Monthly Archives: October 2016

Learn More About Retirement Planning in the Gig Economy

In a previous article we looked at people who now work in the gig economy—taking contract jobs as a freelancer/small business owner rather than taking the more traditional route working as an employee for another business.

It’s not as simple as saying goodbye to your employer and setting out on your own. We looked at things like the self-employment tax and other tax considerations that significantly impact your earnings.

Along with taxes, there’s another consideration—retirement. Maybe you saved up a valuable nest egg before you left your previous job, but for many, they’ve barely started amassing a retirement savings. Because of this, you have to consider your retirement income before going all-in on the gig economy. Yes, you’ll receive Social Security assuming you pay fully into the system, but relying on a government program to keep you financially afloat in your later years isn’t the wisest strategy.

It’s All On Your Shoulders

In our last article we talked about how your employer paid part of your Social Security and Medicare taxes but as a freelancer you have to do it all on your own. The same holds true for retirement. Studies show that nearly 9 out of 10 employers matched a portion of the employee’s 401(k) contributions. That represented a large portion of your retirement savings but as a freelancer, you won’t get any employer match. It’s all on you to save enough to retire comfortably. If you’re 30 and haven’t saved anything, you will need to save about $649 or more per month depending on your income and lifestyle to retire with enough money to live comfortably on. You can estimate the amount you’d need from this calculator.

Have employees? This article may help you navigate their retirement options.

The IRA Dilemma

It’s easy, right? Just start an IRA, contribute as much as you can, and you’re set. There are a host of problems with that plan. First, an IRA comes with a $5,500 annual limit ($6,500 if you’re age 50 or older ) allowing you to contribute a maximum monthly amount of about $458 (or $541 starting at age 50)—not nearly enough if you’re significantly behind on savings. Your spouse can get an IRA, whether he or she is working or not, giving you an extra $5,500 to work with. That’s better but what about if you’re single?

The SEP

The Simplified Employee Pension or SEP is an option. You can contribute the smaller of $53,000 or 25% of your total compensation. Learn more about it in IRS Publication 560. But be careful. Don’t “forget” to claim all of those small-dollar clients that didn’t pay you enough to file a 1099. If you “forget” to claim it, it lowers your maximum.

SIMPLE IRA

The SIMPLE IRA plan for small employers is about as simple as anything involving the IRS can be. It works the same as a regular IRA but your yearly limit is higher. Instead of $5,500, you have a $12,500 limit. If you’re over the age of 50, you can contribute as much as $15,500. Again, Publication 560 will tell you everything you want to know.

Other Options

There are other ways to fund your personal retirement from your company but the SEP and SIMPLE IRA are the most common. There are also profit sharing plans and a self employed 401(k) plan where you and your company make contributions but these are a little more difficult to set up.

Taxes

Assuming you have some kind of formalized business like an LLC, any retirement benefits your company provides to you are a business expense. Your company can write that off as an expense in most cases. How that all works depends on some factors a tax expert will probably have to help you with but it is an expense like any other.

Effect on Pricing

Be honest—as a young or new entrepreneur have you wondered why your competitors are charging so much more than you believe the service is worth? You’re probably beginning to figure out that even a consultant working out of their home has overhead expenses. You have to pay taxes on your earnings and you have to fund your retirement and even insurance. That should drive your hourly rate significantly higher.

Think about it this way. Let’s say that you figured you have to save at least $500 per month for retirement and you’re going to pay about 30% of your earnings in taxes and you work 40 hours per week, and you charge $50 per hour. (For the sake of simple math.)

Just the retirement portion makes your hourly rate $52.50 and taxes add another $15 so now you’re at $67 without taking into account any other expenses. There are surely some other expenses your business incurs like licensing, continuing education, equipment, and more. It wouldn’t be surprising to see that number make it to $80 or more.

Calculate Your Net Worth

Do you know how much you’re worth? Most people don’t but as a business owner, your personal net worth may be important. Although your business is probably legally separate from your personal assets, a bank that considers giving you a business loan will likely ask for personal collateral if your business has little real value. Calculating your net worth gives you an accurate picture of how much of your personal worth you’re pledging to your business.

On a more personal level, having a clear picture of how much you’re worth helps with financial planning. Do you have enough saved for retirement; where is your debt and are there assets that could help you pay it down it down faster? What percentage of your net worth is in liquid investments and is it allocated appropriately? Your net worth is more than a single number—it’s an entire report full of important data.

Terms

Before diving into the calculations, you need to know a few terms:

Asset- Any property with real value. Real estate, a car, and jewelry or art are a few examples.

Illiquid Asset- Something that can’t be converted to cash quickly without a substantial loss. Remember the housing crisis that left people underwater on their homes? Homes became an illiquid asset for many.

Liability- Something you owe—a debt.

Liquid Asset- Something easily sold for profit. Stocks might be the best example.

Personal Property- Something you own that is movable—boats, cars, collectibles, and furniture are examples of personal property.

Real Property- Property permanently attached like a home, a barn, or detached garage.

Gather the Information

Probably the toughest part of calculating your net worth is gathering the information. Some of the information might be an estimate. Unless your real property was appraised recently, you won’t know it’s current value without paying an appraiser. In the case of your home, look up recent sales of similar homes in your neighborhood and use those as a guide for estimating your home’s worth. These are called “comps” or comparables in the real estate business.

