Being a freelancer certainly has its benefits -- namely, you get to be your own boss, set your own hours, and work on projects that appeal to you. But there are certain challenges you'll encounter when you go from permanent employee to freelancer, and if you don't prepare for them, you could get thrown for a loop. Here are a few to watch out for.
1. Variable income
When you work as a salaried employee, you don't have to sit there wondering what your paycheck will look like each month. Freelance work, however, typically translates into variable income, which means it can be hard to map out a budget or juggle your expenses in the absence of a steady number.
The solution? Come in with a strong emergency fund so you're covered those months when your income takes a dip. Most workers are advised to set aside three to six months' worth of living costs for unplanned expenses, but if you're planning to become a freelancer, it pays to aim higher.
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Furthermore, be conservative with your budget and plan your expenses based on what you think your lowest earnings figure will be in a given month. This way, any extra money you take in during busier months can be regarded as bonus cash for you to save, invest, or use to meet your goals. For example, if you expect your monthly income to reach $8,000 some months, but only $5,000 during slower periods, use that $5,000 as your baseline for creating that budget so you don't risk going over.
Finally, aim to line up some contract work that comes with a degree of predictability. Say you're a freelance IT consultant who charges $100 per hour. If you get a company to lock into five hours of work per week, that's a good $2,000 a month you can count on.
2. Estimated and self-employment taxes
When you work as a salaried employee, you have taxes taken out of each paycheck you receive. Not so when you're freelance. Not only are you responsible for estimating how much tax you owe, but you're required to pay that tax quarterly. Furthermore, you're required to pay self-employment taxes that could eat up a large chunk of your income.
As a salaried worker, you'd normally only be responsible to pay 6.2% of your first $128,400 of income into Social Security (earnings above this threshold aren't subject to Social Security taxes). But since freelancers are responsible for both the employee and employer portion of that tax, your total is 12.4%. Furthermore, you're required to pay a total of 2.9% Medicare tax -- 1.45% as employee and 1.45% as employer. The Medicare portion is on your total earnings, by the way.
If this seems like a lot of money to be paying in taxes, you'd be correct. You can make things easier on yourself, however, by tracking your earnings and expenses in detail to get a good sense of what you'll owe each quarter. Also, you should be aware that you're allowed to deduct half of your self-employment taxes when you file your return, so while you are laying out more money up front, you're getting some relief down the line.
3. Having to manage your time
Time management is a skill all workers should master. But whereas slacking off at a permanent role generally won't reduce your paycheck (though it will make you look bad), if you waste time as a freelancer, you stand to lose money. Therefore, it pays to map out a schedule each week that makes it clear when you should be working and when not. This will help you stay on track and avoid a dip in earnings you can't afford.
Along these lines, you may want to come up with some output- or income-related goals on a weekly basis so you know when to push yourself to work and when to let yourself off the hook. For example, if you earn $100 per hour, and it takes $3,000 a week to cover your various expenses (taxes included), you know you need to keep plugging away until you've clocked in those 30 hours.
Though being a freelancer comes with a host of perks, it's not as easy a work arrangement to uphold as you might think. Be aware of these challenges, and with any luck, they won't be a problem as you venture out on your own.
