personal finance
By Charlotte Cowles, the Cut’s financial-advice columnist. In addition to “My Two Cents,” she writes about work and parenting for the site. Previously, she was the senior features editor at Harper's Bazaar and a senior editor at the Cut. She was also the editorial director for MM.LaFleur. Her work has also been published in Glamour, Art in America, Politico, and other places.
Photo-Illustration: by The Cut; Photo: Getty Images
I’m 26 and got laid off from my job last year. I started freelancing pretty much right away (for my old employer, awkwardly enough, because they needed me to finish projects I was working on) and have since gotten other clients, too. I’m on track to make almost $50,000 this year, which is close enough to my old salary that I’ve mostly stopped looking for new full-time jobs.
My question is: How should I be saving money? I used to contribute to a 401(k) when I was a corporate employee, but I can’t do that anymore as a freelancer. My regular expenses are rent and utilities ($800/month; I live in Texas), student loans ($200/month), plus groceries and my phone bill. Things get tight sometimes, especially since my income is irregular, but I still want to save as much as I can — a couple hundred dollars a month, at least. I don’t have any concrete goals at this point, but I do want to feel more secure both in the short and long term. What should I be doing?
The transition to full-time freelance work is both thrilling and terrifying. When it’s going well, it feels great — you are an independent moneymaking entity, unencumbered by corporate bullsh*t, master of your own time and future! But the dry spells are genuinely scary. I’ve known both.
There’s no getting around it: The best (only?) way to make freelancing work in the long term is to build up savings to cushion you in lean times — and when you just need a break. (Freelance burnout is real, and just because you don’t get paid time off doesn’t mean you shouldn’t take it anyway.) But saving is hard to do when your income is unsteady in the first place. You need a plan and some patience.
To start, do a careful inventory of your current spending, says Rafael Espinal, the executive director of the Freelancers Union in New York. “The number one thing that any freelancer should do is look meticulously at what expenses are essential for them to do their work and keep up with their cost of living,” he says. “What are you paying for that you don’t need for your job or to go about your day?” You don’t have to cut your budget to the bone, but it’s crucial to know the minimum amount you need to get by. From there, you’ll need to think about saving for three different buckets —your taxes, your emergency fund, and eventually your retirement.
Let’s get the worst part over with: Your taxes will be higher than you think. Unlike regular employees, freelancers have to pay all of their Medicare and Social Security taxes, also known as FICA taxes. (When you’re a salaried employee, you’re only responsible for half of those taxes, which are withheld from your paychecks automatically; your employer pays the other half.) As a result, Espinal recommends setting aside 30 percent of every freelance paycheck for the IRS. This seems painful, I know, but don’t even think of it as yours. “Put it in a separate bank account that you don’t use for anything else,” Espinal says.
Not to freak you out, but you’ll also need to pay those taxes on a quarterly basis. Failing (or, more likely, forgetting) to do so can result in penalties at the end of the year, explains Katie Brewer, a Dallas-based certified financial planner who has worked with many freelancers during her 15-year career. “Look up the schedule, create calendar reminders for yourself, use this form to calculate how much you owe, and pay online,” she says.
Now for the silver lining of freelance taxes: You can deduct a lot more than you could as a salaried employee. “Keep track of every expense that somehow contributes to your work,” says Espinal. “That could include the cup of coffee you buy to take a meeting, your laptop, your cell phone, your travel expenses. Save receipts and keep track of those transactions so that you can write them off as a business expense when you’re filing your taxes at the end of the year.” Don’t bank on this saving you a ton of money, but it will hopefully result in a slightly larger tax refund than you would get otherwise. It might be worth getting a separate credit card (or debit card that’s linked to your “work” bank account, which is what I do) for any business-related expenses, just to keep them all in one place (and preserve your sanity).
From there, take stock of what’s left over. Let’s do some back-of-the-envelope math: Say you make just shy of $50,000 a year, about $4,100 a month. If you set aside 30 percent for taxes ($1,230), you’ve got $2,870 left over. If your baseline living costs —rent ($800), student-loan bills ($200), internet, phone, transportation, groceries, health care, and other essentials — add up to around $2,200 a month, then that gives you about $670 left over to save. Of course, the numbers will never be that tidy; this is an optimistic approximation! But it’s a start — saving is a real possibility.
The question is how much to save for emergencies and work lulls, versus how much to invest for the long term. “Ideally, everyone should have about six months’ worth of living and working expenses set aside for a rainy day — especially freelancers, given how inconsistent their income stream can be,” says Espinal. This might seem unrealistic, though, so focus on hitting at least three months of expenses at first. (To return to our envelope math: If your baseline cost of living is $2,200, then your three-month emergency-fund goal would be $6,600 — in $670 chunks, that would take you about ten months. Which is a long time, and you will hit setbacks, but doing whatever you can is the point here.)
Once you’ve got three months’ worth of emergency savings, Brewer recommends that you start contributing what you can to a retirement fund as well. (Yes, I know it seems crazy to save for old age when you’re just trying to get through your 20s in one piece, but investing even a small amount now is exponentially better than nothing.) As a freelancer, you have two options for retirement accounts — a SEP IRA or an individual 401(k). Each is subject to slightly different rules and limitations, but both are probably fine for your purposes; don’t overthink it. “Just open the account and put in $100,” says Brewer. Doing so will enable you to invest for the long term and save money on taxes in the meantime, since any money you put in those retirement accounts will be deducted from your taxable income.
One other useful tip: When I first became a freelancer, someone very smart (whom I also can’t remember) told me to keep my “work” accounts separate from my personal accounts, and to “pay” myself every two weeks. You can even set up an automatic transfer from your work account to your checking account, just like a normal paycheck. Remember, you are your own small-business owner, with an employee of one (yourself)! Operating this way has enabled me to budget — and save — somewhat consistently, even when my actual payments are not.
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