Are you thinking of striking out on your own and joining the growing ranks of the self-employed?
It’s an exciting — and possibly a little scary — prospect. But you can remove some of the fear by doing whatever you can to prepare yourself financially for life as an entrepreneur.
What steps can you take?
Here are a few to consider:
• Save as much as you can.
Ideally, you would want to have a couple of years’ worth of living expenses saved before you go solo. But that’s a pretty tall order for most people. And if you have a spouse earning a good income, you may have less need to put away a large sum.
Nonetheless, it’s almost always a good idea to save as much as you possibly can before becoming your own boss.
• Think twice before cashing out a retirement plan.
If you’re leaving a job that provided you with a 401(k), 403(b) or 457(b) plan, you might be tempted to cash out your account to help pay for the transition to the world of self-employment. However, try to avoid this move.
By liquidating your employer-sponsored plan, you will face early withdrawal penalties if you are younger than 59-1/2, and income taxes, too.
Just as importantly, you will be depleting a valuable resource for your retirement.
If at all possible, try to find other sources of income.
For example, you may want to consider a home equity loan; interest rates on these loans are usually competitive, and your interest payments may be tax-deductible.
Be aware, though, that you will be using your house as collateral, so make sure you can afford the payments.
• Consider opening a new retirement plan.
Once you make the jump to self-employment, start thinking of what type of retirement plan you might want to choose.
Fortunately, you have some attractive options that offer both tax advantages and a wide range of investment choices.
If your business has no employees except yourself and possibly your spouse, you may be able to establish a SEP IRA or an “Owner-only” 401(k).
If you will have employees, you might want to consider a SIMPLE IRA or a “Safe Harbor” 401(k). Your tax adviser and investment professional can help you choose an appropriate plan.
• Pay yourself a regular salary.
Depending on what type of business you are opening, you may well experience an uneven flow of income — which could, at times, force you to dip into your long-term investments to help you meet your daily and monthly expenses.
To avoid this potential problem, consider paying yourself a regular salary out of your business’ earnings.
It’s crucial that you live on a pre-agreed amount — even if the only person you have to agree with is yourself.
Too often, entrepreneurs use up one month’s paycheck and then have nothing left in the next down month.
But if you have the discipline to stay within the income you’ve allotted yourself, and your business succeeds, you should eventually build up a cash cushion that can be used for emergencies or investments.
Your career as an entrepreneur can be rewarding in many ways — and you’ll enjoy it even more if you make the right financial moves.
Mike Blaes is a licensed financial adviser with the firm of Edward Jones. For more information, call him at (928) 476-6427.