Budgeting Guide for Freelancers

Budgeting Guide for Freelancers

Freelancing is a great option for making an income but it does require a bit more work and a slightly expanded skill set. This includes setting up and sticking to a budget since freelancers essentially run their own small business.

Freelancers generally have to deal with 3 major items:

  1. Finding clients
  2. Doing the work
  3. Getting paid

Compare that to an employee that only has to worry about #2 "doing the work".

Pros and Cons to Being a Freelancer vs a Regular Employee

  • Freedom of location – freelancers work from home or from any other place where there is an internet connection. Employees generally work where their employer tells them (at the office, on the road, or from home during COVID).

  • Freedom of schedule – freelancers have flexible working hours where employees have more rigid working hours.

  • Income fluctuations / uncertainty – freelancers get paid differently from employees. Sometimes checks get delayed. Sometimes there are disputes with clients. Sometimes a freelancer can find themselves in between clients. Meanwhile employees can expect a steady paycheck and unemployment if they get laid off.

  • Retirement benefits – some companies offer their employees great retirement benefits, and others don’t. Self-employed people have a wide range of retirement vehicles to choose from, but they have to manage it themselves (more on that later).

  • Taxes – employees generally don’t have to think much about taxes, but freelancers need to track expenses and budget for estimated tax payments.

  • Responsibility – as listed above freelancers have more to manage since there are running their own business, need to deal with a bit of sales and advertising, contracts, and accounting.

  • Upside – when a big project comes along freelancers have the opportunity to use sub contractors. In that case they can make a profit selling other people’s time in addition to their own. Employees know roughly what they will make in a year going into a job (except bonuses and the rare stock options payoff).

Given the income uncertainty for freelances, how should a freelancer plan their budget? Read on to get the answers below.

Plan Out Monthly Expenses and Have Some Wiggle Room

Earnings of freelancers can vary from month to month. For this reason, they must carefully plan their expenses. Running out of cash is ‘game over’ in business.

In order to plan monthly expenses it makes sense to setup a personal budget with required monthly expenses such as rent, utilities, transportation, and food. There are also “nice to have” expenses such as travel, going out with friends, buying gifts, celebrations. Freelancers should also have a budget for the business (internet, phone, laptop, office supplies, advertising, business travel, taxes and licenses, etc). The goal should be to keep monthly income well above expenses. When work is slow you will need to draw on your savings. Keeping savings of 6-12 months would be a good place to be for a freelancer. See our post about building an emergency fund for more thoughts on that. To calculate how much you will need and how long it will take to build up see our emergency fund calculator.

Determine a Good Schedule

Being a freelancer is great because you don’t have a cubicle to make it to every morning. This means you can plan your own working hours and minimize stress. But you do need to get work done effectively. So make sure to understand your personal work habits. Procrastinate much? Not much of a morning person? More of a night owl (like me)? That’s okay, you just need to make a schedule that works for you.

In addition to your day to day schedule you also need to balance your attention or else you will go crazy. Some freelancers end up with dozens of clients. Others have an “anchor” client and a few other small ones at the most. It makes sense to break up your schedule by client and carefully manage how much attention each client gets and make sure you don’t get overwhelmed. Some clients want to be able to interrupt you at any time with emergencies or random phone calls. These kind of clients are good candidates to “grow out of”, or even fire.

It also makes sense to build in breaks for exercise or naps to preserve your physical and mental health. Also make sure to dedicate time for hobbies and family to make freelancing extra worth it. The freedom component can disappear if you get overloaded or have a hard time putting work down at the end of the day.

Budget for Accounting and Legal Issues

In order not to mix personal and business finances, every freelancer should open a bank account just for their business. Generally this is free and you can get a debit card to make online purchases.

Opening an LLC or other business entity is also a good idea. It makes you look more official in the eyes of your clients. It can offer some legal benefits. You’ll want to talk to a lawyer about forming your company and drafting contracts for your clients and sub contractor sign. It won’t be cheap, but consider it part of your startup cost. Then you can enjoy writing it off on your taxes at the end of the year.

Some freelancers are okay doing their own bookkeeping while others prefer to have a CPA or accountant handle everything. It makes sense to get the money side of your business figured out around the time you land your first client.

Acquiring Long-Term Clients

How can freelancers gain coveted long-term clients that help to stabilize their income? There are two ways do this:

1) Take on short term projects and work hard to get repeat business.

2) Look for long-term jobs that last from three months to a year or more. This can be more difficult because long-term jobs require specific experience that you may not have gained yet.

Fixed Bid vs Hourly Work

Some projects will be “fixed bid” which means you agree to do the work for a certain price and get payed at the end, or as major portions are completed. This introduces some risk if the client changes their mind half way through, or there is a miscommunication about what was expected vs what was delivered. Experienced freelancers give fixed bids that include padding for unknowns in the price. In terms of your budget, fixed bid work can mean your income fluctuates as payments are more spread out.

Hourly work as freelancer provides both a steady income stream (for example, invoices every 2 weeks due in 15 days) and a capped number of hours per week. The cap protects both sides. The freelancer knows how much they need to do and the client knows the freelancer won’t surprise them with an 80 hour invoice.

One goal for a freelancer might be to sell 35 hours of their time per week across 2-3 clients at 250% what they could make on an hourly basis in a regular job.

Another goal might be to get 6 fixed bid projects at $30,000 per year and take every summer off.

Budget for Estimated Taxes

In the US, payroll taxes that go towards Social Security and Medicare are assessed to both the employer and the employee. When you are a freelancer you have to pay both sides of that, known as Self Employment (SE) tax (roughly 15.3% of your net profit). Note that only your "profit" is taxed, so make sure to keep records of your deductible expenses such as your laptop, office supplies, online services, etc.

Taxes can be a big surprise to new freelancers and at first they take some getting used to. Consider that anywhere from 25% - 40% of your income will go directly to taxes. To make it more painful, you will be writing those checks yourself instead of having it silently deducted from your pay. On top of SE taxes there is also federal income tax, state income tax, and local business taxes that vary by location.

Another surprise to new freelancers is the government wants their money on a regular basis. If you only settle up once a year when you file you will pay “underpayment penalties” on the amount you owe. Estimated taxes are paid quarterly, in April, June, September, and January of the following year (although it typically makes sense to pay your January payment in December so it counts for that tax year).

In order not to have problems with paying your quarterly taxes one strategy is to open a savings account just for estimated taxes. As invoices are paid transfer 25% - 40% to the saving account and consider that money spent after it is transferred.

Budget for your Retirement

Freelancers do not have a work sponsored retirement plan like they might at a regular job. So freelancers are on their own in this regard but there are a lot of really good options.

The first thing to do is calculate how much you would like to pay into your retirement account each month or year. Check out our Saving for Retirement Calculator for some ideas.

The other thing they to do is setup a retirement plan that works best for your. There are several types to choose from:

  1. Traditional or Roth IRA
  2. SEP IRA
  3. Solo 401(k) – allows employee and employer contributions, and some brokerages allow Roth contributions.
  4. Defined benefit plan.

Read more about these retirement plans in our article retirement savings plans for the self-employed.

The post Budgeting Guide for Freelancers is part of a series on personal finances and financial literacy published at Wealth Meta. This entry was posted in Personal Finance, Budgeting
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