Can You Afford to Be Your Own Boss? Ask Yourself 5 Essential Questions
The next time you’re out in a public place—at a coffee shop, for example, or at the market—look around you. One out of every 10 people you see is self-employed, according to a recent report by the Pew Research Center.
If you dream about becoming an entrepreneur, you’re no doubt attracted to the freedom and flexibility that can come only from being your own boss. But if you want to launch a business or strike out on your own, the first key to success is to carefully consider, and plan for, the potential financial impact.
To make sure you can afford to be your own boss, ask yourself these five questions.
1. How much money will you need to get your business off the ground? Because every business is different, the amount of up-front money you’ll need can vary tremendously. If you plan to offer your services as a consultant, for example, you may not need much more than a computer, a phone, some software and maybe a website to get your business off the ground. If you plan to make and sell things, you may need to pay for office or production space, equipment, inventory and, possibly, employee salaries. You may also need to get liability insurance or obtain professional certifications. Learn more about estimating your startup costs on the U.S. Small Business Administration website.
2. How will you cover the initial costs?Once you have a realistic sense of what your initial expenses will be, get a plan together to cover those costs in advance. The last thing you want is to find yourself in a financial bind, having to worry about paying for basic living expenses as you’re trying to launch a business. And this is especially important if you’ll be leaving behind a steady paycheck to go out on your own. So, think through your available sources of income. Will you rely on savings to cover your startup costs and help pay the bills in the short term? Is your spouse or partner working? Can you tap into the equity in your home or borrow against the accumulated cash value of your life insurance?1 Or will you try to secure a loan or a grant? Explore your options, and then get a plan in place before you set up shop.
3. Once the money starts coming in, how will you handle uneven cash flow?One of the most difficult parts about being your own boss is getting used to life without a steady paycheck. Some weeks you may bring in a lot of money, and other weeks you may not make any. Can you stomach the uncertainty? One way to help plan for irregular income streams is to deposit a percentage of each check into three buckets—business checking, business savings and personal. Business checking should cover monthly expenses; business savings should cover items such as taxes, expansion plans and emergencies; and personal is your paycheck. Determine each percentage based on your expenses and business objectives. For example, a consultant with nominal operating expenses could allocate 30 percent to business checking, 30 percent to business savings and 40 percent to personal. But someone who rents a facility or sells products may need to put more into business checking.
4. Have you thought about income taxes?When you work for yourself, you’ll be fully responsible for paying your federal and state income taxes—which means you’ll probably pay more in taxes that you did when you were employed. Here’s why. When you work for someone else, your employer shares the burden of paying your federal income taxes that go toward Social Security and Medicare. When you’re on your own, you pay the full amount yourself, in a tax known as self-employment tax—and it can add up fast. As a self-employed person in 2016, you’ll pay an additional 6.2 percent of your first $118,000 in income to Social Security and an additional 1.45 percent of all your income to Medicare. So before you decide to head out on your own, know that the money you bring in won’t stretch quite as far after taxes.
5. Can you afford to give up (or fund yourself) employer-provided benefits?When you go solo, you’ll have to build (and fund) your own benefits package or do without some of the benefits your employer may have provided. So as you evaluate the financial impact of launching your own business, two of the most important benefits to consider are these:
- Insurance: In addition to health, dental and vision, many employers provide group life insurance at little to no cost. When you’re self-employed, it’s even more important to protect yourself and your family. Disability income insurance can help fill in the gaps if you become sick or injured. In addition to death benefits, some life insurance policies accrue cash value that can be utilized for emergencies or used as collateral for your business.
- Retirement Savings: If you participated in an employer-sponsored retirement plan such as a 401(k) and your company matched a portion of your contributions, you’ll obviously lose out on that match once you become self-employed. But you can set up and fund your own retirement plan—with tax benefits similar to a 401(k)—such as a Simplified Employee Pension (SEP) IRAs, Savings Incentive Match Plan for Employees (SIMPLE) IRAs or Solo 401(k)s.
There’s much to consider as you think about the financial impact of launching a business. So you may want to work with a financial professional to make sure you start what may be the most exciting chapter of your life on the best financial footing possible.
1Utilizing life insurance cash values through policy loans, surrenders of dividend values or cash withdrawals will or could reduce the death benefit, necessitate greater premium outlay than anticipated and/or result in an unexpected and/or adverse taxable event.