot, you have to make more money to pay it off, which means that you’re always incurring new tax debt. Making the effort early on to stay current with your taxes can save you a lot of stress and heartache down the line.
Once your business is up and running, and generating a profit, you can turn your thoughts to the future. You no longer have a 401(k) set up for you, so preparing for retirement is entirely up to you. At first, a traditional or Roth IRA might be enough (2020 contribution limits are $6,000, plus $1,000 if you’re age 50 or older). Once you outgrow those accounts, you will have multiple options available to you: a SEP IRA, a SIMPLE IRA, a solo 401(k) – all of these are designed for self-employed individuals or small businesses.
Don’t forget to look at your full family picture; if your spouse has a retirement plan through work, make sure you’re taking advantage of that – particularly if there’s an employer match on the table.