If you have jewelry, some jewelry stores have appraisers on staff or they can recommend somebody.

For assets like your car or some collectibles, look at online guides that list their value. If you haven’t dug into the value of a 401(k) from a past employer or the cash value of a life insurance policy, set up online accounts with the firms holding these investments or call and request a current statement.

If you’re going to invest time into calculating your net worth, do the legwork to compile the most accurate data. The more you estimate, the more inaccurate your final calculation will be.

The Calculation

Calculating your net worth is simple once you have the information. It’s simply your assets (what you own) minus your liabilities (what you owe). Add everything you own including:

Money in savings or checking accounts
Actual cash
CDs or treasury bills
Annuities, bonds, mutual funds, pensions and other retirement plans, stocks
The cash value of any life insurance policies
The value of real and personal property
Anything else that you own that has sellable value.
Next, add your liabilities

Loans—car, mortgage, home equity, second mortgage, boat
Credit card debt
Medical bills
Student loans
Personal loans
Taxes due
Any other debt or outstanding bills
Subtract your total liabilities from your total assets. Now you know your net worth.

What’s Next?

Once you do the work the first time, the calculation is easier the next time around. If you haven’t already, use a free service like Mint.com to keep many of the numbers up to date in one place. Instead of having to compile the value of each of your investment accounts, credit cards, and everything else, you simply open Mint and copy the numbers into your spreadsheet.

In fact, Mint tracks the estimated value of many of your personal and real assets and gives you your net worth based on the information it has. It won’t be perfect but it will be pretty close.

Tips To Reduce Business Debt

Your business is no different than your home—too much debt can cripple you. Although it might be ideal to run a debt-free business, that’s virtually impossible. The best you can do is to manage and reduce it as much as possible. Here are some ideas.

1. Know Your Numbers. Don’t just be familiar with your numbers—know them. Knowing them means that you know the cost of each of your raw materials, labor, rent or lease costs, and everything else. Do you know what each item costs down to the penny? Do you know the interest rate on each of your debts? If you don’t, you’re probably paying too much for something.

2. Be Smart About Your Ordering. Sometimes you stock a poor-margin item that gets people into your store, but as a general rule, if it’s not getting you to the margins that others in the industry report, it may not be worth your time. Sales that result in ultra-low margins are costing you money. Identify unprofitable sales and eliminate them or look for a lower price from suppliers.

3. Increase your Margins. Speaking of margins, each industry has its own benchmark for what are considered strong margins. Do you know yours? Check with your industry trade group, but once you know it, make adjustments. You can raise your prices, lower your costs, or both. The goal should be to raise margins without raising your overhead expenses. What are others charging for the same item? Can you purchase more at a significantly lower cost without losing the savings to debt service?

4. Watch Your Inventory. Like your refrigerator at home, some items tend to linger. Don’t put off ordering more of your popular inventory but look for the product that isn’t selling and liquidate it.

Inventory is probably where most of your money is tied up. You’re probably paying interest on that stale inventory that everybody forgot about. Don’t let it sit in your store unnoticed. Even if you move it at cost or for a small loss, liquidating is better than keeping the money tied up. Sell it online—eBay or Craigslist, for example.

5. Check Your Interest Rates. Business owners are still enjoying an economic climate of low interest rates. If you have older debt, it’s time to renegotiate the terms.

6. Talk About the Terms. If you’re having trouble making payments, talk to the supplier about extending the terms. You aren’t going to save any money but lower payments may give you the financial room you need until the product sells.

7. Sell and Lease Back. Do you have relatively new fleet vehicles or other larger items? Sometimes it makes sense to sell the items and lease them back. Payments might be lower. To gauge the payoff that comes from this strategy, you will likely need help from a professional crunching the numbers.

8. Ask Your Employees. You were an employee at some point. You know that the people on the front lines will see things that the managers may not. Your employees know where money is being wasted. Ask them. They may be skittish about telling you for fear of retaliation. Explain to them why you’re asking and maybe offer a bonus to anybody who helps the company save money.

9. Be Tougher on Your Customers. Don’t become that business owner that every customer hates but do insist that customers meet their payment terms. You probably won’t go to battle if payment is a few days late but when a couple of weeks go by, it’s time to start calling the customer to ask for payment. If late paying customers are a big problem, you may want to add a late fee clause to agreements you have customers sign before you begin work for them. Check with your local professional advisors to find out if there are any laws that regulate what late fees you can charge. Good business relationships happen when both parties feel respected and valued.

10. Reduce Staff. Nobody likes to reduce staff, but if your business fails, the reduction in staff will be much larger. Sometimes you have to make tough decisions that negatively impact the few to protect the many. Are there employees you could do without? Could you consolidate positions by paying one person more rather than paying benefits for two employees?

11. Speak to a Credit Counselor. Most credit counselors are consumer-based but some work with small businesses. If you’re having trouble negotiating better terms, a credit counselor might be able to help.

12. Hire a Debt Management Company. Debt Management companies come into your business and sniff out where you’re losing money unnecessarily. They may be expensive but worth it in the long-run.

13. Bring on an Investor. If things are really bad, an investor can offer an injection of cash often in exchange for a piece of your company. In general, avoiding this option is best since it involves signing away a portion of your future profits but if times are really tough, it’s worth considering. However, finding investors is difficult. Don’t wait too long to start looking.