Navigating finances as a self-employed person can be tricky, if not downright confusing. Where do you start? How do you go about investing and building financial security for yourself when you’re wholly responsible for your success and failure?
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Financial YouTuber Tae Kim recently posted a video, “Optimal Order Of Investing For Self-Employed,” addressing this very topic. Here’s how he said to invest in yourself and your financial future.
Set Aside a Year’s Worth of Money in Your Emergency Fund
While many finance experts suggest having three to six months’ worth of cash set aside for emergencies, Kim suggested upping that amount to a full year — or even 18 months if you can. That’s because the traditional advice is geared primarily toward those with a regular job and stable income.
Since self-employed individuals’ incomes can more easily fluctuate, having that extra cash can come in handy if, say, one of their long-term clients suddenly drops off. It also gives them more time to recalibrate and get their business back on track.
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Get Proper Insurance Coverage
Kim recommended getting four main types of insurance, even if the premiums are high. These are homeowners insurance, auto insurance, term life insurance and health insurance. According to Ramsey Solutions, health insurance plans alone start at around $350 per month for self-employed people.
Despite the cost, having these policies can protect self-employed individuals financially if something happens and they need them.
As an example of this, Kim shared a story of how he had an accident when he was 10 years old but his family didn’t have health insurance. The accident entailed a trip to the ER via ambulance and stitches, all of which ended up being quite expensive out of pocket.
Get Rid of All Debts (Except Your Primary Mortgage)
Self-employed individuals have a different risk profile compared with those who make consistent income. To mitigate some of this risk, Kim suggested paying off all debts aside from a mortgage.
Kim pointed out that the more debt you have, the more your focus shifts from your work to other stresses. According to him, self-employed people have to focus on everything from marketing their services to managing overhead costs. Worrying about other bills or debts makes it harder to stay clear-headed and focused.
For this one, Kim suggested using either the debt snowball method — tackling the smallest debt first and then moving on to the next one — or the debt avalanche method, tackling the debt with the highest interest rate first. Whatever strategy you use, the goal is to cut down on how many monthly payments you have so you can prioritize your business and money elsewhere.
Get a Self-Employed Retirement Plan
According to a 2023 Fidelity survey, 85% of self-employed or microbusiness owners knew they should be saving more for retirement, and 42% worried they’d never be able to retire. While it can be difficult to plan for retirement, it’s important for self-employed individuals to do so.
Kim said self-employed individuals will want to get a self-employed retirement plan. Each plan has its own rules and contribution limits, so choose the one that best suits your needs and goals — and contribute as much as possible.
Possible plans include the solo 401(k) plan, the Simplified Employee Pension (SEP) IRA and the Savings Incentive Match Plan for Employees (SIMPLE) IRA.
Contribute to a Roth IRA
A Roth IRA is an individual retirement account in which you contribute after-tax money that then grows tax-free (and has tax-free withdrawals). You can get one even if you work a traditional job, but they’re especially helpful for self-employed folks.
Note that these plans have contribution and income limits. These limits typically change every year. And it’s important to be aware of them, as it could mean a Roth IRA is not be available to some higher earners.
Have a Health Savings Account
The next big investment is a health savings account (HSA). These accounts have a “triple tax benefit” — tax-deductible contributions, tax-free growth and tax-free withdrawals for qualifying medical expenses. You’ll need a to be covered under a qualified high-deductible health plan to qualify.
The individual plan contribution limit is currently $4,150, but it’s set to increase to $4,300 next year. Under the family plan, the contribution limit is $8,300 but will increase to $8,550.
Set Up a 529 Education Savings Plan
If you’re self-employed and raising kids, Kim suggested getting a 529 education savings plan.
“I like to simply think of a 529 education savings plan like a Roth IRA but for education expenses,” he said. You can use the funds for things like K-12 tuition, apprenticeship programs, college and even student loan repayment.
Kim added that leftover funds can be used for other purposes, like funding a Roth IRA. Unlike an IRA, however, 529 plans have no annual contribution limits. Contributions up to a certain amount — $18,000 in 2024 — are also considered gifts and qualify for the annual gift tax exclusion.
Get a Taxable Brokerage Account
This is another account that’s funded with after-tax money. Any dividends you receive are taxable, however. You’ll also have to pay capital gains tax on withdrawals.
“You want to make sure you’re taking advantage of all tax-advantaged accounts available to you before funding a taxable brokerage account,” Kim said.
Invest In Real Estate
There are several ways to get started with real estate investing. Kim suggested purchasing rental property directly, investing via an online real estate crowdfunding platform or investing in a real estate investment trust (REIT).
Each method has its pros and cons, so do your research before choosing one.
Pay Off Your Home Mortgage
Once you’ve got a handle on everything else, Kim suggested paying off your home mortgage. At this point, you’ll be completely debt-free and have some much-needed — and much-deserved — mental and emotional peace.
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This article originally appeared on GOBankingRates.com: How To Invest If You’re Self-Employed, According to Financial YouTuber Tae Kim
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