Personal finance for the self-employed - WTOC-TV: Savannah, Beaufort, SC, News, Weather & Sports

By Andrew Housser

During and after the recent Great Recession, growing numbers of U.S. residents started self-employed careers. Every month in 2009 and 2010, 0.34 percent of the U.S. adult population created a new business. That rate is the highest in 15 years.

A big part of the entrepreneurial dream is obtaining financial independence, but it can bring along some challenges, too. Self-employed individuals need to take certain steps to gain financial stability and avoid plunging into debt. Here are seven things self-employed people must do to manage their personal finances:

1) Create a backup fund for monthly expenses.

Unexpected expenses or late payments can ruin your cash flow. Create an emergency fund and build up backup savings equal to about a month's expenses. If you are low on cash flow, you can draw from this fund until checks come in. Replenish the fund after you are paid.

2) Plan for taxes.

One of the biggest responsibilities of self-employed individuals is paying both personal income taxes and self-employment tax. The self-employed must pick up the portion of FICA (Social Security and Medicare tax) that employers cover for employees. In exchange, a deduction partially softens the blow. Self-employed individuals find that annual tax costs can easily total at least 20 percent of their income -- and sometimes significantly more. Make sure to talk with an accountant for individual counsel on how much tax you should be withholding, and whether or not you should be paying quarterly estimated tax payments (see No. 3 below).

3) Pay quarterly estimated taxes.

Self-employed individuals usually pay quarterly estimated income taxes. This means sending one-fourth of the annual tax due to the IRS (and often to a state authority as well) four times per year. If you miss a payment, you could owe penalties and late fees.

4) Take the tax benefits due you.

On the plus side: Self-employed people can deduct expenses for running their business. Examples include office supplies, telephone and Internet costs that are necessary for doing business, bank and loan fees for the business, mileage for car trips for business purposes, office rent and utilities, and even some costs related to doing business in your home.

5) Save for retirement.

Many corporations make retirement savings easy, with automatic contributions from paychecks into a 401(k) account. On your own, retirement savings are up to you. Set aside a portion of your income (ideally, at least 10 percent) and stash it in an appropriate retirement savings vehicle. Self-employed people have several options, including a SEP-IRA, a solo 401(k) or a SIMPLE plan. Talk with a financial advisor or do careful research to find the best plan for your money -- and then use it.

6) Be prepared if you need a mortgage.

Especially if you are new to self-employment, mortgage lenders might see a big yellow "caution" light over your application. Some lenders worry you won't have enough income to pay the mortgage. The longer you have been in business, and the more tax returns you have filed as a self-employed person, the more comfortable lenders will be. Improve your chances of securing a mortgage loan by paying off all other consumer debt and accumulating a large savings cushion. Many lenders would like to see a year's worth of mortgage payments available in a savings account. Also be prepared to provide documentation such as contracts, invoices, bank statements and profit-and-loss statements, in addition to tax returns.

7) Build or manage a strong credit score.

A strong credit score is important for everyone. But it might be even more important for the self-employed. Self-employed people often are viewed as greater credit risks for all types of loans. With greater risk can come higher interest rates. Additionally, personal credit scores can play into credit availability for business loans. Maintain the best score you can by paying all bills on time, never defaulting on loans, and keeping credit utilization -- the amount of available credit that you use -- low. For the best credit score, keep utilization below 30 percent of available credit. (For example, no more than a $300 balance on a credit card with a $1,000 limit.)

Working for yourself means you will need to take responsibility for managing your own financial well-being, more than you ever have before. Fortunately, with some planning, you can live the entrepreneurial dream, achieving independence as well as financial security.