Sixty-four million Americans freelanced in 2023, whether full time or for gig work, according to an Upwork study. That not only represents a new high for that category of work but also a significant percentage: 38% of the American workforce is earning income on a per-job basis. Freelancers often trade in traditional 9-to-5 jobs for benefits such as flexible work, setting their own hours and independence.
However, freelancing comes with trade-offs, many of them financial. Freelancers face irregular income, a lack of employer-supported benefits, such as a retirement plan and health insurance, and shouldering the full federal income tax burden. These trade-offs don’t necessarily have to be viewed as disadvantages. With the right mindset, planning and financial strategies, freelancing can be a stable(ish) form of work or additional income stream.
Navigating Instability
Employees receive regular paychecks in fixed or anticipated amounts. However, freelancers must ride the tide of pay for projects. They may go weeks or months between paydays, and their rates vary based on the client and work completed. Hiccups in processing or accounting may mean paychecks don’t show up when expected. All these factors can make budgeting challenging because freelancers sometimes don’t know how much they’ll earn in a certain time frame.
Michael Raimondi, MFA, CFP®, a wealth manager and director of operations at Clarus Group, specializes in serving creative professionals who often take on contract work. “You can let this fear of unpredictability eat you up,” he says. To overcome this instability, he advises clients to find peace of mind by knowing their numbers. He helps them dig into their fixed expenses and discretionary spending without judgment to identify core monthly amounts they need to live on.
Then, he advises developing a plan to divert extra cash into savings during monetarily robust times. Freelancers can then draw upon these savings to create stable monthly or weekly “salaries” and/or to cover expenses during lean times. These funds should be easily accessible—in savings accounts, for example, rather than in investment funds. “Knowing that data helps artists and gig workers get out of their own way. These are facts and not feelings,” he says.
Financial experts recommend having at least six months of cash reserves saved before launching a freelance career. However, it may not always be possible to have these funds saved ahead of time. Some may find themselves launching a freelance career unexpectedly after being laid off or when life circumstances necessitate a job change. In those cases, having a fund to float the freelancer between projects becomes a goal to work toward rather than a starting gate necessity.
Understand Your Freelance Budget
Getting a full picture of a freelancer’s budget also requires understanding expenses. New freelancers may not have a clear picture of these costs, so Dwight Dettloff, CPA/PFS, CFP®, founder of Winding Trail Financial Planning, recommends consulting with other colleagues to identify these needs.
Budgets should also be dynamic, Dettloff says. “I like to do rolling budgets that are updated as new information comes in,” he says. Leaning on other similar professionals may also help navigate freelancing in general. “You’ll have some of the highest highs and the lowest lows. They can help you understand that you might be solo, but you’re not alone.”
Strengthen Stability Through Diversification
Diversifying revenue streams can also create more financial stability for freelancers. Diversification can be viewed through two lenses. First, it may be valuable not to rely on just a single client or a couple of clients. If those clients choose to hire elsewhere or funding dries up, that can leave project-work-reliant contract workers without income. Having more clients, even less lucrative ones, can help cushion the effects of these types of changes.
Second, it’s important for freelancers and gig workers to look at the breadth of their skills, Raimondi says. “They feel like they can only do one thing. ‘If I don’t pursue this one thing, someone else will,’” he says. He advises thinking about “what you’re really good at, what brings you joy and what people come to you for.” This may open pathways to other types of jobs and new ways to sustain a freelance career through inevitably turbulent times.
Overcoming The Scarcity Mindset
Raimondi says diversification may also help freelancers avoid a scarcity mindset—a pattern of thinking about what they don’t have or may not have enough of in the future. “It’s so difficult to escape that mindset,” he says. “No matter how successful you are as a freelancer, you’re always acutely aware that [the work] could be temporary.”
That mindset may lead contract workers to take on more projects than they can feasibly do or accept work they don’t truly want to be doing. This may be necessary to establish a freelance career, but even if it is, Raimondi recommends planning for an exit strategy from this approach. “Maybe it’s a time in your life where you do burn the candle at both ends, but just like when you have an investment, set a ceiling when you say ‘no more,’ or put an end date on that,” he says.
He also recommends “giving a little bit of time and energy to ‘What if it all works out?’ It’s our nature to protect ourselves and look at potential threats. It’s survival. When you’re no longer in a place of just surviving, and you’re truly thriving, that scarcity mindset can be given a little bit of a break and you can not be so hard on yourself.”
Planning For Taxes
Dettloff says the biggest practical mistake he sees freelancers make is not setting aside enough for taxes. Employees have federal and state income tax, where applicable, withdrawn from their paychecks. However, freelancers must cover these taxes themselves—including the portion their employers would have paid.
Online calculators can help predict taxes owed. However, for more accurate predictions based on individual circumstances, Dettloff recommends consulting with a tax professional. With a target amount set, Dettloff advises automating savings by setting up withdrawals to an earmarked account for taxes. Estimated tax payments should be made quarterly, on April 15, June 15, Sept. 15 and Jan. 15 of the following year.
Many first-time freelancers are unaware of the self-employment tax, which requires them to cover the full boat of employer and employee federal income tax, Social Security and Medicare contributions. “That trips a lot of people up. It essentially doubles [your tax obligation] when you’re self-employed,” he says. The self-employment tax rate in 2024 is 15.3%.
Although running their own business also means freelancers are entitled to deduct business expenses, not all expenses are deductible. And “if you didn’t document it, it didn’t happen,” Dettloff says. “Software can help with that. You’re innocent until proven guilty, except in the eyes of the IRS.” He recommends particular care in documenting meals and entertainment, travel, and automobile expenses, which he says are the categories most likely to draw the eyes of IRS auditors.
Creating A Retirement Strategy
Another key area freelancers overlook is retirement, since it’s usually covered or automated by employers. Raimondi recommends freelancers set aside 50% of their income for taxes and retirement. After they pay taxes, which often equate to 20%-30% of their income, freelancers can devote the remaining funds to retirement.
Simplified Employee Pension plans (SEP-IRAs) are relatively simple to set up and they lower a freelancer’s taxable income. However, freelancers who establish S corps may opt for 401(k)s if they anticipate funding employees’ retirement funds in the future. Either way, these funds should remain untouched and be allowed to grow for as long as possible. Other peace of mind and brokerage funds can act as emergency funding to handle unexpected expenses in the short term.
Budgeting Apps
Budgeting and financial apps can assist freelancers with tracking income, expenses and taxes. These apps can also facilitate timely invoicing and follow-up, which is critical to keeping cash flowing for gig workers. Ultimately, financial advisers say the best app choice may be the one that a CPA or financial planner recommends and that integrates with their systems.
Additional options include Xero, QuickBooks, FreshBooks and Wave.
Photo courtesy of Gumbariya/Shutterstock
