Six months ago, I left my full-time job to become a freelancer. Like many other freelancers, gig workers, and contractors, I made a deal with myself: I was giving up the stability of a more traditional 9-to-5 job in exchange for greater creative control over my projects and the freedom to set a schedule that aligned with my own personal goals.
But as the weeks went by and new work assignments waxed and waned, I learned a pretty big lesson firsthand as a freelancer: the savings strategies I’d relied on as a W-2 employee needed some serious restructuring. As I talked to other gig workers and friends who were taking on contract projects, I realized we were all learning how to adjust our own ways of doing this financial balancing act.
Make some serious adjustments
I’m not the only freelancer tweaking their savings strategies: Amy Schultz, co-founder of the financial coaching firm Boulder Money, says she often speaks with freelance clients who come to her after realizing their original plans need some major adjustments.
“I think a lot of people jump into it thinking, ‘I’ll have so much time freedom!’ But the reality quickly sets in,” she says. “There are so many more balls in the air and you have to figure out how to juggle them.”
As an employee of a large company, I knew all my tax preparation required was setting up my tax withholding and checking with HR before filing. Similarly, my 401(k) savings required little maintenance.
But when it comes to saving for these things — plus emergency savings, business expenses, health insurance, and so on — freelancers are on their own.
Changing your savings strategy when you transition from full-time corporate work to freelance work can ultimately save you money on taxes, help you supplement your budget during leaner months, and ensure you’re on track to retire.
Tax savings
When transitioning from full-time corporate work to less stable freelance or project-based income, new freelancers like me need to rely on a certain order when dipping into our savings.
“Every industry is different and has different income stability, but unfortunately taxes are the first thing I want to talk to people about because the IRS never forgets about it,” says Danielle Allotta, CFP and principal financial planner at Brooklyn Plans.
Allotta recommends saving for taxes first, then prioritizing emergency savings, and finally saving for retirement. For workers who have only ever worked full-time W-2 jobs, it can be hard to plan for quarterly payments aside from taxes, but if you’re not prepared to pay when tax time comes, you’re prioritizing things wrong.
In the first year of your freelance business, it’s a good idea to tread conservatively and set aside more than you’ll need for quarterly estimated taxes, Schultz says.
“When you get a W-2 job, you expect your taxes to be withheld and deducted,” Schultz says, “but as a freelancer, no one does it for you.”
When setting aside money for your taxes, keep federal, state, city and other tax rates in mind. Add estimated tax due dates to your calendar so you know when and how much to save.
These little tax hassles may seem like a hassle, but the consequences can be dire, says Malik Lee, CFP, managing principal and investment advisor at Felton & Peele Wealth Management.
“We recently looked at a client’s tax return and they owed $7,000 in penalties,” he says. “They made a huge amount of net profit, $600,000, and they hadn’t made any estimated taxes. We said, ‘Hey, pay this tax. You’re wasting $7,000 in penalties.'”
Lee recommends putting your tax savings into a separate account entirely, so you’re not tempted to divert funds to less-important purchases, and keeping the money you save for taxes in liquid assets will make paying your taxes easier when they’re due.
Saving for emergencies
For freelancers, an emergency fund isn’t just there for when your phone screen breaks or an unexpected medical expense hits — it’s also something you can rely on to stabilize your cash flow while adapting to the ups and downs of your freelance income.
“One of the biggest challenges we hear about is inconsistent income from month to month,” Schultz says. “Most of the freelancers we talk to work on a project-by-project basis. They don’t have a contract that lets them make the same amount every month.”
Working on a project basis is one of the reasons I was excited about freelancing. After years of exhausting dead-end work in a 9-to-5 media job, I loved the ability to juggle one high-intensity, more lucrative gig with another that paid less but was less time-consuming and less stressful. But achieving that balance also meant getting used to some pretty wild fluctuations in my checking account. One job paid me nearly triple what I was making in a month at my previous corporate job, then the next week my new job was making $0.
So, Arlotta says, keeping a close eye on your cash flow and building up emergency savings where possible can help bridge the gap.
“Of course, you need to have an emergency fund, but it’s also important to keep your expenses consistent,” Allotta says. “That way, months when your income drops a little won’t hurt as much because your periods of much higher income will make up for them.”
While conventional financial wisdom advises setting aside three to six months’ worth of living expenses in an emergency fund, Allotta says he encourages his freelance clients to have even more than that, if possible. “I tell most of my freelance clients, especially in the first two or three years, you can’t err on the side of caution,” Allotta says.
But emergency funds aren’t just for unexpected expenses or fluctuations in income, Schultz said: While a full-time job might give you paid sick leave or vacation time, freelancers need to set aside money for those times.
“For freelancers, the amount of money you make is directly related to your ability to do the job,” Schultz points out.
Saving for retirement
When I thought about saving for retirement before I went freelancing, I was fortunate: My previous job offered a generous 401(k) match and I took full advantage of that benefit during my previous tenure. Before leaving my most recent job, I maxed out my savings so I could comfortably handle the transition to a less stable income.
Not everyone can do that, and some employees considering freelancing may not have their own retirement savings in place, Lee says.But before weighing the pros and cons of different plans, he advises his freelance clients to first take a careful look at their cash flow and think about how much of their overall savings they can contribute.
“The deciding factor for your retirement plan should be how much you can afford to save today,” he says. “And whatever you choose today, don’t think you can’t adjust it later. As your business grows, you can adjust these plans. You can pivot.”
Schultz says that many people leaving full-time jobs with 401(k) plans can make the change with minimal effort. All a freelancer has to do is transfer their old 401(k) plan into an individual retirement account (IRA), so they now have a retirement savings vehicle. Then, figure out how much money you can put aside each month.
“If you’re in your first year, unfortunately, retirement savings is going to be a lower priority, but you can say, ‘I’m not going to put as much away this year, but going forward, I’m going to take into account the fact that I used to be able to put away 10 to 20 percent of my paycheck,'” Schultz says. “Nobody’s going to do it for you. There’s no matching anymore, there’s no automatic deposits from your paycheck anymore.”
Conclusion
Saving as a freelancer requires a bit more self-discipline. But by keeping an eye on estimated tax deadlines, building an emergency fund, and rethinking your approach to retirement savings, you can reap the benefits of being self-employed without sacrificing financial security.