A trip to the fax machine changed Charmaine Davis’ life. At the time, she was working as an information technology consultant for a major Washington, D.C., consulting firm. She noticed a sheet of paper that revealed the company was charging clients $90 an hour for her services. Based on the firm’s rate, Davis calculated that if she worked a traditional 40-hour work week, her earnings totaled more than $187,000 a year. “I was making $50,000, which isn’t bad in D.C.,” she says, “but when I saw the fax I realized they were keeping most of the money they were making off of me.”
Even before discovering her worth as an information technology consultant, Davis, 43, was already considering working for herself. She was frustrated with the lack of input on assignments and the direction of her career. These frustrations led her to become an independent contractor in 1992, working as an information technology consultant for companies such as Computer Sciences Corp. and TRW and earning $100,000 to $150,000 a year.
Davis may work independently, but she is not alone. A tight labor market has pushed many American workers to enter the risky business of independent contracting. Although accountants, consultants, writers, hair stylists, psychotherapists, and other professionals who work as independent contractors have the freedom of being their own boss, it takes a lot of planning and hard work to stay financially afloat. A survey conducted by the National Association for the Self-Employed found that 49% of respondents don’t have health insurance because they can’t afford the premiums.
Finding affordable health insurance is just one challenge. Independent contractors must deal with issues that people in traditional jobs often don’t handle entirely on their own, such as retirement and tax planning, obtaining adequate insurance coverage and tracking business expenses — all while juggling work and generating new business leads.
“My primary fear was that I wouldn’t be able to stay employed consistently, but that turned out not to be a problem,” says Davis, who is currently parlaying her interest in fitness into a new career as a personal trainer. “The information technology industry was booming during the height of my consulting, so whenever a contract was coming to an end, I simply posted my resumé on two or three Internet job sites and received as many as five calls a day.”
Sometimes Davis works for several employers. At least three companies allow her to invest pre-tax income in their retirement plans by classifying her as a W-2 hourly employee, and she can add to the plans each time she has an assignment with the company, which deducts income taxes from her wages. She puts after-tax income in Individual Retirement Accounts and mutual funds and says she’s saved about $78,000 toward retirement.
Davis has worked between contracts for as long as two months so she was advised by her sister, an accountant, to keep five months worth of expenses on hand. Some of those costs include $225 a month for an Aetna health insurance plan for self-employed individuals that covers medical and dental care.
Generating new business isn’t easy for Raynelle Swilling, 36, a freelance writer in Studio City, California, who has worked on television sitcoms such as In the House, Moesha, and Meth & Red. When she’s not busy on a show or other project, she’s constantly writing and pitching ideas to producers.
“When it’s good, it’s good,” Swilling says. “In 1998, my second year in business, I made more than $150,000.”
She celebrated by taking trips to New York City and spending $400 a night to stay in the swanky Soho Grand hotel. “I was living it up.”
The next year wasn’t so great. “In my third year I made zero. Some years you could make $200,000 to $300,000. No one ever told me this. When you are on a show you have so many friends, but when it’s over, honey, it’s over.”
That experience taught Swilling to save a year’s worth of expenses from current projects so that she would have a cash reserve during leaner times. Now, when she gets a big project she puts a chunk of money into another account that she never touches — even when work is bountiful. She hopes to use that money to finance her own projects.
Since independent contractors have to look for work, they must learn to handle rejection. Swilling will often pitch a project to studio executives only to find out later that her idea didn’t make the cut.
“Throughout the year, I may get one job on a television show or a film, but I may have written eight scripts. You have to be passionate about this business. You have to want to do it 100,000 percent,” says Swilling, who says she often stays home, turns off her phone and writes for days at a time. “You get rejections every single day.”
Unlike many independent contractors, Swilling has some benefits through her membership in the Writer’s Guild, which includes a health and retirement plan. It cost her $2,500 to join, and the Guild gets 1.5% of her income each year, but she’s currently entitled to about $1,000 a month in retirement based on her earnings as a writer. One catch is that she has to make a minimum of $28,000 a year to get benefits. During one of her leaner years, she lost medical coverage for a while and had to have surgery. She is still paying that bill. In situations like that, buying a temporary insurance plan to get through a short period can be a good solution.
Eric Childress, a 33-year-old father of four, was a college junior when he left to attend cosmetology school and become a hair stylist. “When the kids came to me, I needed to do something to make money,” he says.
