The Surprising Reality of Self-Employment: Is It Worth It?

It is getting easier to start your own business given rapid technological advances, increased ability to buy your health insurance, ability to outsource your needs, growth in the sharing economy, and innovative financing choices. 

There are significant advantages to starting your own business: being your own boss and having control, flexibility, working as hard as you want, and owning your successes. If you are a disciplined self-starter, have a vision and a plan you want to carry out, this may be an excellent path for you. The high risk/high reward opportunity is attractive.

The disadvantages are risks associated with potentially high upfront costs, a poor business plan, lack of provided benefits, taking care of taxes, raising money, need for support, and the difficulties of handling the business.

We will review the benefits and drawbacks of being self-employed but let’s define the term first.

What Does Self-Employment Mean These Days?

Generally, it means working for oneself as a freelancer, independent contractor, or business owner rather than getting wages (and taxes withheld) from an employer. The exact definition of self-employment may vary between the Bureau of Labor Statistics (BLS) and IRS. As more people take on side hustles and work for someone else, it is confusing how many are genuinely self-employed.

How Many Self-Employed Workers Are There? It Depends

In 2015, the Bureau of Labor Statistics (BLS)  reported 15 million workers were self-employed, or 10.1% of the total US workforce. The BLS survey in May 2017 estimated workers in contingent or alternative worker arrangements or both. Government data sources have had difficulty counting the number of gig workers as they may be working at more than one job.

Contingent workers are those who do not have an explicit or implicit contract for continuing employment. These constituted an estimated 5.9 million workers at that time. Workers in alternative employment arrangements include independent contractors, freelancers, independent consultants, on-call, and temporary jobs amounted to 10.6 million workers but may also be part of the contingent category.

The IRS says you are self-employed if you carry on a trade or business as a sole proprietor or independent contractor, member of a partnership, or otherwise in business for yourself, including part-time work.

Therefore, it is taxable if you are generating supplemental income, and you may be deemed self-employed and responsible for paying your taxes. Some people are earning full-time wages from employers but may be earning part-time income as contractors or freelancers.

Want To Be Your Own Boss?

The Fifth Annual  “Freelancing in America”  study by the Freelancer Union and Upwork estimated 56.7 million freelancers in 2018. They believe a majority of US workers will be freelancers by 2027. Since the pandemic, more people prefer remote work, and people may value their freedom more. As such, they are asking themselves, “Should I be my own boss?”

Benefits of Being Self-Employed:

1. You Have More Control Over Your Life

It often gets frustrating to work for others. Your ideas are listened to but sometimes abandoned, your schedule is rigid with many inefficiencies, and you don’t see the upside potential. We have all been there.

According to a TD Ameritrade Self-Employment survey, 76% of respondents had traditional employment before venturing out on their own.

Often a switch to working for yourself stems from a negative experience at your job. In an Intuit-Quickbook survey, 68% of respondents affirmed that they had an experience that pushed them to start working for themselves.

Having the ability to set your own goals, make your own decisions, and carry them out can be exhilarating. You can work remotely from home in sweatpants, making the hours you want and be your own boss. 

Although working for yourself means you should be a self-starter, it doesn’t necessarily mean more extended hours. Of those surveyed for the Quickbooks-Intuit study on Work/ Life Balance,  38% worked shorter hours, 35% worked longer hours, and the remainder worked similar hours as before.

2. Flexibility

Many companies offer flex-time as a perk, and that is increasing due to the pandemic. Having your own business allows you to have maximum flexibility over your schedule and how you work. As long you have access to the internet, you can work from anywhere. Starting a home-based business may be more cost-efficient with lower fixed costs. It can be a great option as long as you aren’t easily distracted.

Back in the day, my parents’ family retail business stayed open seven days a week to make a living. With technology allowing for an online store, your only limitation is your desire to make money.

3. Improved Work/Life Balance

Surveys have shown that having extra time for you and your family is an excellent benefit of being self-employed. Depending on your choice of business, you may eliminate a long commute, travel to meetings, the need for more formal clothing, and unwanted meals out with clients.

Having a better balance should reduce some of the work stresses of a traditional job. Those self-employed often say they experience greater satisfaction and a higher quality of life working for themselves for these reasons.

4. Higher Earnings Potential

Initially, you will have start-up costs to absorb on low revenues, if any sales at all. Longer-term, your outlook is more promising. According to ZipRecruiter, the national salary average for self-employed workers is $88,400/year as of July 2019, and Freshbooks reports that 24% of survey participants earned over $100,000.

