Self-Employed? Here’s How To Plan Your Finances
27 Aug 2021
There are always two sides to the same coin and the self-employment story is no exception to this rule. India has a large proportion of self-employed individuals, accounting for over 50% of the country’s workforce. Three broad categories can be drawn among the self-employed–millennials with an entrepreneurial spirit, traditional family-run businesses, and the new-age gig workers.
For the self-employed workforce of India, creating financial robustness has become paramount and finding the right means to do so in a sea of multiple financial instruments is not an easy task.
It is no secret that self-employment involves a certain amount of financial risk. Unlike the organized labor force, the self-employed don’t get a monthly pay check and work on a project model, which leads to disorganized income. They don’t have employee provident funds, medical insurance covers or paid sick leaves, travel allowance etc. They are also wholly responsible for the financial stability of their businesses in a crisis or boom. They are unique players in the overall financial system, playing a crucial role in the making of the economy. Their financial preparedness, therefore, plays a crucial role for the overall ecosystem.
Four Key Steps in Preparing For a Disciplined Financial Life
1. Keeping personal and business accounts separate – In a one-man business situation, it is very easy for income, personal expenses, business expenses and investments to get overlapped and entangled. First step to establishing a financial discipline is to separate personal and business accounts. All business-related expenses like travelling for assignments, project-related expenses, paying for your team, etc., must be managed from the business account. It is absolutely critical to create a salary-like structure for yourself so that the income you generated over and above the expenses can be invested in appropriate financial instruments.
2. Get a financial and tax consultant – When you are running a business of your own, it is tempting to put all your money towards growing it further. While growing your business is important, it cannot be done at the cost of personal financial preparedness and stability. It is ideal to get a financial and tax consultant as a third-party unbiased view of your business as well as personal finances can prove to be beneficial.
It is imperative that one do a thorough background check and research regarding the advisor and financial manager you choose. Once chosen, it is equally important to stay involved in the management of your own finances and not leave it up to the financial manager to take care of matters.
3. Keep family members in the loop – In formal employment, the family details are available with the employers and incase of any unfortunate case of death or health issues, family members are supported by the human resources team. But for self-employed individuals, that option is not available, so financial transparency with spouse and other family members is necessary. Nominations and joint holding on investments may be an option. One can get guidance from financial advisors to keep financial life smooth in any circumstances.
4. Estate planning/will – Many self-employed individuals invest in non-financial assets, such as gold, real estate, commodities, other alternate and non-traditional investments. Estate planning or financial will can come handy in case of any unfortunate incident and can smoothen legal matters for one’s heirs.
Once the above aspects are taken care of, you must address some routine or day to day aspects of financial planning and wealth creation for long-term financial stability.
Financial Planning For Long-term Stability
1. Maintain a monthly budget and iron out the uneven income flow
Self-employment often results in uneven income, leading into sporadic lifestyle changes, which can impact the quality of life. Certain expenses like home rent, monthly instalments (EMIs), school fees and utility bills are unavoidable on a monthly basis. It is critical to sketch out a monthly budget to plan ahead.
This budget will help in approximation of monthly expenses and saving requirements for the future. With a disciplined approach, one can create an estimate for regular expenses for a year and plan for additional expenses which may occur. It will enable better liquidity for the short term and investments for the longer term.
2. Creating emergency fund
A contingency fund is a safety net, essential to secure the aspirations of the loved ones from unforeseen events. It is ideal to keep the contingency fund parked in savings products like bank deposits or debt mutual funds which are liquid in nature.
For employed individuals, keeping three to six months’ worth of expenses is enough. However, given the irregularity of a self-employed individual’s income, it is ideal to keep a bigger corpus ready, accounting for six to eight months of expenses. Self-employed individuals should carry out a similar exercise to tide over any unforeseen disruptions in their business to ensure continuity. Should an emergency arise, this fund can absorb the temporary financial shock and help one tide through a rough patch without affecting monetary stability.
3. Creating regularity in income
Considering uncertainty of income for freelancers and self-employed, there are financial products available that can offer a structure to earnings by creating a secondary income source. There are income plans specifically created for this purpose. Tax efficient tools like monthly income plans from post office, mutual funds as well various insurance products are also recommended.
4. Protecting self and loved ones
No financial portfolio can be complete without adequate protection. The Covid-19 pandemic has highlighted a stark need for life insurance and critical illness covers to ensure a sudden impact on livelihood doesn’t create a dent in one’s savings.
Typically, corporations provide insurance covers to their employees through group insurance. However, given the nature of their jobs, self-employed people don’t have such benefits attached to their jobs. So, insurance is a priority purchase for such individuals.
There are many profession-related insurance solutions available too. For instance, is your office space insured from accidental damages? One needs to assess the risk factor of the businesses, which could cause threat to financial health and a suitable insurance cover must be purchased to provide for such risks.
5. Plan for retired life
The average life span of Indians is improving, with the proportion of the senior population increasing gradually. This indicates the need for a focus on retirement planning, especially for those who are working now. For a self-employed individual, lack of retirement can not only elongate their working years, but also keep the uncertainty of income alive for a long time.
Individuals in formal employment get employer pension or a retirement corpus through PF, VPF and gratuity. A self-employed individual, however, is at a bigger risk for economic de-stability and therefore needs to start planning for their retirement early on.
National pension scheme (NPS), income plans or annuity and retirement solutions specifically provide avenues to create a retirement corpus. These plans are also eligible for tax deductions and therefore can contribute to tax saving when planning your portfolio.
6. Long-term wealth accumulation
Whatever life stage one is in, finance always determines the quality of life. Irrespective of the level and stability of income, individual dreams and aspirations continue unabated, such as building a dream home, higher education for children, buying cars etc. All these goals require a large sum of money and therefore need a critical look at management of one’s finances.
One can choose from financial instruments such as NIFTY 50 funds, mutual funds, guaranteed plans etc., to create a path for disciplined wealth accumulation. Taking guidance from a financial advisor is always recommended in this aspect.
7. Using tax saving tools for financial discipline to support long-term wealth accumulation
Section 80C of the Income Tax Act offers many tax saving investment options. This segment is equally important for all earning individuals, more so for the self-employed individuals. In formal employment there are various checks like mandatory submission of investment details under Section 80C to save taxes which also aids in automatic wealth accumulation. In absence of such an automatic checks, self-employed individuals need to be more aware of tax saving instruments such as Public Provident Fund with 15-year maturity, equity-linked savings scheme with a three year lock-in period, life insurance ULIP scheme with five-year mandatory lock-in, tax-saving fixed deposits in banks with three year lock-in etc. These instruments are beneficial tools for tax saving as well creating a financial kitty in the long term as they instill a savings discipline due to the lock-in element.
Lastly, perhaps the most important lesson in managing your finances is remembering that while taking advice from qualified financial advisors is recommended, you cannot blindly follow their advice. You have to be heavily involved in managing your portfolio because nobody knows your current needs or can anticipate your future needs as accurately as you can. You have a much better view of how you see your life stages as well as how your business is likely to pan out over the longer term. So, take charge and start financial planning today for a more secure tomorrow.
It is a good idea to do some research and take help from qualified financial advisors to ensure financial health.