Many people become freelancers to escape the rat race; to take control of their schedules, earning potential, and projects pursued. Who doesn’t love the idea of making great money when you want, from wherever you want?
What few people realize is that freelancing can become another type of rat race. If not done right, you can find yourself working long hours on projects you don’t enjoy, for less money than you’d like.
I’ve been there before, and I’ve known many other freelancers who have struggled with this same challenge.
After that, it comes down to avoiding these 5 common freelancer money mistakes:
1. Forgetting to set money aside for tax season
When you work for a company, taxes are automatically deducted from your paycheck. When you’re self employed, taxes are 100% your responsibility. And it certainly isn’t fun to discover that you owe Uncle Sam thousands of dollars with an empty bank account.
Once you start making a substantial amount, the IRS will likely tell you to pay quarterly taxes – but initially, the bill will come at the end of the year. Either way, taxes can ruin your life if not planned for ahead of time.
I recommend saving 25% of your income for taxes. Ideally you’ll be able to keep a portion of this, but it’s better to be safe than sorry. Personally, I like to use the Qapital app to automate my savings – as I can schedule regular deposits and top it off when I need to add extra. By automating at least a small weekly/monthly transfer, you’ll be more likely to make it through tax season without going hungry.
2. Not writing off appropriate business expenses
There are a lot of purchases that freelancers can write off as business expenses. When something is written off, it means that you don’t have to pay taxes on the money spent to buy those items.
Common expenses that freelancers write off include computers, faster internet, coworking spaces, home offices, mileage spent for work, related education, etc.. Just remember, if you only use a portion of a purchase for work, you can only write off that percentage.
Because your personal tax rate will easily sit around 25% (much more if you’re making serious money), every dollar that you write off as a business expense reduces your taxes by at least $0.25 – meaning your $1000 work laptop reduces your tax bill by $250! Work with a tax professional or use TurboTax (my personal favorite) to ensure that you get the highest legal deductions – and don’t push the envelope too much.
3. Failing to save for retirement
According to Business Insider, a 30 year old who wants to retire with $1 million at 65 needs to save at least $200/month (likely more, as their chart assumes a 12% annual return — which is very high). You can calculate your own retirement needs using the free Personal Capital retirement calculator.
If you’ve followed Money Nomad for a while, you know that I love investing – and have several favorite investment tools. However, many freelancers are not as fascinated with investing as I am. And that’s fine – you just don’t want to find yourself stuck working forever.
For someone overwhelmed by investing, my personal recommendation is to start with WiseBanyan. The technical jargon is that WiseBanyan is the first no-fee robo-advisor that allows you to diversify your investments. In layman’s terms, sign up for WiseBanyan, receive a $20 bonus after adding your first dollar, and let your money grow without having to do anything about it.
To reduce your tax bill further, try to add up to $5,500 every year into an IRA retirement account. This will ensure that your retirement nest egg is growing tax free. I’ll share additional resources and options about these in the future.
By automating your retirement savings early on, you’ll find yourself able to live a comfortable life free from financial worry when you’re ready to retire.
4. Not planning for time off
The beauty of freelancing is that you can earn more by working harder (unlike with an hourly job). The drawback to freelancing is that you don’t receive paid time off or sick days. If you don’t produce one day, you don’t get paid.
How do you handle this? By planning for time off and putting money aside to cover any emergency expenses during this time.
A typical job offers about 1 day off every two weeks (between holidays, sick days, etc). Therefore, transfer 10% of your pay into a separate account (another great time to use Qapital). Allow this to build up to cover your costs if you have a sick day or need to take a well-earned vacation.
5. Viewing your life in terms of dollars per hour
One of the biggest mistakes that a freelancer can make is to view every hour in dollars earned (or lost).
Although this is great when selling your services, it doesn’t bode well in relationships, personal time, or when serving others.
Some things truly are priceless. Even if your time is worth $100/hr when working, you should never look at a day spent with family or friends as $800 lost.
Make a deliberate effort to keep your personal time separate from your work time, and you’ll discover life to be far more enjoyable.
To conclude, strive to live on 50-60% of what you earn as a freelancer – this will give you financial flexibility to cover taxes, pay for retirement, and give yourself a day off now and again.
It’s still a lot of work, but when you plan out your finances effectively at the beginning, freelancing can truly become your path to freedom.
For the comments: Are there any financial challenges that you’ve run into as a freelancer? Have you found an effective way to overcome them?