The US Small Business Administration (SBA) reports that self-employed earn higher incomes than employees on average. Keep in mind that at least at the start, there may be a long learning curve before you break even and generate positive earnings.

Self-employed people need to make sure to do their proper accounting of revenues and costs. There are software packages for accounting, budgeting, expense tracker, billing, invoicing system and tax preparation.

5. Tax Deductions For Your Business

You must file taxes annually and pay estimated taxes quarterly and pay the self-employment tax.

As a self-employed owner, you can deduct certain expenses. However, the recent 2017 Tax Cuts and Jobs Act eliminated some of those deductions. You can still deduct costs associated with your home office, use of a car for business, meals, and health insurance premiums. You should review the specific IRS rules and consult with a tax professional.

Most importantly, you need to keep stellar records of your costs related to your business.

Home Office Costs

Deductions for your home office costs are among the more complex rules. You may deduct workspace costs you use regularly and exclusively for your business. Determine your office space at home by measuring specific square footage allocated for your business’s purpose.

Other costs associated with your home office may provide tax benefits proportionate to your space: mortgage interest, homeowners insurance, property taxes, and utilities.

There are two methods you can choose from standard method and simplified method. The standard option can be a pain as you have to calculate your costs on an allocated basis diligently. On the other hand, the simplified process is easier but may be capped in the home space used.

The costs associated with your workspace in your home that may be deductible are the office portions related to your mortgage interest, property taxes, insurance, and maintenance. Business communications expenses like phone bills, internet, and faxing may also be deductible.

Health Insurance Premiums

If you purchase your health insurance and cannot be part of your spouse’s plan provided by their employer, you may deduct premiums for vision, dental, health, and long-term care.

Business Meals, Cars, and Overnight Travel

You may deduct 50% of business-related meals based on receipts or records you keep. Travel-related expenses may be deductible if overnight for specific business activities.  Your travel must be away from your home base. Keep good records of your purposeful trip as meals, car rentals, or Uber may be deductible.

Car costs associated with business use are tax-deductible overall.

Employer-Related Part of Self-Employment Tax

If you are paying the self-employment tax, you may deduct part of the FICA taxes that cover Medicare and Social Security that is employer-related.

6. Retirement Planning

As you are accountable for doing your taxes, you are also responsible for your retirement planning. You won’t be entitled to an employer match as you are now self-employed. On the positive side, you may have the ability to contribute higher tax-deferred dollars to your plan.

You have a few good options:

Traditional IRA or Roth IRA

These are the most straightforward plans you can set up yourself, but they also have the lowest contribution limits. Contributions are up to $6,000 in 2021, up to $7000 as a catch-up contribution for those 50 and above. There is a tax deduction for the traditional IRA and no immediate deduction for Roth IRA.

If you contributed to your IRA plan in your previous job, you could roll over the plans.

Solo 401K

This plan is for a business owner or self-employed person with no other employees except your spouse. The solo 401K plan has a particular benefit as the participants are both employer and employee, which means the self-employed person can contribute in two ways. As an “employee,” you can contribute $19,500 in 2021, or $26,000 if you are 50 or older.

Then as “employer,” you can contribute up to 25% of compensation annually, up to a maximum of $58,000 in 2021 on an annual basis. 

The owner’s spouse may also contribute if they are working for the business, thereby potentially doubling the contribution.

SEP IRA

The Simplified Employee Pension or SEP IRA is good for business owners or self-employed with no or few employees. Employers must set annual contributions at the same percentage of compensation for all employees, including the business owner. Annual contributions are limited to $58,000 as of 2021, and employee contributions are business expenses.

There is no Roth IRA option.

SIMPLE IRA

Savings Incentive Match For Employees or SIMPLE IRA plan is for larger businesses with up to 100 employees. Contribution limits are up to $13,500 in 2021, with an additional $3,000 in the age 50 or older employee. These amounts are a deductible expense, but distributions in retirement are taxed. Employers must make some kind of contribution annually, so this is a less flexible plan.

Defined Benefit Plan or Pension

This plan is best for a self-employed with no employees. It is more complex and generally an option when the business has a high income and wants to save a lot for retirement on an ongoing basis. Contributions are calculated by an actuary using the business owner’s age, expected return on investment, and expected annual benefit.

The maximum annual retirement benefit is at $230,000 and is tax-deductible generally.

