This post was written by freelance writer and blogger Mike Collins.
So you’ve decided to take the plunge and ditch your day job to focus on building your own business or freelancing as an independent contractor. That’s fantastic news and I’m sincerely happy for you. Millions of people dream about escaping the rat race of a nine-to-five job but precious few of them are actually able to go through with it.Millions of people dream about escaping the rat race of a 9 to 5 job but few of them are able to go through w/ it. Click To Tweet
But before you run off and tell your boss where he can shove it, there are some details that you should iron out first.
As Benjamin Franklin once said,
“By failing to prepare you are preparing to fail.”
If you haven’t carefully considered each of the items below you could be in for a rude awakening once you’re actually self-employed. You can’t say you’re ready to quit your day job unless you have a good answer to each of these three questions.
Cartoon is courtesy of Cartoon Resource.
What happens if you get sick?
If you’re like most people you purchase benefits such as medical, dental, and life insurance through your employer. Of course, once you quit your job you are no longer eligible to participate in their benefits program so you’ll have to go out and find some health insurance of your own. If you haven’t already shopped around and compared prices you may be in for a severe case of sticker shock.
Why is health insurance for the self-employed so expensive?
Well, for one thing you’ll be buying insurance as an individual. Larger companies can demand huge discounts because they buy in bulk (just as stores like Target can get better deals on merchandise than a mom and pop shop could ever hope for) but you don’t have that kind of leverage.
Not only that, but your employer is likely paying a sizable portion of your health insurance premiums for you. According to a report from the U.S. Bureau of Labor Statistics, employees typically only pay about a quarter of the medical insurance premium for single coverage and about a third for family coverage.
When you’re self-employed you’ll be stuck footing the entire bill yourself.
Are you ready for taxes?
We all have to pay our share of taxes, but as an employee we really only worry about it once a year when it comes time to file our income tax return. Throughout the year your employer automatically deducts tax withholding from each of your paychecks so that at the end of the year your tax obligations are already fulfilled (in theory anyway).
If you’re self-employed, there is no tax withholding so you have to track your income and estimate how much tax you will owe and then send the IRS estimated payments once a quarter. Not only that but you’ll also be required to pay the full amount of Social Security and Medicare taxes rather than splitting them with your employer.
As an employee you are required to pay 6.2 percent Social Security tax and 1.45 percent Medicare tax while your employer picks up the other half. But when you’re self-employed the Social Security tax rate is 12.4 percent and the Medicare rate is 2.9 percent.
In the blink of an eye you just lost 15.3 percent of your profits to taxes.
Do you have a stockpile of cash set aside?
Personal finance experts love to preach about the need for an emergency fund to cover unexpected costs like a broken down car, an illness, or a job loss. This is great advice and I think everyone should follow it.
But a cash stockpile is even more vital when you’re self-employed. Since you won’t have the comfort of a steady paycheck to fall back on, there is much less room for error. If business is slow or you lose a big client, you need to have cash reserves on hand to help you weather the storm until things turn around.
Without a stockpile of cash to fall back on your business could be sunk by the very first rough patch it encounters.
Amanda's Note: I personally quit my 9-5 job working for the State of Texas in early 2013 to pursue my business full-time. It was a hard decision to make, and I went back and forth on it! One thing I made sure was in place before making the jump to self employment? A full year's emergency fund. Typically, financial gurus say you should have 6 months set aside for an emergency. But if you're doing something like going into self employment, you definitely want to cover yourself by having a year or more set aside. It can really take awhile before you start earning decent money (trust me, I know!).