Working for yourself can be exciting, but there are also pitfalls. Watch out for these financial mistakes common to freelancers.
This blog post was written as part of a sponsored program for State Farm®. All views expressed are entirely my own, and were not influenced or directed by State Farm.
When I started freelancing, I didn’t really think about what to do with my money. I just thought it would be nice to pay the rent and supplement my (then) husband’s student loan income as he worked on his Ph.D. I didn’t want to work outside the home, but the student loans weren’t enough to support us. With my freshly-minted journalism degree, freelancing seemed perfect.
I made plenty of mistakes to start. I just wanted to make sure we had money coming in, and I didn’t think beyond that. After a couple years of struggling with taxes, credit, and other issues, I realized I needed a better plan to manage my money as a freelancer. Here are 5 financial mistakes to avoid as a freelancer:
1. Blending Personal and Business Finances
Even if you operate as a sole proprietor or have a pass-through LLC, you need to keep your personal and business finances separate. I used to put all the money in one big pot, and at tax time I had a terrible time sorting out the personal expenses from the business expenses. Keeping it separate means better record-keeping and a happier IRS.
One year, when I was sent a letter stating I owed more in taxes, I couldn’t verify things because my record-keeping was so poor. Since I couldn’t challenge with proof, I just had to pay the bill.
2. Forgetting Quarterly Taxes
My first year as a freelancer I didn’t know about quarterly taxes. At the end of the year, I had a bigger-than-expected tax bill, and it was a headache to deal with because I couldn’t afford it. I started paying quarterly, and things improved. Remember, though, a successful freelancer earns more each year, and so the tax bill grows as well! I started setting aside extra money each month to pay my taxes and cover the bigger bill. Taxes as a freelancer aren’t fun, but they are a part of the planning.
3. Spending to Match Your Best Month
During my third year as a freelancer, I started seeing more success and I began spending more to match. Lifestyle inflation is a very real problem for many freelancers. It’s exciting to watch your income grow. However, you don’t want to base your spending on your best month, or even your best year. Instead, look over the last 24 months. What was your worst month? That’s the month you should use to figure out your average spending. If you make more than that, sock it away in an emergency fund for use later. You want to make sure you can handle emergencies (and months) when you don’t make as much.
4. Failure to Save for Retirement
You might think that you don’t have enough money to set aside for retirement, but the truth is that you probably can start saving. The important thing is building that habit of saving, even if you only put aside $10 per week. You won’t have an employer plan to fall back on, so you need to get started as early as possible. There are plenty of options for self-employed freelancers, including:
- SEP IRA
- SIMPLE IRA
- Individual 401(k)
- Traditional or Roth IRA
- Defined benefits plan
Research the options and see what works for you. Open an account and start setting aside money as soon as possible so it can start growing. You want to secure your future, and one of the best ways to do that is to start early and save often, even if you don’t have a “traditional” job.
5. Neglecting Your Credit
Even as a freelancer, you should have a credit card. This is a good step toward building good credit. This is important because, as a freelancer, you will have more financial hoops to jump through as you go through life. If you want a car loan or a mortgage, you need good credit. Start building that now. When my ex and I bought a home several years ago, we based it mainly on my income, since I made much more as a freelancer than he did as a Ph.D. student. If I hadn’t built good credit, we wouldn’t have been able to qualify for the best mortgage rate. (The income audit to prove my freelance revenue was a different story altogether.) Start building credit now so that you have that good financial reputation on paper later – even as a freelancer.
Freelancing can be a great way to make money and design your ideal lifestyle. Just make sure you avoid the financial mistakes that can hold you back.