Though there are many benefits to being a freelancer, one drawback is having an income that can fluctuate significantly from one month to the next. Having a variable income can make managing your money an utter nightmare if you aren’t careful. Here’s how three Motley Fool investors — all freelancers — do it.
Daniel B. Kline: In the early 2000s, I worked as a freelance writer with multiple clients. In any given month, I wrote articles for at least a handful of different magazines and websites. Each company I wrote for paid on a different schedule, and many of them were not predictable.
Because I was never sure when I was going to get paid, I learned to be very careful. I never spent money based on the work I completed. Instead, I was very careful to pay bills first (our mortgage and utilities were the big ones at the time), and only engaged in discretionary spending when payments came in from clients.
In my current situation as a contract writer for The Motley Fool, I don’t have to worry about when (or if) I will get paid. I do, however, have to worry about what happens if I can’t work (or choose not to work) for a prolonged period of time.
Because I don’t get paid if I don’t work, I have remained conservative in my spending. That applies to more than just my day-to-day spending. When my wife and I bought our condo, we spent less than we could have in order to give ourselves a cushion in case the unexpected happened.
Whether you work from home as a freelancer or you hold a traditional job, it’s always smart to spend less than you could. If you’re conservative, your reserves will build faster and you will be ready should a rainy day come. Of course, if that day never comes, you’ll have more cash on hand, and that’s never a bad thing.
2. Use a SEP IRA
Selena Maranjian: If you’re a freelancer, you know that you’re out of luck when it comes to having a nice 401(k) plan offered to you by your employer, complete with matching funds. You’re not without any recourse, though. You can save for retirement with a SEP IRA, which is what I’ve been doing for many years. (The term SEP IRA is short for Simplified Employee Pension IRA.)
A SEP is set up by an employer (including a self-employed person) and has the employer (not the employee) making contributions to the SEP IRA accounts of eligible employees. The employer gets a tax deduction for contributions made, and the employees are not taxed on them when they’re made, but do have their ultimate withdrawals taxed, at their income tax rate. (Of course, self-employed persons are both employer and employee in this case, so they fund their own accounts.)
Regular IRAs, traditional and Roth, are great, and you can use them, too. But their annual contribution limits top out at $5,500 (for 2018) — or $6,500 for those 50 and older. SEP IRAs, though, have much more generous limits, permitting you to sock away even more than you could with a 401(k). For 2018, the limit is 25% of your net income, up to $55,000. (It can be a little tricky figuring out exactly how much you can contribute, so using tax-prep software or a tax pro can help.) You can set up a SEP IRA at most major brokerages and can invest your money in a very wide range of stocks and bonds, not to mention gobs of mutual funds and ETFs.
Since my income varies from year to year, I never know exactly how much I’ll be able to contribute to my SEP IRA, but I always aim for the maximum amount possible. By doing that — and also contributing to an IRA — I know I’m preparing for retirement and will be able to generate some meaningful income when I’m no longer working.
3. Pay yourself first
Maurie Backman: As is the case with my fellow freelancers, I only get paid when I work. And the amount of work I’m able to do in a given month depends on a number of factors that are often outside my control. That’s why when I do get paid, I aim to send a large portion of my earnings directly into savings before spending any of it.
I do this for a couple of reasons. First, because I’m liable for self-employment taxes, I need to make sure I have the money on hand to make my quarterly payments. But it’s not just taxes I’m saving for. I want that money around for a variety of purposes: emergencies, retirement, home improvement projects, and travel, to name a few. But I find that if I don’t pay myself first, that money magically has a way of disappearing.
If you make a point to consistently fund your savings, you may be surprised at how much you manage to sock away on a variable income. Incidentally, paying yourself first is a good practice for salaried workers, too. Once that money hits my savings account, I assume it’s no longer mine to use for day-to-day expenses. And that mentality can help anyone struggling to save to meet financial goals.