His relationship with his children’s mother ended and Childress eventually got custody of his daughters. He was renting a booth in a Los Angeles salon, but it was still a struggle to finish work in time to shuttle the girls to and from dance and cheerleading practice. “I was on the phone talking over my clients’ heads, being a referee, and asking, ‘why aren’t you helping your sister with her homework?’ or ‘why aren’t you helping your sister wash the dishes?'” he says.
He was persuaded to take his independence a step further when the salon’s owner was in the process of renegotiating the rent. He saw the lease and discovered that her rent was only $1,000 a month. He and the other seven stylists paid $1,000 a month each to rent a booth. “Once I saw that, I could see that she could do OK without me,” he says.
Childress spent $10,000 to transform a storage room in his home into a hair salon and moved his business there in December 2004. He saved money by enlisting his daughters to help him paint the salon’s walls with colorful faux finishes.
“As I was setting up, I was dreading having to leave because I had built relationships with co-workers,” Childress says. “It was the best salon I ever worked at, but I realized that I needed to be at home to raise my kids. I always had nightmares about being a young grandpa. We come from a long line of young parents, and I just don’t have that vision for my children and I don’t want them to develop that vision for themselves.”
Since striking out on his own, Childress saves $36,000 a year in overhead since he doesn’t have the booth rental fee, commuting expense, and no longer pays a shampoo assistant. A steady stream of clients and his daughters keep him from feeling isolated. He regularly attends hair shows and takes classes to keep on top of trends and learn new techniques.
Childress and his daughters have subsidized health insurance through Health Net, which offers coverage in California and costs $60 a month for the entire family. Co-payments for doctor’s visits are $20. He has a financial planner and has saved $2,000 toward retirement so far. He has disability insurance as part of h
is Universal Life Plan, along with a plan for chronic and terminal illnesses. “I have all of my insurance automatically debited from my checking account,” says Childress. “I also put money aside for my daughters’ college fund,” he says, although he admits that he has been falling behind. He has only about $1,000 saved for each of his daughters, and $170 a month is automatically transferred into a mutual fund for his 16-year-old daughter’s education. He has $50 a month automatically transferred to each of the accounts of his 12-year-old twins since they have a longer time before going to college.
Since Childress has only been working at home for one year, he hasn’t experienced a great deal of tax savings so far. However, he expects to be able to deduct a portion of his mortgage and utilities, including all phone bills, as well as the cost for buying and maintaining computers, Internet service, and even landscaping.
It’s tough for small business owners and people who work on their own to put plans in place that will create security. “So many small business owners are so focused on the survival piece of the business that many times they don’t plan for the future,” says Brenda Ross-Dulan, senior vice president and regional president of Wells Fargo’s Los Angeles Crossroads Division, which has an African American Small Business program that offers seminars and other resources.
Separating Business andPersonal Expenses
Independent contractors will have fewer headaches at tax time if they separate business and personal expenses. “If you comingle business and personal expenses in an audit, the IRS may make assumptions,” said Marvin Kingcade Jr. of Philadephia-based Kingcade & Kingcade Tax Service. “If you pay for a personal expense out of a business account, and that’s detected, they might find some of your legitimate business expenses questionable.”
Kingcade recommends setting up a checking account in the name of the business, using inexpensive bookkeeping software
such as QuickBooks, or setting up a system using a spreadsheet program such as Microsoft Excel to record every financial transaction related to the business. Enrolling in a financial services program such as Open: Small Business Network from American express, can save you time and money because it automatically separates and itemizes your personal expenses from your business purchases. Receipts related to the business should be stored in one place. If a receipt doesn’t clearly show that it is a business expense, attach it to a sheet of paper that explains it, he says. Independent contractors should plan to set aside an hour a week to keep finances organized, he says.Getting All the Tax Breaks You Deserve
Independent contractors are eligible for many tax deductions. Childress is able to deduct a portion of his mortgage because his salon is in his home. Swilling often has to have business meetings to generate leads, so she can deduct meals and entertainment expenses related to her work. “You have to think about everything that you do that relates to your business. For example, if you were to have a meeting in your office and you have expenses for refreshments and setting up, that’s really a valid expense — you would certainly want to document that,” Kingcade says. You might even consider having people who attend the meeting sign in or staple the meeting agenda to the receipt to avoid questions regarding the expense, he says.
