How much of your income to set aside for taxes, retirement, and your salary if you freelance

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"I think I'm ready to take the leap," I told my mom on the phone. "I have saved enough that I could survive even if I didn't get a single gig for a year." It was 2016, and it was the first time I told anyone that I wanted to try self-employment.

At that point, I'd been in the workforce for five years and held a variety of jobs. I'd been a barista, a babysitter, worked for a late night show for a year, spent two years in public relations and then been at a financial technology services start up for another two. Amid all of this, I'd also started a personal finance blog in 2013 called "Broke Millennial," which had led to freelance writing and speaking opportunities. 

Then, at the beginning of 2016, I got a book deal based on my work with the blog. It came with a modest advance, and while it wasn't even close to "quit your day job" kind of money, that accomplishment felt like a sign that I could turn this side hustle into full-time career.

I'm a type-A kind of planner who loves an itinerary and can't go through a day without writing a to-do list. I'm not a fan of unknowns or variables or, frankly, risk in general. Self-employment would come with plenty of unknowns and variables. But I was able to put my planning skills to work and create a business structure that helped me hit the ground running. 

Many of us are navigating job losses and unpredictable income right now. Figuring out how much of my income I should put aside for taxes, retirement, and other priorities helped me manage my money with a variable income when I got started and still help me today. 

Put away 40% for taxes and retirement

Being self-employed means paying quarterly estimated taxes, as well as filing an annual tax return. Failure to pay quarterly estimated taxes could mean paying a penalty to the IRS for underpayment. You might also have to pay fees or taxes based on how your business is structured.

In order to be prepared for all these lump sum payments throughout the year, I set aside 40% of every paycheck into an account I labeled "Uncle Sam's Money."

Common advice for freelancers is to set aside 30% of a paycheck for taxes. I save that additional 10% to help contribute to my retirement account. While many companies offer employer-matched retirement plans, as someone who is self-employed, I know how important it is to continue to invest in your future. 

When I started doing Broke Millennial full time, I had rolled over all previous employer 401(k)s into an IRA and then set up a SEP IRA as my own retirement account. In the beginning, I didn't set a big goal for how much to invest for retirement, usually put in whatever remained after paying taxes, but as I gained more clients, I was able to ramp up over time. 

How to pay taxes as a freelancer

Video by David Fang

Pay yourself a consistent salary 

The remaining 60% of each paycheck from a client stays in my business account, and I use that money to pay myself a salary.

When figuring out how much you should be paying yourself, I would speak to other self-employed people in your industry to see if there's a time of year that tends to be slow. In my industry, summer months are often slower, which I didn't realize my first year, and it caused me a lot of panic. 

One of the ways I mitigate that stress now, even during seasons with more consistent work, is by paying myself a monthly set salary out of my business account that goes to my personal account. Depending on how you structure your business, this may be a requirement. I recommend consulting a CPA to figure out how to structure your business in a way that works best for you. 

Erin Lowry is the founder of Broke Millennial.
Courtesy Erin Lowry

Paying myself a set salary minimized any temptation spend more during higher income periods. It also helps me save consistently month to month, which has sustained me during leaner times.

There have also been times when I've reduced my salary down to a little more than my bare essentials, particularly during the pandemic, in order to bolster the reserves in my business account. More on that below.

Separate your business and personal accounts

For a few months before I gave notice, I stopped paying my bills with my regular paycheck. I inverted my usual system and began saving my paycheck and using my side hustle money to cover my expenses. This helped me understand how to budget without knowing exactly how much I'd be making month-to-month, especially if I had to account for late payments from clients.

Between this tactic and other savings, I had at least a year's worth of bare minimum living expenses set aside outside of my retirement account.

I learned the hard way about the importance of the need for your business and personal finances to live in two separate accounts. My first full year of self-employment I didn't have a dedicated business account, which made streamlining my record-keeping and taking business deductions a real pain. With help from an accountant, I was able to make sure that all my income would always go directly into my business account. That's a system that I still have in place. 

Paying myself a set salary minimized any temptation spend more during higher income periods.
Erin Lowry
Founder of Broke Millennial

Have a bare essentials budget ready to go

In  the spring of 2019, I had wrapped a nine-city book tour to promote my second book, "Broke Millennial Takes On Investing." The book tour did have sponsorship, but I also put in some of my own money. I also had to take time off of earning income the ways I normally do — like speaking engagements and other writing projects — in order to focus on making the tour and book launch a success. When June arrived, I realized I had no work lined up for the summer and a business account that had taken a hit during the tour.

In order to play defense, I created a bare essentials budget. 

How reverse budgeting can relieve money stress

Video by Courtney Stith

My bare essential budget centered around the minimum amount my husband and I needed to make our ends meet each month. Knowing this exact number helped me figure out how much I needed to reduce my salary until I secured more work. My husband and I decided to press pause on our more aggressive savings goals that summer and cut down on nonessential purchases. But having that bare essentials budget in our back pocket was invaluable when the pandemic hit six months later.

Within a week of shelter-in-place orders being announced, speaking engagements scheduled months away were canceled. I knew my income was likely to take even more of a hit as my clients reduced their own budgets. But instead of waiting to see how bad it got, I took action. I immediately cut my salary by nearly 50% and implemented our summer budget again, as a starting point to our Covid-19 plan.

The lessons from the last four years have helped me save money and approach my business in new ways such as creating digital download products, like one to help other people create their own bare essentials budget. Even though these are uncertain times, I know I'll be able to continue to invest in myself and my future.

Erin Lowry is the author of  Broke Millennial," "Broke Millennial Takes On Investing," and the forthcoming "Broke Millennial Talks Money: Stories, Scripts and Advice for Navigating Awkward Financial Conversations." You can find her at Broke MilliennialTwitter, and Instagram.

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