Thinking of Cutting the Corporate Umbilical Cord?

Here’s a Self-Employment Birthing Kit

By Ken Segal

eal estate agents, writers, lawyers, graphic designers, computer specialists, business consultants, and so many other professionals are cutting the corporate umbilical cord in exchange for more flexible hours and the independence to pursue their own dreams as independent contractors.  And women make up the largest percentage of this exodus from suburban office parks and high-rise office buildings. According to the Women’s Business Center (www.womenbiz.org), from 1987 to 2000, the number of women-owned firms in the U.S. more than doubled to 10 million businesses, and it’s predicted that there will be about 4.7 million self-employed women by 2005. That’s an increase of 77 percent since 1983, compared to a 6 percent increase in the number of self-employed men during that time.

            If you’ve been thinking about joining the ranks of those who are their own boss, the first thing you should do is develop a financial plan.  Although working for yourself affords new freedoms, it also presents unique financial challenges.  Here are some important things to consider:

v                  Setting up your business.  One of the first decisions you'll need to make is whether to be a sole proprietor or choose some form of incorporation, such as a C corporation, subchapter S or limited liability company. Most self-employed individuals operate as sole proprietors, because it's less complicated and less expensive than incorporating. However, incorporation may be attractive if you have concerns about legal liabilities, since the various forms of incorporation can offer limited liability protection.  Through your decision-making process, be sure to consult with professional advisors who can help you choose what’s best for you. For more information about starting and financing your own business, visit the U. S. Small Business Admininistration’s Online Women’s Business Center (http://www.sba.gov/financing/special/women.html).

v                  Managing cash flow.  As an independent contractor, you may face periods of uneven cash flow. Without scheduled paychecks from an employer, you could end up flush one month and penniless the next.  To ensure that you always have cash at hand, develop a budget and a financial plan that allow for your swings in income.  Determine an average of how much revenue you can count on, and use that as a base for monthly expenses.  During months that you make more, stash the extra cash in an interest-earning savings account or money-market account and draw from it during months when you have little or no income.  Also, you should consider paying yourself a salary and keeping your personal and business cash in separate accounts.  Combining them can complicate tax deductions and potential reimbursements.

v                  Obtaining insurance.   If you’re married, do some research and see if you can piggyback on your spouse's benefit plan. Otherwise, you must make plans to provide your own health, disability and life insurance.

            Health: Unfortunately, many self-employed individuals ignore this need once they leave their companies.  According to the National Association for the Self-Employed, more than 60 percent of America’s 41 million uninsured are from households headed by a self-employed individual.  If you can't get health insurance through a working spouse, consider a medical savings account (MSA). An MSA allows you to take a tax deduction for the money you put into the account to pay for out-of-pocket medical expenses associated with a high-deductible health-care policy. If you don't spend all the money you put into the account, it can stay there and earn interest tax-deferred.

            [For more specifics on medical savings plans, read “Would You Believe a Health Insurance Plan That Saves You Money?” in the November/December Issue of MAKING BREAD, available in our Issue Download Center after you purchase a TRIAL SUBSCRIPTION.]

            Disability:   Finding a good, affordable disability policy to replace lost income can be tough for the self-employed, because disability insurers generally work with groups. One possibility is to join an industry trade association or alumni organization that offers access to disability insurance.

            Life: Life insurance can help provide money to pay off your mortgage or send your kids to college if you die.  There are many types of life insurance, ranging from term insurance (death benefit only) to cash value (cash accumulation and death benefit) and combinations of the two.  However, be aware that getting life insurance on your own might be a problem if you have pre-existing medical issues. [For more specifics on how to get the right life-insurance coverage for you, read “Don’t Make This Grave Mistake,” in the January/February Issue of MAKING BREAD, available in our Issue Download Center after you purchase a TRIAL SUBSCRIPTION.]

v                  Saving for retirement.  If you’re self-employed, you can forget about 401(k)’s.  They're too complicated and expensive for your purposes. Instead, research other tax-deductible vehicles, such as Keogh plans and Simplified Employee Pension Plans (SEPS), as well as traditional individual retirement accounts (IRA’s). You also may want to consider nondeductible alternatives, such as a Roth IRA and annuities.  If you choose to incorporate as a small business, consider getting a Savings Incentive Match Plan for Employees (SIMPLE) IRA.  Designed for companies with fewer than 100 employees (including self-employed workers) with no other qualified plan, SIMPLE IRA’s offer income-tax-deferred savings and employer-matching flexibility. 

v                  Managing taxes. The bad news is that taxes aren't taken out of income received by an independent contractor, as they are with employee paychecks. You're responsible for paying income and Social Security taxes. As a result, it's important that you save for taxes from each payment you receive, before you start spending the income. Otherwise, you may not have the money on hand to pay any taxes due when it's time to file your quarterly estimated or annual return.  On the other hand, the self-employed may be eligible for certain tax breaks.  Contributions to retirement plans, health-insurance premiums, auto expenses, travel costs, meals, entertainment and office-related expenses all may be deductible.  Make sure to keep all of your receipts so that you can save during tax time.

Working on your own can be both intimidating and exciting. Remember that being “self-employed” doesn’t mean you have to do everything by yourself. Whether you are planning for your new opportunities as a free-lancer or growing a small business, give your new venture a head start by meeting with a certified financial planner to lay the groundwork for your financial success.

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Ken Segal is an American Express Financial Advisor, based in Philadelphia, with 13 years’ experience in compensation and benefits analysis and financial planning. For further information, contact him via phone (215-940-0123) or e-mail: kenneth.m.segal@aexp.com.

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American Express Financial Advisors Inc. Member NASD. American Express Company is separate from American Express Financial Advisors Inc. and is not a broker-dealer. This communication was published in April 2003 in the United States for residents of New Jersey and Pennsylvania only, and this advisor is licensed only in the states of New Jersey and Pennsylvania. This information is provided for informational purposes only. The information is intended to be generic in nature and should not be applied or relied upon in any particular situation without the advice of your tax, legal and/or your financial advisor. The views expressed may not be suitable for every situation.

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