Six Money Management Tips for the Self-Employed

Why Traditional Financial Advice Doesn't Work

If you're one of the 14.6 million self-employed people in the U.S., you may have a tough time relating to traditional financial advice.

"It's harder to budget when you don't make the same amount of money each month," says Denise Kiernan, co-author of "The Money Book for Freelancers, Part-Timers, and the Self-Employed." But if your paychecks aren't regular or you have no employer withholding your tax contributions, budgeting and financial planning get a little more complex.

From saving money for taxes to ensuring your retirement needs are met, here are six steps to money management if you're self-employed.

Think Percentages, Not Dollars

If your monthly income fluctuates, designating a specific dollar amount to emergency savings or retirement accounts could "lead you to save too little during high-income months and too much during low-income months," Kiernan says.

Instead, Kiernan and co-author Joseph D'Agnese recommend allotting a percentage of your monthly income to three purposes: taxes, retirement and emergency savings. That way, you'll contribute more to your most important financial goals when you have more money, and less when you have less. Regardless of what you make in a given month, 10% always can be set aside for your emergency savings fund.

Taxes Supersede Savings

Forget about the old adage, "pay yourself first." If you are self-employed, Uncle Sam actually must take precedence. While corporate paycheck earners have their taxes withheld, self-employed individuals must set aside taxes on their own. One of the biggest mistakes that self-employed people make is "failing to set aside money for taxes and learning they owe $10,000 or $11,000, which they don't have," says Daniel R. Kaufman, an accountant in Avon, Conn., who specializes in working with self-employed individuals.

Self-employed people also must make estimated tax payments on a quarterly basis. If you pay late, you'll end up paying interest and penalties, which will ultimately cost you more. To make sure you have enough set aside, Kaufman recommends stashing away 35% to 40% of everything you make for taxes. Business deductions likely will cause the tax bill to be lower than that range, but it's better to be safe than sorry. "Taxes are hardly ever that high, so you'd likely have enough to pay the taxes and a little bit left over as a bonus," Kaufman says.

Make Taxes Pay

While you're preparing for that tax bill, "it's perfectly acceptable to make a little money on the money you're using to pay your taxes," Kaufman says. Though you won't get rich off of the returns, an interest-bearing checking or savings account will at least let you make something on the money that you're stashing aside. While you won't be writing many checks from this account, make sure you won't be penalized for low balances because you will be raiding it to pay your taxes every three months.

Short-term CDs are another option for those who want to make a little money on their tax savings. Unlike checking and savings accounts, which offer more liquidity, CDs tie up your money for a set period of time. If you pull your money out before the maturity date, you'll be hit with a penalty, losing interest and possibly some of the principal. But for self-employed individuals who know they won't be touching that money for three or more months, a three-month CD could be a smart place to let tax money sit.

For those lacking in discipline, a CD's lack of liquidity also could provide a nice barrier to keep you from spending those tax savings.

Calculate the Basics

While you may not be able to predict your income from month to month, you can determine how much money you need to live on. Figure out how much you must spend on housing, utilities, food and other expenses, and then use that money to determine how much you'll be allotted to spend each month. You might even transfer this amount each month from a business checking account to a personal checking account.

If you're not reaching this number consistently, you're not making enough money. If you make more than that amount in a given month, don't increase your spending. "The wealthiest people are often the most frugal," D'Agnese says.

Build Stability With Windfalls

During some months, you'll invariably do better than others. When you have a month in which you double or even triple your typical income, take out your percentages of taxes, retirement and emergency funds, give yourself your salary, and put the rest in what's called an overhead account, Kiernan and D'Agnese say.

As funds in the overhead account build up, you'll have a cushion from which to draw your monthly salary. So if you pay yourself $3,000 per month to take care of your basic expenses and you have $12,000 in your overhead account, you know you have money to support yourself for the next four months, even if your business doesn't bring in another cent.

Setting up this account provides a sense of financial security, and you won't be so worried about where your next check will come from, Kiernan says.

Tackle Other Financial Goals

Once you have three to six months' worth of expenses in an overhead account, you can start focusing on other financial goals. If you have substantial debt, you'll want to tackle that first. After that, ask yourself how you can best use your extra cash flow, says June Walker, a tax and financial consultant to the self-employed. For instance, do you have two teenage kids to send to college, or do you want to travel?

Since your basics are covered at this point, the extra money you make in a good month can go toward paying down that debt or building up that 529 college savings plan. If you're consistently making more money than you need, increase the percentages you're allotting to retirement and savings.

Once your financial plan is set, check in periodically to make sure you're consistently paying all expenses while adding to savings and retirement. "Look at your financial expectations and compare them to what actually happened," Walker says.