Hanging out one’s own shingle is a dream for many, whether that means having your own startup or selling your own services. But first, to ensure success, it’s important to lay a solid financial foundation to weather even the smallest of money storms. We spoke with financial advisors about what strategic moves would-be self-employed individuals should strongly consider before striking out on their own.
Wait longer than you think
“Work your day job as long as you can and do your side business after hours and on weekends,” advises Robert Pagliarini, president of Pacifica Wealth Advisors Inc. in Mission Viejo, CA and author of The Other 8 Hours: Maximize Your Free Time To Create New Wealth & Purpose. “I’ve seen too many people quit too early and then struggle,” he says. While waiting can be frustrating, it can also help you get your ducks in a row when it comes to your other financial dealings so that when you do make the leap, you’re in a good place to do it.
Pay down debt to improve future cash flow
While you’re still employed, try and pay down as much as you can on your debt, recommends Terrance Martin, managing partner at Tranquility Financial Planning in McAllen, TX. That not only helps with cash flow on a monthly basis once you’re on your own, but can also improve overall credit worthiness in case you need a business or personal loan in the future. Moreover, better credit scores could also make it even easier to refinance existing loans to free up more cash as well, Martin says.
Refinance while you have regular income
Pagliarini says that if you’re contemplating self-employment, consider taking out consolidation loans or refinancing student loans or mortgages before you quit your job, as lenders typically want to see a recent pay stub as well as two years’ worth of tax returns showing steady income. “Lenders ask for a lot more information and they don’t put as much weight on self-employment income,” Pagliarini says. By successfully refinancing a mortgage and student loans for longer terms, you might be able to make lower monthly payments.
If you’re wondering when to do this, early 2016 may be the most opportune time to refinance existing loans as borrowing rates will likely start to move up this year, says Kevin J. Meehan, regional president at Wealth Enhancement in Itasca, IL. However, keep in mind that only a fixed interest rate will protect you from rising rates.
Figure out your health insurance plan
Leaving a full-time job also means leaving behind employer-based insurance benefits. However, you may be able to enroll in continuation coverage per the Consolidated Omnibus Budget Reconciliation Act, or COBRA, Meehan says. This option allows you to continue coverage under your existing plan, typically at your own expense. “This is a very expensive option and should only be used for a short period of time,” says Meehan.
Alternatively, you can opt for a high-deductible health plan, which can be combined with a health savings account (HSA) to allow the individual to pay for qualified out-of-pocket medical expenses on a pre-tax basis, Meehan says. Financial advisor Terrance Martin says individuals who are married might fare better by getting listed under their spouse’s health plan with their employer. If you are single or your spouse doesn’t work, you should compare the plans offered on the Affordable Care Act health exchanges and determine if they are less expensive than a COBRA plan.
Have a retirement savings game plan
While you might have to forgo adding to retirement savings at first as you get your company off the ground, don’t let this slide too long, especially as the contribution limits can be higher than your old 401(k).
“This is where you really see the benefits in having your own business, because as a business owner, you get to save more in retirement plans,” Pagliarini says. “The best plan for you will depend on how many—if any—employees you have and how much income you make.” While offering an employer-sponsored retirement plan will help attract employees, it may not be in a startup’s best interests to set one up right away, Meehan says. “Focus on attaining profitability first, then introduce savings plans into the mix,” he says. “When the time is right, keep it simple and cheap.”
A SEP IRA is likely the best way to go for the solo self-employed, as they’re easy to establish, easy to administer, and allow for flexibility regarding contributions, Meehan says. Martin says those contemplating self-employment should ask themselves several additional questions:
- How will you pay for your business expenses?
- Do you have a cash reserve for your business?
- How will you pay or be covered for income tax purposes to ensure that you have enough withholding for the year?
- Will you submit quarterly payments or will you hire a payroll company to help issue you a periodic paycheck?
- Do you currently have a disability insurance policy in place?
“This is very important to consider, especially if you are your family’s breadwinner,” he says.
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