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Top 7 Financial Mistakes Made by the Self-Employed

So, you've taken the plunge into the world of self-employment. You're your own boss, you set your own work hours, and you even get to pick and choose the projects you want to tackle. But, with this freedom comes a bit of responsibility, especially when it comes to managing your finances.

You see, many of us make some common financial mistakes that, if left unattended, can stir up trouble down the road. But fear not, in this blog, we're going to have a heart-to-heart about the top seven financial goof-ups the self-employed tend to make.

Key Insights

  • Budgeting while being self-employed creates financial flexibility in times of lower income.
  • Set aside a self-employment tax percentage to prepare for tax season.
  • Self-employed health insurance provides protection to assets in times of need.
  • Being self-employed, forming a retirement plan early takes advantage of compound interest.

1. Neglecting To Create a Budget

Creating a budget might not sound like the most thrilling thing to do with your time, but trust me, it is worth it. Think of a budget as your financial roadmap. It's like having Google Maps for your money. It tells you where you're going, how much gas you have, and when you might need to make a pit stop.x

Here are the steps you should take to make your first budget, preferably on Microsoft Excel or Google Sheets, and not on a piece of notebook paper.

  • List Your Income. Think of this step as taking inventory of all the money coming in. List out all your sources of income - the money you're bringing in from your primary business, any secondary income streams, and those occasional windfalls.
  • Identify Fixed Expenses. Now, these regular expenses are as predictable as the sunrise. We're talking about rent or mortgage payments, utility bills, insurance premiums, and any loans you're chipping away at. These are your steady monthly outflows.
  • Allocate for Variable Expenses. Variable expenses are the sneaky ones that can creep up on you. They include groceries, entertainment, dinners out with friends, and all those little treats you deserve. To get a handle on these, take a look at your past spending patterns and make some educated guesses about what you might spend in the future.
  • Include Savings. This part is all about securing your future. Allocate a chunk of your income to savings and investments. This isn't just for emergencies; it's also for those big dreams, like a dream vacation or a cozy retirement.
  • Monitor and Adjust. Your budget isn't set in stone and doesn't need to be. Think of it as a flexible friend. Regularly check in with it to see how you're doing. 

Playing it safe? Build an emergency fund to prepare for unforseen expenses.

2. Not Keeping Personal and Business Finances Separate

Now, let's talk about a common pitfall: the mix-up of personal and business finances. It's a tempting thing to do, especially when you're just starting out, right? But, it can create quite a financial tangle down the road.

  • Create a Separate Business Bank Account. Open up a separate bank account just for your business earnings and expenses. Think of it as giving your business its own little island in the financial sea. When business money comes in or goes out, it's all neatly recorded here.
  • Consider a Business Credit Card. It's like having a special business credit card that's used exclusively for your business expenses. This card helps keep your personal expenses and business expenses as different as night and day. Plus, it's a handy tool for tracking what you're spending on your business.

Now, why is this separation so crucial, you ask? Well, it's not just about avoiding financial chaos. It also makes tax time way less stressful. You'll have crystal-clear records of your business finances, making it a breeze to calculate and report your business income and expenses.

What's more, it gives you a snapshot of how your business is doing financially. Is it thriving? Is it ready for expansion? Having a separate account means you can see, at a glance where you stand.

Proving Your Income

Proving income as a self-employed individual can be a bit tricky, but to do it right just takes some planning. Traditional pay stubs might be out of the question, and income fluctuations can make lenders and landlords uneasy. However, there are several ways to substantiate your earning ability.

  • You can use 1099 documents if you're a freelancer or independent contractor, showing income reported to the IRS.
  • Maintaining profit and loss statements is an excellent practice; it not only serves as proof of income but also aids in business decision-making.
  • Bank statements with consistent deposits and withdrawals demonstrate your financial stability, especially over 6-12 months.
  • Annual tax returns are perhaps the most credible proof, as they detail your total income for the year. If necessary, you can even create your own self-employed pay stubs, containing gross pay, deductions, and net pay. Don't worry if it sounds complicated at first – with practice, it'll become second nature.

3. Failing To Set Aside Taxes

Self-employed collage

Alright, let's tackle a topic that's not always the most exciting but is super important: setting aside money for taxes. Now, this is one area where self-employed folks like us have to roll up our sleeves and take the reins because, unlike our 9-to-5 friends, we're responsible for handling our own taxes.

Here's the deal: When you're self-employed, you're not just dealing with regular income tax like most folks. Nope, you also have to handle something called a self-employment tax. It might sound a bit daunting, but with a little planning, we can handle it like champs.

So, here's the secret sauce: every time you receive a payment, whether it's a big commission or a small project fee, set aside a portion of it specifically for taxes. Think of it as paying your future self. This way, when tax season rolls around, you won't be scrambling to come up with a big lump sum.

Now, I can't stress this enough, it's wise to team up with a tax professional. They're like our financial GPS. They can help you determine exactly how much you should be setting aside based on your earnings and expenses. Plus, they'll keep you in the loop on any tax deductions you might be eligible for.

