5 Financial Mistakes Freelancers Make (And How to Avoid Them)
You became a freelancer so you could spend more time doing things you love, not to deal with things like insurance, taxes, investments, and accounting - right?
Unfortunately, an essential part of being a freelancer is effectively managing your money - both for the business and your personal life.
Being a freelancer and business owner myself, I know what it's like trying to balance your creative work while still trying to keep up with client relationships and everything else that needs to happen to run an efficient business.
But if you're able to avoid these 5 mistakes, you'll be able to spend more time doing what you love and less time trying to figure out the best ways to manage your money.
Mistake #1) Not separating business and personal accounts
Whether you're a full-time freelancer or you just work on projects on the side, if you're getting paid from your work, the first thing you need to do is set up separate bank accounts for your freelance income & expenses and your personal income & expenses.
If you've set up your freelance business as a legal business entity (e.g. single-member LLC, S-Corp), you can open business bank accounts at any bank as long as you have your EIN number (which is like a social security number, but for a business).
Note: Contrary to popular belief, you don't need to set up a business to get started freelancing. However, setting one up can help with credibility when meeting with potential clients and can protect your personal assets in the event your business had to go through a lawsuit.
If you're only operating as a sole proprietor, meaning you haven't established yourself as a business, your options for a business bank account may be limited. However, you can open a separate personal checking account and use it exclusively for business income and expenses.
The reason you want to have separate accounts is because when it comes tax time, you want to be able to see how much income you've received from freelancing and what expenses you incurred throughout the year that can be written off.
Write-offs are used to lower your taxable income and may include expenses such as:
- Home office
For example, if you were a full-time freelancer and made $50,000 and had $10,000 in freelance expenses to write off, rather than paying taxes on $50,000 of income, the $10,000 in write-offs mean you would only have to pay taxes on $40,000, lowering your total tax bill.
Getting separate personal and business bank accounts set up is one of the first and most important things to do as a freelancer.
Mistake #2) Not setting aside money for taxes
As a freelancer, you most likely aren't having taxes taken out of payments like someone who receives W-2 income from an employer does, so it's vital that you set aside money for taxes.
A general recommendation is to set aside 25% of your freelance income in a separate savings account to pay quarterly taxes.
If you over-save, it's okay. You can treat that extra money as a bonus.
But if you under-save, you'll have to dig into your emergency fund or personal savings to cover the tax bill (ouch).
Make it a habit that whenever you receive income, automatically transfer ~25% of it towards a savings account designated for your future tax payments.
It's tough to remember to do this every month, so you can set a reminder on your phone or calendar so that at the end of the month, you can review income in your accounting software and transfer the money to the designated tax savings account - which leads us to the next mistake.
One app that I've seen other freelancers talk about that I personally haven't used yet is Catch. It's supposed to help with making estimated quarterly tax payments, finding health insurance, as well as investing.
Mistake #3) Not using an accounting software
Whether you keep track of your freelance income in the Notes app or a Google Sheets, getting an accounting software is an upgrade that will save you time and money in the long run.
You can easily view reports such as your income and cash flow, send invoices, or even easily pull documents for taxes.
I currently use two different accounting softwares (for 2 different businesses):
The classic accounting software. They raised their pricing within the past year to $25/month which is why I started using Wave Accounting for my freelance work, but it doesn't get much better than Quickbooks.
Every accountant and tax preparer should be familiar with the software, making it easier to collaborate and submit documents come tax time and if you need help learning how to use it, there are many step-by-step tutorials on YouTube.
In my opinion, this is the best free accounting software. I recommend Wave if you're just getting started and you're wanting to keep expenses as low as possible because it doesn't get much better than free, right? It can do just about everything Quickbooks can and most importantly you're able to keep an eye on your income and expenses, see your balance sheet, pull tax documents, and even send invoices.
Mistake #4) Not investing
When it comes to your money and your life, investing is something that needs to be done.
But before your eyes glaze over, investing is more than just picking stocks and hoping they go up.
Investing means putting something to work now, for a better result in the future.
This includes your money, yourself, and your business.
As a freelancer, your income is tied to your skillset. Don't be afraid to invest in courses, tools, or communities that can help you become a better freelancer because by doing so, you're growing your network, your resource library and over time, these investments will lead to more confidence, better skills, and more opportunities.
You can view these as investments because you're getting better at your craft and over time, you should be able to raise your fees - which ideally, will lead to higher income.
On the flip side, investing for retirement is one of the most boring things to do, but it's a necessity. As a freelancer, you have a few accounts available that are specifically designed for retirement investing. These accounts have tax benefits that a normal investment account (like what you get with Robinhood) doesn't provide.
A few retirement accounts available to self-employed individuals are:
- Roth IRA
- SEP IRA
- SIMPLE IRA
- Solo 401(k)
These can typically be opened at brokerages such as Vanguard, Charles Schwab, or TD Ameritrade.
Mistake #5) Not building a safety net
As I'm sure you know, life happens. Whether you forget about an annual insurance payment or you have to replace your laptop, it's important to have savings to cover these expenses to avoid taking on credit card debt or selling off investments.
Generally, it's recommended to have 3-6 months of personal living expenses saved in an emergency fund. And an emergency fund isn't a special kind of bank account, it's just a savings account that you use specifically for emergencies.
And as much as I wish they were, buying new AirPods or upgrading tech just for fun aren't emergencies...
Emergencies would be things such as unexpected medical expenses, car repairs, income replacement, or whatever else life decides to throw your way.
As a freelancer, I would strive for more than 3 months of expenses saved because as you know, income isn't always regular. You may have months where you land a new client and make $7,000, then the following month you only bring in $2,000.
I learned firsthand the importance of an emergency back in 2020 as I was starting my business.
At the time, I was doing DoorDash to cover some of my personal monthly expenses because a majority of my money was going towards the business. Then one day I wake up, take my dog outside for a walk, and notice that my car wasn't in its regular parking spot. Turns out, it was stolen. Long story short, it was found a week later completely torn apart and barely drivable. But I had a small emergency fund to cover the ~$1,500 it cost to get it running again so I could get back to doing DoorDash to build up my emergency fund again.
All of that to say, please start building an emergency fund. The peace of mind knowing that you can cover unexpected expenses is extremely worth it.
I typically recommend two different places to open high yield savings accounts for emergency funds:
You can keep your emergency fund as a savings account at your regular bank, but high-yield savings accounts offer higher interest rates — meaning you can earn more simply by opening an account at one of these high-yield online banks.
There are few better careers than being a freelancer. I mean, where else can you charge what you want, work with who you want, and do the work you actually love doing?
But there are complexities that need to be taken care of as well to make your freelancer journey smooth from a financial standpoint.
By avoiding these 5 mistakes that I see many new (and experienced) freelancers make, you'll be able to remove the stress and worry from your finances and be able to spend more time on your passions.