Most independent contractors will file IRS form Schedule C and Schedule SE for self-employment taxes. It’s also a good idea to file quarterly tax estimates, especially for payroll and sales. While some independent contractors believe it’s a good idea to incorporate or set up a limited liability company, it’s often not necessary, Kingcade says. The main advantage of setting up an L.L.C. for the independent contractor is that it protects personal assets if the business is sued.
Planning For Retirement
The easiest way for an independent contractor to fund a retirement plan is to set up a Simplified Employee Pension (SEP) IRA plan or a one-person 401(k) plan, says Crystal Alford-Cooper, a certified financial planner and vice president at Law & Associates in Glen Echo, Maryland.
Like a traditional IRA, the money invested in SEP IRAs and one-person 401(k) plans is tax deductible and grows tax free until the money is withdrawn at retirement. Check out Fidelity Investments, which offers SEP IRA and 401(k) plans with no setup fees. For more information and to download forms, go to http://personal.fidelity.com/products/retirement/.
ShareBuilder.com recently launched what it calls The Plan4One, a 401(k) that can be set up online for $75 and a $15 monthly fee to cover administrative costs. For more information, go to www.sharebuilder.com. Investsafe.com offers a Solo-401(k) that costs about $100 a year to administer.
Meeting Insurance Needs
Independent contractors should research and consider buying several types of insurance including health, liability, disability, business interruption, and life. “You’re going to see the accountant, the banker, and the lawyer. The insurance agent is the fourth person you should see,” says James Ralph Jr., president of Southfield, Michigan-based James Ralph Agency Inc. and chairman of the finance and insurance sector for Minority Business Enterprises in Michigan.
Buying an individual health insurance policy can be costly. Policies can range from $250 to $500 a month for an individual, and prices
can escalate quickly if you need to insure family members. In addition to researching rates and features of insurance plans online, there are a number of professional organizations that offer group plans at more competitive rates. Sometimes local chambers of commerce, credit unions, credit card companies, alumni associations, and other organizations offer plans. Some states offer low-cost insurance options for families with children.Disability insurance can protect you if you are unable to work. “A lot of people don’t think it’s important because they don’t think that it’s going to happen to them.” Ralph says. “If you are the only employee and you are an independent contractor — and the business is not operating at that time — disability insurance is designed to replace income that you are losing.” The cost depends on how much income you are trying to replace, Ralph says.
Business interruption insurance will make up for lost income if you aren’t able to work because of theft, fire, natural disasters, and other unforeseen events such as the loss of a key client. Professional liability insurance, on the other hand, can protect you if someone gets hurt or if there’s some type of dispute that leads to a lawsuit. Although forming an L.L.C. will protect personal assets from a lawsuit, it still might not provide you with enough protection, Ralph says. This type of insurance should cost about $1,000 a year.
As an independent contractor, you will probably need to buy life insurance as well. Depending on how much coverage you need, a policy can cost $100 a month.
Some insurance agents offer a special plan for business owners, which can include liability and business interruption insurance as well as a policy that covers the loss of contents from your office and other business-related equipment. These packages can also cover property in transit, such as laptop computers, that you use during travel. Depending on what you do, you might be able to find a policy for as little as $500 a year, Ralph says, but it depends on the risk associated with your work.
Being an independent contractor can be extremely lucrative depending on your skill set and ability to generate contracts. But managing your finances will keep you from turning your new-found freedom into a disaster.
— Additional reporting by Janelle A. Williams
MORE HEALTH INSURANCE TIPS
The following is advice on how
you can reduce insurance costs and keep your bank account healthy:
- Save money by paying premiums annually.
- If you and your family have enjoyed good health for a number of years, consider a higher deductible to save money.
- Make sure your policy doesn’t exclude pre-existing conditions.
- Review your policy each year; make sure you know what’s covered.
- Check with professional organizations since many offer group plans at lower rates.
- Some credit unions, credit card companies, alumni associations, and similar organizations offer health coverage.
- Identify discount cards to save money on exams, procedures, glasses, and contact lenses. Depending on the amount of the discounts, the cards may cost $10 to $25 a month.
- If you have a spouse, consider getting on his or her plan. Many companies now offer benefits for domestic partners, which can include same-sex and non-married couples.
- Start a health savings account to set aside tax-free money for health-related expenses.