The Real Costs of Freelancing

Posted: April 20th, 2010

Image by Dave P. (Flickr)

Image by Dave P. (Flickr)

You’ve seen it everywhere; freelancers are making their presence known, even during rough economic periods. Having been one for about eight years now, I’d say freelancing is the greatest job I’ve ever had. Jump right in!

Well, not so fast.

It takes some time for a freelance business to get wheels underneath it and to turn into a profitable income. What usually makes or breaks a freelancer’s goal of independence, though, are the financial aspects that have to be considered.

In short, the cost of doing business isn’t cheap and can’t be winged. And, no, we’re not talking about having to stick with that 5-year-old laptop and using your coffee table as a desk to cut costs.

These are the real deal costs that every business, freelance or not, has to deal with.

(Note: This post is primarily geared for freelancers in the U.S. )

Taxes

For freelancers the IRS want you to know about a little thing it likes to call a self-employment tax which is roughly 15% of your income. This is on top of the tax that you have to pay from your income minus expenses and deductions. The worst part is that estimated taxes have to be paid quarterly over the year or you are penalized with additional fees come time to file taxes.

Health Insurance

It’s easy to skip this one but there is always that big “What if I get sick or hurt?” you have to think about. This is often a tough choice, too, having to decide between a huge slice of your income going to pay the premiums or an astronomical slice going toward medical treatment. Here is even more reason to not let health insurance slide by.

Operating Costs

Most freelancers can minimize their expenses by working at home and over the internet. Did you know, however, that the time you put into your business that isn’t income generating (i.e. searching for clients, invoicing) are also costs to you too?

Spending too much time not generating income and less time on actual work and, well, you get the idea.

The Payment Buffer

In a perfect world, all freelance work is paid immediately upon completion. Back on earth, though, there is almost always a lag time between completing work and receiving payment. That lag time is usually a month or more.

Living month to month and desperately depending on those payments, therefore, does not become an option. Not even when starting in freelance.

So What To Do?

This shouldn’t be a discouragement to your venture into freelancing, but financial planning will do you a world of good before taking the leap.

  • Consider freelancing part-time in addition to your job. In addition to having a fallback income, you may be able to hold on to your health insurance if it applies to you.
  • Minimize living expenses and save, save, save. That savings cushion will almost always come back to save you someday.
  • Don’t forget to set aside 20% of all income received from freelancing in a separate bank account for taxes. And don’t skip payment on quarterly taxes which are due on April 15th, June 15th, September 15th, and January 15th.

If you have any other financial advice for freelancers, feel free to leave it in a comment below.

More on the author, Johnny Spence
Johnny is the founder of The Freelance Rant and a freelance web programmer with 8 years in the business. Have a visit at his company Oscarrr!web or see what he's up to on Twitter.

6 Comments. Join In!

  • Jon Buscall

    April 20th, 2010 at 8:39 pm

    This post really strikes a chord with me, J. Here in Sweden taxes are immense. I basically lose half of what I charge to tax. So when I hear about the small business tax breaks friends in Germany and France get, I’m very envious. In fact, I’m beginning to think whether the Nordic region is the right climate for the next twenty years of my business!

    The other thing I find hardest to cope with is clients not paying up on time. Here it’s practice for clients to pay 30 days after you complete a job. It’s very hard to get money up front. One of my biggest clients, a university. pays after 2 months.

    It was hard going the first couple of years but now 5 years in I find I’ve got enough going around to keep going, but it’s not easy.

    I wonder what other readers think about their country as a prime location for a freelance / small business.

    After 20 years in the Nordic region I can tell you it’s not easy.
    .-= Jon Buscall´s last blog ..Are you ready to become a publisher? =-.

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  • bangladesh freelance

    April 21st, 2010 at 3:16 pm

    Yes,freelancing has the the potentiality to be a safe source of income of any person.

    Interesting post!

    Thanks!

    bangladesh freelance

  • Johnny

    April 21st, 2010 at 6:24 pm

    Yep Jon, The EU is really tough on freelancers when it comes to taxes. The States take a much lesser cut but then you have to pay high premiums for shoddy health coverage. You bring up a nice point, too, about whether freelancers in other countries face these high costs. Maybe it is time to move!

    As for waiting for clients to pay, well, that’s something you get use to and eventually get better at no matter where you are. Get that upfront deposit!

    I appreciate your thoughts here as always.

  • Kimmo Linkama

    April 22nd, 2010 at 9:37 pm

    Even though Estonia is generally considered a low-cost country, the tax situation is exactly the same here. Income tax in itself is not so bad, at the moment a fixed 21% independent of your income. This is much better than in Finland, for example, where I used to work before. Finland has progressive income tax, so the higher your income, the higher the tax percentage.

    Another good thing is that you only pay income tax on what you take out of the company, ie your salary plus benefits. Whatever you leave in the company is not taxed.

    On top of the 21-per cent income tax Estonia charges 33% social security tax plus compulsory unemployment insurance, so you end up paying a little more than half of what you take out of your company to the government.

  • Johnny

    April 22nd, 2010 at 11:09 pm

    Thanks for the lowdown on Estonia. Seems almost a consensus that about half your income goes straight to taxes, unemployment and health. I still wouldn’t give up freelancing!