3 Important Financial Lessons I've Learned as a Freelance Worker

There have never been more opportunities in the gig economy than there are now. If you want to use your skills and resources to become a freelancer or pick up a side hustle, now could be a great time to try it.

Like any major life decision, there are pros and cons. After all, if freelancing was an ideal situation, everyone would do it. While the flexibility of freelance life can be fantastic, and ambitious freelancers can essentially control their own income in many cases, there are some drawbacks.

Compared to being an employee, you're likely to discover that your financial life is much more complicated as a freelancer. Here are three important financial lessons to keep in mind if you decide to pursue work in the gig economy.

1. Taxes can be devastating if you don't plan ahead

In my first full year where freelancing was a large source of income, I was shocked to find out that I owed the IRS about $14,000 at tax time. I simply figured the withholding from my W-2 employment would cover whatever I had to pay -- after all, prior to becoming a freelance worker, I received a tax refund every single year. (To be fair, I wasn't a Certified Financial Planner® way back then!)

The point is that freelancers need to understand how they're taxed and how to properly plan for it.

On the latter issue, the IRS generally requires freelancers to make quarterly estimated tax payments based on their anticipated tax liability. But even paying a lump sum every three months can be a burden. I typically suggest freelancers set aside a reasonable percentage of their income for taxes every time they get paid.

It's also important to know that in addition to paying federal income tax, freelancers also have to pay self-employment tax to cover their contributions to Social Security and Medicare. In a nutshell, because these taxes are generally split between the employer and the employee, and freelancers are technically both of these things, you'll end up paying double the Social Security and Medicare tax that you would as an employee with the same income.

However, there are several unique tax breaks available to freelancers, such as the home office deduction and a deduction for mileage you drive for business reasons. In short, my advice would be to learn as much about self-employment taxes and tax breaks as you can.

2. Retirement contributions will sneak up on you

One of the most valuable tax breaks available to freelancers is the ability to use retirement accounts such as SIMPLE IRAs, SEP-IRAs, and Solo 401(k)s. All of these options have much higher contribution limits than traditional IRAs and Roth IRAs do.

However, be aware of your contribution deadline and plan accordingly. Retirement contributions can be a fantastic tax break for self-employed workers. For example, the contribution limit for a SEP-IRA is essentially 20% of your net self-employment earnings up to $66,000 for 2023. But you don't want to have to come up with your entire contribution right before the deadline -- it's best to spread it out over the entire year.

3. You need more emergency savings than the average worker

Fortunately, I didn't learn this lesson the hard way, but I know several freelancers who did. Financial planners generally suggest aiming for six months' worth of savings in an emergency fund, but this is even more important for freelancers.

Think of it this way: Who is more likely to need to cover several months' worth of expenses -- a W-2 employee who has been at their job for 10 years or a freelancer whose income varies significantly from month to month and depends on several different client relationships?

Is being a freelance worker worth it?

To be sure, there are some financial drawbacks of being a freelancer. Even if your tax burden ends up being lower than it was as an employee, it's likely to be far more complicated. And you're on your own for retirement savings, while employees generally have a 401(k) or similar plan to use.

However, there are some rewarding qualities of freelance life, especially when it comes to flexibility and work-life balance. For example, I've been self-employed as a freelance writer and investment analyst for more than a decade, and I don't exactly miss the need to check my PTO balance every time I want to take a day off.