Budgeting

Home Finance

As a freelancer, budgeting is imperative. Unlike a full-time employee, freelancers have to worry about highly variable income, quarterly taxes, and business expenses (on top of the usual personal expenses)! Below we provide some guidance on how to budget effectively.

Importance of tracking expenses

The most important money principle for everyone — freelancer and full-time employee — is to spend less than you earn. For this to be the case, it's important to have an understanding of how and where you are spending your money. If you don’t already, start tracking your spending! You can do this in whatever way you are most likely to stick with - a spreadsheet, a notebook, or an automated program like Mint. Once you are able to properly track and monitor your expenses, you will be able to apply the 50/30/20 budgeting rule!

The 50/30/20 Budgeting Rule

Step One: Calculate your after-tax net income

As a freelancer, your after-tax net income equals your total (aka gross) income minus your business expenses as well as the amount you set aside for taxes. As explained more in depth here, we recommend you set aside 25% - 30% of your net income (gross income minus business expenses) for taxes.

Step Two: Limit your 'needs' to 50% of your after-tax net income

'Needs' are... well things you need! Think things like groceries, housing, utilities, health insurance, and car insurance. Any payment that would severely impact your quality of life, such as electricity and prescription medicines, is a need. If you can't forgo a payment such as a minimum payment on a credit card, it can also be considered a "need," because your credit score will be negatively impacted if you don't pay the minimum.

Once you figure out what your needs are, limit these to 50% of your after-tax net income. Before spending money on anything else, you should make sure you are able to cover all of these.

Step Three: Limit Your "Wants" to 30%

'Wants' are basically any payment that you don't need and can forgo with only minor inconveniences. This can include your cable bill or back-to-school clothing or going out with friends. Once you figure out what your wants are, limit spending on these to 30% of your after-tax net income.

Step Four: Spend 20% on savings and debt repayments

You should spend at least 20% of your after-tax net income repaying debts and saving money in your emergency fund and your retirement accounts. If you carry a credit card balance, the minimum payment is a "need" and it counts toward the 50%. Anything extra is an additional debt repayment, which goes toward this 20% category. If you carry a mortgage or a car loan, the minimum payment is a "need" and any extra payments count toward "savings and debt repayment."

Freelancers aren’t automatically enrolled in a company’s 401(k) plan, which means it takes a bit more effort to save for retirement when you’re on your own, and it’s easy to put off. But it’s just as important to start putting money aside. You should aim to save to least 5% - 10% percent for retirement. It’s important to build the habit, even if it’s $50 a month.

50/30/20 Budgeting Example

Step One: Calculate your after-tax net income

Let's assume your total (gross) income every month is $5,000.
Let's assume your total business expenses (deductible expenses) are $1,000.
This brings your net income to $4,000 ($5,000 - $1,000).
You will want to save 25% of your net income for taxes, which amounts to $1,000 ($4,000 * 25%).
This leaves you with an after-tax net income of $3,000 (4,000 - $1,000)

Step Two: Limit your 'needs' to 50% of your after-tax net income

Now that you know your after-tax net income, multiply that number by 50%. That is the amount you should be spending on your needs. In this case it would be $1,500 ($3,000 * 50%).

Step Three: Limit Your "Wants" to 30%

The amount you have available for your wants is $900 ($3000 * 30%). Note that sometimes you might have to spend a smaller percent in this category if you're running short on your 'needs' category.

Step Four: Spend 20% on savings and debt repayments

You now have $600 left, and you know what to do with this. Pay back debts, set some aside as an emergency fund (you never know when things will get rough), and set some aside for retirement.

Managing your finances as a freelancer can definitely be hard and scary. Tracking your cash flow and planning a budget is one of the tools you can use to help you make smarter decisions and be more at ease!

Written by
Samuel Gordalina
Last modified on
May 1, 2020