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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

There are a lot of things to consider if you are thinking about leaving the corporate world to become a full-time entrepreneur. While you may have thought about how to make ends meet without your salary, you leave behind more than just a steady paycheck when you submit your resignation.

Many entrepreneurs don't consider the costs of employer-sponsored taxes and benefits such as health insurance and 401(k) plans, which they are 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, founder and president at Bredin. "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 prepare for these financial obligations before you quit your day job. 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? 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."

Joel Klein, CEO of BizTank, suggests hiring an accountant or having an individual session with one before you hire an employee.

"Before you hire an employee, make sure you either understand the basic tax rules and obligations or you at least have an accountant you can go to if you have questions," he told Business News Daily. "Once you hire an employee, payroll taxes become a huge factor in increasing your tax obligations."

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 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 … 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 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 your primary source of income is freelancing, another option is to join the Freelancer's Union and purchase insurance (among other benefits) through the organization.

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."

There are many retirement plan options available, but things start to change once you start hiring employees. It's important to look for a plan that best suits your business's growth strategy, Klein said.

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."

For more information on retirement plan options for business owners and self-employed individuals, visit this Business News Daily guide.

There are a lot of unexpected costs once you become a full-time entrepreneur, and having an emergency fund set up could save you a lot of headache, Klein said.

"Having money in your savings that you plan to use to take on your business is one thing; having an emergency fund for outside expenses is another," Klein said.  

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 advised seeking insights from people who understand the business you plan on 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.

Additional reporting by Nicole Fallon. Some source interviews were conducted for a previous version of this article.

Saige Driver

Saige Driver graduated from Ball State University in 2015 with a degree in journalism. She started her career at a radio station in Indiana, and is currently the social media strategist at Business News Daily. She loves reading and her beagle mix, Millie. Reach her by email, or follow her on Twitter.