Speaking of deductions, here are some common deductions you may want to pin for the future:

  1. Home Office Expenses: If you have a dedicated space in your home for work, you can often deduct a portion of your rent or mortgage interest, utilities, and maintenance costs.
  2. Business Supplies: Expenses related to your business, such as office supplies, software, and equipment, can often be deducted.
  3. Travel Expenses: If your work involves travel, you may be able to deduct expenses like transportation, lodging, and meals. Keep detailed records of your business-related trips.
  4. Health Insurance Premiums: Self-employed individuals can often deduct health insurance premiums paid for themselves, their spouse, and dependents.
  5. Vehicle Expenses: If you use your vehicle for business purposes, you can deduct a portion of expenses like gas, maintenance, and depreciation.
  6. Marketing and Advertising: Money spent on advertising and marketing to promote your business is generally deductible.
  7. Meals and Entertainment: You can often deduct a percentage of meals and entertainment expenses related to business activities, as long as they're directly related to your business.
  8. Education and Training: Expenses for courses, workshops, or training directly related to your business can often be deducted.
  9. Retirement Contributions: Contributions to retirement plans like a SEP IRA or a Solo 401(k) are not only a smart way to save for the future but can also lower your taxable income.

Remember, tax laws can be complex and subject to change, so it's essential to consult with a tax professional who can provide guidance tailored to your specific situation. They'll help you navigate the tax landscape and make sure you're taking advantage of all the deductions available to you, keeping your hard-earned money in your pocket where it belongs.

4. Forgetting To Prioritize Insurance's like having a trusty shield in your financial armor. You might not need it daily, but it's a real lifesaver when you do.

Insurance can feel like a never-ending maze of options. So, let's break down the essentials:

  • Health Insurance: This is your safety net for medical expenses. You never know when you might need it, and a sudden health issue can drain your savings faster than you can say "ouch." Health insurance helps cover those costs, so you're not left with a hefty medical bill. Plus, there are studies that have found that self-employed individuals do face slightly more health risks.
  • Disability Insurance: Think of this as your financial lifeline if you're unable to work due to illness or injury. It replaces a portion of your income, so you can still pay the bills and keep the lights on even when you can't work.
  • Liability Insurance: This is your shield against legal troubles. If something goes awry in your business and you find yourself facing a legal issue, liability insurance can help cover the costs of legal representation and potential settlements.
  • Worker's Comp Insurance: If you have employees, don't forget about worker's compensation insurance. It provides financial protection for your workers in case of on-the-job injuries or illnesses. It's not just a legal requirement in many places; it's a way to ensure your team's well-being.

Insurance premiums can feel like an extra expense. But think of them as an investment in your peace of mind. They're there to catch you when life throws curveballs, so you can keep focusing on your business without worrying about financial devastation.

5. Not Building a Retirement Nest Egg

Retirement planning often takes a backseat for the self-employed, mainly because we don't have those cushy employer-sponsored retirement plans to rely on. But here's the thing, securing your financial future is a must, no matter your employment status.

So, here's the deal: think about opening an Individual Retirement Account (IRA) or a Simplified Employee Pension (SEP) IRA. These are like treasure chests you fill up over time, and they'll be your lifeline when you're sipping lemonade in your golden years.

The beauty of it is that you don't need to stash away huge sums right away; start small and contribute regularly. Over time, those contributions will grow thanks to the magic of compounding interest.

6. Poor Tax Record Keeping

Tax record keeping is the backbone of financial sanity. We're talking about tracking your income, expenses, and deductions. Why? Because come tax season, you don't want to be caught off guard, missing out on deductions that could save you money.

Consider investing in accounting software or, if you're not the tech-savvy type, hire a professional to help you manage your finances efficiently. These tools and experts can not only make your life easier but also ensure you're reporting proof of income correctly, which is essential for tax purposes.

7. Not Diversifying Your Income

Relying solely on one client or one income source is risky business. If that one golden goose stops laying eggs, you could be in a real financial pickle.

The solution? Diversify your client base and income streams. Imagine it as planting multiple money trees instead of just one. This might mean expanding your services, reaching out to new clients regularly, or even exploring different markets for your skills.

Remember, having multiple income sources doesn't just create a safety net; it can also open up exciting opportunities for growth and financial stability. Plus, when you're reporting proof of income from various sources, you're painting a more robust financial picture, which can be valuable for future planning and opportunities.

Need your portfolio diversified sooner? Consider other income streams.

Self-Employed Financial Mistakes Avoided

We've explored the top 7 financial mistakes that self-employed individuals often encounter, and armed with these insights, you're better prepared to steer clear of these issues. So, as you continue forging your path towards self-employment success, embrace these financial strategies. Your future financial well-being and the realization of your entrepreneurial dreams are at stake.

What can you do right now? Start by assessing your financial situation and implementing these strategies one step at a time. Whether it's crafting your budget, opening that separate business bank account, or exploring short-term financial options, each action brings you closer to financial security and prosperity on your self-employed journey.

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