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Managing money can be difficult even with a steady income. But when you’re a freelancer or self-employed, dealing with fluctuating earnings each month makes it even trickier. From my experience, setting up a reliable system is key. Once it's in place, it safeguards your finances for the long run. Let me share the system I follow.
Things You Should Know Before Starting Freelance Work
I've been freelancing for several years now, with most of my clients being long-term ones. However, I’ve had my fair share of unpredictable months when I first started. Even now, my income can fluctuate by a few thousand dollars every month, especially if I take time off for vacations or other personal reasons.
Looking back, I realize I made a few mistakes when I first transitioned into freelancing. I didn’t fully grasp how different freelancing was from a regular, full-time job. Here are some financial tasks I wish I had tackled beforehand:
Build a bigger emergency fund. I always had an emergency fund, but I didn’t anticipate how much larger it would need to be once I switched to freelancing. As you adjust to this new lifestyle, unexpected expenses will arise: business costs, taxes, health insurance, losing a client, and all the other realities of being self-employed. My first year as a freelancer, I emptied my emergency fund. It was a wake-up call.
Get ready for taxes and insurance. The main reason I drained my emergency fund was because I didn’t know how much I owed in taxes. I was used to my employer handling tax deductions, so I didn’t set aside money for my own taxes, which is what you’re supposed to do as a freelancer. Health insurance also took me by surprise. (Mine costs only $200 a month, which is a bargain compared to other premiums.)
Have a buffer for irregular costs. When your income is inconsistent, the last thing you need is unexpected expenses. You can get a sense of your irregular costs by reviewing your past year's bank transactions, but something will always pop up unexpectedly, whether it’s a business expense like video editing software or a course you need to take. Along with a larger emergency fund, I should have set aside extra money for these kinds of expenses.
The key takeaway: freelancing comes with a number of financial surprises. Stay prepared.
Keep Your Business and Personal Finances Separate
Most experts and experienced freelancers suggest maintaining separate accounts for business and personal finances. For a long time, I mixed everything together, and honestly, it worked fine. However, as my freelance business grew, I hired subcontractors to assist with tasks like video editing, transcribing, managing my schedule, and more. I also started purchasing more business-related items—software, apps, and other essentials for my work.
In other words, things got more complex. Managing my finances wasn’t as simple as handling a few client payments anymore; I now had to account for several additional expenses. On top of that, I had to track everything for tax purposes. Keeping my business and personal accounts separate made organizing everything much simpler. Here's a breakdown of the bank accounts I use and their purposes:
Business checking: This is my main account for client payments and any business-related expenses.
Business savings: While not strictly necessary, it came with the checking account, so I use it to set aside money for taxes.
Personal checking: This account covers all of my personal expenses, from my mortgage and utility bills to dining out and other non-business costs.
Personal savings: An emergency fund that I avoid touching (unless there's a true emergency, of course).
It may sound like a lot to manage, but once the system is in place, it’s simple. When it’s time to write off my business expenses, I can easily track them by reviewing my business checking account transactions.
Just a quick note: Some business accounts are specifically designed for businesses and might require you to be a DBA or an LLC. While they may come with some benefits, you don’t need a special business account to manage your business expenses. Any account will do as long as you keep your personal and business finances separate.
Calculate Your Average Monthly Earnings
The key to keeping my entire system running smoothly is based on a straightforward concept: pay yourself a salary. Each month, on a set date, a portion of my business earnings is automatically moved to my personal checking account. It's just like receiving a paycheck from a regular employer—except that employer is me!
A lot of advice suggests starting by figuring out your monthly necessary expenses, then determining how much freelance income you need to cover those costs. However, that approach isn’t very useful when it comes to budgeting with irregular income that you already have.
Instead, I’ve found it works better to base things on your average income over a specific period—say, the last 12 months. My income has been relatively stable over the past year, so I feel comfortable using that time frame. If your income fluctuates more, you might want to adjust your own time period for averaging. When my monthly earnings are above average, I have extra left over in my business account after paying myself. During slower months, I use that surplus to cover my salary. I also review things periodically and make adjustments if my income dips.
You may choose to break your monthly salary into bi-weekly paychecks, a standard practice for many full-time employees (at least in the U.S.). Personally, I prefer simplicity, so I stick to one monthly payment.
Determining your average monthly income is the first step. But before calculating exactly how much to pay yourself based on this, you need to allocate money for a few other essential expenses specific to self-employment.
Cover Essential Business Expenses First, Then Pay Yourself
As a freelancer, you don't have an employer setting aside funds for things like retirement or taxes. Therefore, before you calculate your own salary, you need to factor in these necessary expenses too.
Here’s a breakdown of where my monthly freelance income goes, along with the percentage of my average monthly income that each expense represents.
Health Insurance (3%): I’ve set up an automatic monthly payment to my health insurance provider, and it’s deducted directly from my business checking account.
Taxes (20%): I also move part of my monthly income into my business savings account for taxes. I figure out this amount by multiplying my average monthly income by my estimated tax rate. Here’s a tool to determine your tax bracket. Qapital is a fantastic budgeting app that we’ve mentioned before; it allows you to automatically save a percentage of every deposit made into your account, which makes setting aside money for taxes automatic.
My Personal IRA (10%): I use Vanguard to make automatic contributions to my Individual Retirement Account (IRA) directly from my business checking account every month. To streamline things even more at tax time, I should probably set up the transfer from my personal checking account instead.
Business Cushion or SEP-IRA (15%): I like to keep a cushion in my business account when I can. I think of it as an emergency fund for my freelance business. This allows me to invest in tools, products, or services that improve my business when needed. After paying quarterly taxes, if there’s excess in my business account, I transfer the funds to my SEP-IRA.
After covering these expenses, around 50% of my average monthly income is left for my paycheck, and fortunately, this is enough to meet my budget. If it weren’t, I would adjust contributions to my retirement accounts or business cushion. While these last two are somewhat optional, saving for retirement is essential.
Naturally, these percentages can fluctuate since my income isn’t always the same. Your percentages may change as well. If you’re just starting your freelance career and aren’t making much yet, you might not have the same ability to save as much for retirement or build a cushion as I can. I certainly didn’t when I first began (and there are still months when I can’t). Your tax percentage will also differ. However, I believe these are good categories to aim for, even if you need to adjust the percentages according to your own circumstances.
Additionally, all these transfers are automated. I set them up through my bank, Vanguard, and my health insurance provider. The only thing I have to remember is to pay my taxes each quarter, which I keep track of with simple Google Calendar reminders.
Determine Your Pay Schedule
Whether you choose to pay yourself once a month or bi-weekly, you need to decide exactly when you’ll get your “paycheck.”
I set my payday based on when I typically receive client payments and when my bills are due. Most of my bills are due at the end of the month (and for those that aren’t, I’ve reached out to adjust the due dates). Most of my clients pay me before the 20th of each month, so that’s when I schedule my payday. I’ve set up an automatic transfer to ensure I have enough time to get paid and cover my bills.
Any money remaining in my personal checking account after I pay my bills is available for me to spend until the next 20th.
That’s essentially how I manage my freelance income. Keep business and personal accounts separate, figure out your average income, pay yourself a salary, and automate your other expenses. It may sound straightforward, but it took me some time to get it right. Your system might look a bit different, but this can serve as a solid foundation to create one that works for you.
Illustration: Angelica Alzona
