- Essential benefits coverage to obtain if you decide to become self-employed include liability insurance, health insurance, disability insurance and a retirement plan.
- Your options for obtaining self-employed health insurance range from government markets to professional employer organizations (PEOs).
- Additional expenses to consider include self-employment taxes, payroll taxes and overhead.
- This article is for aspiring entrepreneurs and freelancers looking to get their benefits set up – and their expenses covered – as they go solo.
Trading in your full-time day job to become an entrepreneur means losing more than just your salary. When you give your two weeks’ notice, you should also be prepared to lose benefits like PTO, health insurance and a 401(k) plan.
The true cost of being an employer – even if you’re the only employee – is staggering. Preparing for these financial obligations before handing in your letter of resignation is crucial. Here’s what you need to know about covering benefits and tax-related expenses when you’re self-employed.
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Benefits coverage for entrepreneurs and the self-employed
Employee benefits plans aren’t cheap. In addition to monetary costs, they require research, attention and follow-up. “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, a research and consulting firm focused on small businesses. “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.”
If you’re starting a business as a solo entrepreneur, here are the primary employee benefits to secure.
1. Entrepreneurs should secure liability insurance.
When you set out on your own, you must arrange insurance to minimize liability if you ever face legal action. Your business and industry will guide the type of insurance you need. Jeff Somers, chief operating officer at HouseCanary, said you must understand your industry’s business insurance risks before purchasing business insurance.
“Every industry is different, and so are the risks that an entrepreneur might face in their particular industries,” Somers explained. “For example, accountants will want to consider professional liability insurance in case a client files a lawsuit claiming there was a costly error on their tax return. Restaurant owners are more likely to need general liability for slip-and-fall accidents.”
To choose the right insurance for your company, assess your risk exposure, analyze your legal responsibilities and decide how much coverage you want – and can afford.
2. Entrepreneurs should secure health insurance.
Along with business insurance, you’ll need health insurance and other personal coverage, including dental and life insurance. Corporate employers typically offer this type of insurance, but it’s trickier to navigate when you’re self-employed.
Unless you’re covered under a parent or spouse’s plan, you must do some comparison shopping and secure your coverage. Forgoing health insurance to save money – even temporarily – is ill-advised. (While Americans who forgo insurance no longer have to pay a fine to the federal government, some states have passed mandate laws.)
Your options for entrepreneur health insurance coverage include the following:
- COBRA: COBRA insurance plans allow you to keep the insurance coverage you have from your employer after leaving the company. Each COBRA plan is different. The costs will not be the same as when you were employed, and COBRA availability may be limited to a few months or years.
- Short-term health insurance: Short-term plans let you bridge coverage gaps that often arise when starting a business. The idea is to use the short-term plan until you can establish long-term insurance through another means.
- HealthCare.gov: 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, noted John Swanciger, head of business development and strategic alliances at Toast. 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.
- PEOs: The best professional employer organizations (PEOs) offer insurance specifically to employers. PEO benefits exist for startups and entrepreneurs that can create tax benefits and even provide short-term health insurance cost assistance.
PEOs are also available for more than just health insurance. They can also be used to manage HR and workers’ compensation.
3. Entrepreneurs should secure disability insurance.
Paul Davidson, director of HR services at Paychex, believes that disability or income replacement insurance should be a significant priority for entrepreneurs. However, he 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,” Davidson advised.
4. Entrepreneurs should secure retirement plans.
Preparing for retirement is crucial for all business owners. Self-employed business owners have several ways to approach retirement, including the following:
- Traditional IRAs: Traditional IRAs are individual retirement accounts you can contribute to regularly. Taxes on contributions are deferred until you withdraw from the account.
- Roth IRAs: A Roth IRA account is similar to a traditional IRA, but taxing is inverted. You pay taxes on Roth contributions, but you’re not taxed when you withdraw from the account after you retire.
- Solo 401(k)s: A self-employed 401(k) plan is a 401(k) plan that does not have an employer matching it. A 401(k) is like a traditional IRA in that taxes are deferred. The advantage of a 401(k) is that the annual contribution limits are much higher.
- Simplified Employee Pension (SEP) IRA: A Simplified Employee Pension (SEP) IRA is ultimately an IRA, but the setup and management are streamlined to make them less expensive. The trade-off is that they have fewer options.
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 complicated or expensive (beyond administrative fees). However, if the employer participated in 401(k) matching, you must consider 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 explained. “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.”
Some of the best employee retirement plan providers may also offer self-employed 401(k) plans. Comparing these providers can streamline your search for the right 401(k) vendor.
Other additional expenses
Unexpected costs frequently arise once you become a full-time entrepreneur, and having an emergency fund set up could save you a lot of headaches, advised Joel Klein, CEO of BizTank. “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 noted.
In addition to unforeseen emergencies, here are some operating expenses you should plan for as a self-employed business owner.
1. Plan for overhead costs as an entrepreneur.
Once you’re an entrepreneur, you’re responsible for all your equipment, including laptops, office supplies, printers and phones. You should also research and develop a relationship with an IT specialist in case of equipment malfunctions.
Bredin advised seeking overhead cost insights from people who understand the business you plan to start.
“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,” Bredin advised. “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.”
2. Plan for payroll taxes as an entrepreneur.
You know those federal and state tax deductions that come out of your paycheck? Your employer splits those taxes with you. But when you strike out on your own, your tax obligations, including payroll taxes, will increase significantly if you hire people.
“Many entrepreneurs are shocked when they realize 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.”
Klein suggests hiring an accountant or having an individual session with one before hiring employees. “Before you hire an employee, make sure you either understand the basic tax rules and obligations, or at least have an accountant you can go to if you have questions,” Klein advised. “Once you hire an employee, payroll taxes become a huge factor in increasing your tax obligations.”
3. Plan for employee retirement plans as an entrepreneur.
There are many retirement plan options for small business owners. However, things start to change once you hire employees. Finding a plan that best suits your business’s growth strategy is crucial.
A SEP IRA is an option for businesses with employees. It allows you to contribute to your account and theirs without the operating costs of conventional retirement plans. When you reach this phase, Davidson advised 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,” Davidson explained. “Plan participants must also receive regular notifications about their plan accounts and be notified of any significant changes in the terms of the plan.”
4. Plan for self-employment taxes as an entrepreneur.
Even if you’re operating solo, you’ll still have to pay self-employment taxes or deal with freelance tax issues. 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.
You’ll also need to figure out how much to pay yourself as a business owner. Depending on the legal structure of your business, designating a personal salary may incur a tax break.
Get ready to fly solo
Leaving your day job to pursue successful self-employment is a big decision. Before you make the leap, you’ll want to be prepared for the realities of self-employed life. If you’re not sure whether you’re truly ready yet, read stories about how prominent entrepreneurs knew it was time to quit. If you feel ready to follow in their footsteps, getting all your benefits in place and preparing for additional expenses is a great first step.
Max Freedman and Nicole Fallon contributed to this article. Source interviews were conducted for a previous version of this article.