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Start Your Business Startup Basics

Quitting Your Day Job? The Basics on Benefits Coverage for Entrepreneurs

Quitting Your Day Job? The Basics on Benefits Coverage for Entrepreneurs
Credit: Aysezgicmeli/Shutterstock

If you're planning to leave the corporate world to become an entrepreneur, you've probably thought a lot about how you'll make ends meet without a salary. You've made a meticulous budget for your personal and business finances. You already know how you'll cut costs and keep your startup lean. You're prepared to live off your savings or take on credit card debt until you start turning a profit. But have you accounted for all the other expenses that come with being self-employed?

When you quit your full-time job to start a business, you're leaving behind more than just a steady paycheck. Entrepreneurs often initially overlook the costs of employer-sponsored taxes and benefits like health insurance and 401(k) plans, which they're now fully responsible for covering.

"Many of us do not fully understand the cost of benefits when we work for someone else," said Alice Bredin, an entrepreneur and small business adviser to American Express OPEN. "Double-digit annual increases in these costs are not uncommon, so business owners may struggle both to find an affordable solution that meets their needs, and to pay for benefits as the costs increase."

"First-time business owners who previously were with a company will indeed face some challenges as they seek to establish benefits, especially in terms of costs and availability," added Paul Davidson, director of human resource services at Paychex. "An important first step is to prioritize the benefits that you must have for yourself initially and offer to new employees as your business grows."

The true cost of being an employer — even if you are your only employee — is staggering, and it's important to think about these financial obligations before you turn in your resignation. Here's what you need to know about covering benefits- and tax-related expenses when you're self-employed. [See Related Story: How to Start a Business: A Step-by-Step Guide]

You know those federal and state tax deductions that come out of your paycheck? You might not realize that your employer splits those taxes with you, so when you strike out on your own, your tax obligations will increase significantly if you hire people.

"Many entrepreneurs are shocked when they realized the true cost of bringing on an employee," said Ed Suarez-Solar, an attorney with Gunster law firm. "[There are] payroll taxes, the employer's share of Social Security and Medicare taxes, workers' compensation insurance and the state unemployment tax."

Even if you're operating solo, you'll still have to deal with the self-employment tax. If you've freelanced or done independent contracting work on the side before, you're probably familiar with this: At tax time, you owe the IRS a portion of your net earnings for the year to cover Social Security and Medicare. You may be able to deduct some of this, but it's a good idea to set aside money from what your business brings in to avoid a big dent in your cash flow when you file taxes.

Visit the IRS website to learn more about how the self-employment tax works.

Most new entrepreneurs know they will have to consider their options for business insurance policies like general liability. But personal coverages like medical, dental and life insurance, which corporate employers typically offer, can be a little trickier to navigate when you're self-employed.

Unless you're covered under a parent's or spouse's plan, you'll need to do some comparison shopping and secure your own coverage. Forgoing health insurance to save money, even for a short time, is very ill-advised. The Affordable Care Act currently dictates that individuals may be penalized up to 2.5 percent of their household income if they do not carry coverage, Suarez-Solar said. 

Depending on your situation, you may want to continue using your employer-sponsored health insurance after you quit. Under COBRA (Consolidated Omnibus Budget Reconciliation Act), you're able to retain your coverage for up to 18 months if you pay the full premium, plus an administrative fee. This can be a good stopgap if you're having trouble finding a suitable plan on your own, especially if your current coverage is good. However, Jackie Breslin, director of human capital services at HR solutions company TriNet, noted that new entrepreneurs may be surprised at the price tag on their COBRA insurance.

"They may underestimate the cost of continuing their benefits through COBRA since they did not stop to calculate the amount of premium their employer was contributing," Breslin said. "Some of the benefits employers offer can [also] be difficult to convert to an individual plan or obtain on one's own. Disability insurance may be difficult or incredibly expensive for an entrepreneur to purchase and it is such an important type of insurance to have."

Davidson agreed that disability or income replacement insurance is a big priority for entrepreneurs, but noted that underwriters are concerned about the risks associated with providing disability insurance to new business owners.

"Entrepreneurs should be prepared to put the time and resources required into finding the right disability policy," he said.

Health plans obtained through healthcare.gov can also be quite expensive, but as a self-employed business owner, you may be able to deduct premiums for yourself and your dependents on your tax return, said John Swanciger, CEO of the online small business community Manta.

If you've worked a few different corporate jobs, you probably already know that the money in your retirement savings account can roll over from plan to plan. Converting from an employer-sponsored plan to an individually maintained one isn't difficult or expensive (beyond administrative fees), but if your employer had a contribution match rate, you will have to think about whether you can afford to make up the difference.

"Many well-established companies match their employees' 401(k) contributing rates — a luxury that isn't possible for a self-employed person," Swanciger told Business News Daily. "However, the good news is that an individual 401(k) or solo 401(k) works the same as traditional retirement plans offered by larger companies."

One option solopreneurs may want to explore is myRA.gov, a program launched by the U.S. Treasury in 2015. Retirement savings accounts through myRA are specifically designed for workers who don't have access to employer-sponsored retirement plans, including self-employed individuals. Unlike most traditional retirement accounts, there are no fees or costs to open, contribute to or maintain a myRA account, and your money is safely invested in a special Treasury bond, rather than the inconsistent stock market. You can also withdraw money from your account, if necessary, without paying taxes or a penalty fee.

If you have employees, you can set up a Simplified Employee Pension (SEP) retirement plan, which allows you to contribute to your own account and theirs, without the operating costs of conventional retirement plans. When you reach this phase, Davidson reminded business owners to research the compliance and regulatory measures that apply to employer-sponsored retirement plans.

"For instance, when establishing a 401(k) plan, the employer has to adopt a formal plan document and notify eligible employees about the plan, including who may participate and how it works," he said. "Plan participants must also receive regular notifications about their plan accounts and be notified of any significant changes in the terms of the plan."

Benefits and taxes aren't the only expenses you'll inherit as you transition away from corporate life. TriNet's Breslin reminded entrepreneurs that they'll be responsible for all the equipment and office supplies their company once provided — laptops, specialized software, printers, phones and even technical support.

"An entrepreneur will need to build a relationship with an IT help desk consultant, as they no longer have an IT department to reach out to when they have problems with the network, laptop or phone system," Breslin said.

Bredin, of OPEN, advised seeking insights from people who understand the business they're starting.

"One of the best ways to find out about all of the costs associated with running a company is to talk to an accountant who is familiar with the type of business you want to run," she said. "Attending events where business owners congregate can also be helpful. At these gatherings you can speak to multiple business owners who may be willing to share the surprises — good and challenging — of running [this] type of company."

Leaving your day job to pursue entrepreneurship is a big decision, and no matter when you choose to do it, it's important to be fully prepared for the realities of self-employed life. If you're not sure whether you're truly ready yet, read the inspirational stories of how these entrepreneurs knew it was time to quit.

Nicole Fallon Taylor
Nicole Fallon Taylor

Nicole received her Bachelor's degree in Media, Culture and Communication from New York University. She began freelancing for Business News Daily in 2010 and joined the team as a staff writer three years later. She currently serves as the assistant managing editor. Reach her by email, or follow her on Twitter.