Many options provide more significant contribution limits to the self-employed person.

Drawbacks of Being Self-Employed

1. Sole Proprietor (SP)

Most small business owners may set themselves up in the form of a sole proprietorship. Although SPs have some benefits, there is greater exposure to personal liability. If the sole proprietor is sued and loses, the winner of the case may take personal assets like the car and the house to settle the claim. Being a sole proprietor carries a higher risk than other forms like incorporation or an LLC.

2. You Are On Your Own

You are probably going to handle a lot of the business aspects on your own. Consider outsourcing at least some of the functions. Many people have a strong vision, motivation, hard work ethic, decisive, and strong skills.

However, you are running a business on your own. Your management abilities will be just as necessary, if not more so. You need to deal with a lot more than when you were working for an employer.

When you are not yet generating much in the way of revenues, seeing losses pile up can be scary and stressful. You may also feel isolated at times. Make sure to make contacts, find mentors who could be helpful, join associations and network with people important to your business or who are in similar situations.

3. Unpredictable Income

Depending on the type of business you are running, you may always be subject to sporadic earnings unless you have a subscriber business. At a minimum, you need to create a budget for your business, understand your revenue inflows, fixed expenses, and variable expenses. Track your costs for potential reduction opportunities.

According to Pew Research, more than one-third of US households experienced a 25% change in income year-to-year.

Make sure that you pay yourself a salary and save as much as possible for those times your monthly income is lower. You need to have an ample emergency fund for six months or more to pay for your living expenses. Arguably, your emergency fund should be for as much as a full year if your earnings are volatile.  You do not want to borrow money to pay your basic expenses.

In the TD Ameritrade survey of self-employed people, 59% say they are more anxious about earning a steady income.

4. Raising Money For Your Business

It is harder to get loans as a new business owner in its start-up phase. While you may have had a proven track record at your previous employer, banks will be looking at you in a new light. They will review your business plan, your budget, and balance sheet. Importantly, they will be reviewing your credit report and credit score in great detail.

Before you even form your business, it is vital to review your credit report for possible errors. Fix them ahead of approaching the lenders for a loan. There may be hits to your credit report that you can explain.

Most importantly, you need to prepare for the possibility of needing funds in the future for various reasons. It could be that you underestimated your business’s costs, want to seize an opportunity that has presented itself, or demand is growing faster than anticipated. According to the SBA, 50% of small businesses fail within the first five years.

Insufficient capital is often one of the primary reasons that some businesses fail.

Many self-employed take financial risks to start their business, but only 27% rely on personal borrowing. Very few seek small business loans/credits (8%) or even federal loans or grants(2%) available to them. It is worth checking the Small Business Administration’s (SBA’s) website to see if you qualify for a low-cost loan or grant.

Innovative financing is available to you to pursue. Consider crowdfunding as a financing source that works for small business owners, particularly women.

 

5. No More Company Benefits

Being self-employed hits you with the realization that you no longer have paid benefits you may have enjoyed at your previous employer. You still need to have access to some of the critical benefits and purchase them on your own.

Thanks to the Affordable Care Act, you may be able to buy cheaper health insurance. Health plans can be obtained by HealthCare.gov though they may be expensive. Positively, you can deduct the premiums for you and your dependents. If you are a freelancer, you can join the Freelancer’s Union for free. You can purchase different types of insurance and retirement plans as a member.

You can try a few places concerning all kinds of insurance–dental, vision, and disability. Freelancers Union may provide some of these benefits.

When you are your own boss, it will be up to you to take off regularly to take care of yourself and your family. 

Final Thoughts

The benefits of being self-employed and your own boss outweigh its drawbacks for many people. The key is knowing if it is right for you. Hating your job and your boss is not necessarily a sign of your potential success in starting your own business. Changing jobs may be the better decision.

Having your own business is a high-risk/high reward decision to make. Some people have begun their own business as a part-time side job, retaining their full-time job as a way of trying out the business. Others have gone out on their own after a considerable amount of planning and saving.

Essential Characteristics For A  Self-Employed Person:

• Self-starter
• Not A 9-5 person
• Lifelong learner
• Determined and have been obsessively planning
• Have many skills, including communicating with others and  problem-solving
• Need good financial habits, financially prepared and disciplined
• Strong work ethic and ethical
• Can be patient

Being on your own is a big decision to make. Talk to others, especially your family. At the very least, listen to your inner self, and the answer is there.