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The True Cost of Self-Employment
Now you think you are ready to make that jump and go from being an employee to full self-employment? The profit from your part-time (up till now) business is already matching your normal paycheck. You think it’s the time to fire your boss now and make a living without that paycheck from your employer.
Before you take that final step to personal freedom, make sure you really understand what you are giving up in that moment. Do you know that your employer paid benefits that may cost you more than you realize if you have to pay for them yourself. For most people it will take much more than $50,000 of profit per year to replace a $50,000 annual salary from a job. On average an employer pays 25% - 35% on top of your salary for your benefits (this number may vary for businesses with less than 50 employees).
When we talk about that your employer pays for the benefits we're not referring to the "free" office supplies, subsidized or free soft drinks, coffee, or tea, or even the occasional free meal at the holiday party. The items that you need to think of are the benefits that are going to cost you the most money. We are talking about the employers part on your health insurance premium, unemployment, life insurance, 401K, and so on. So, to make up for all those things your $50,000 salary suddenly needs to be around $65,000+ per year.
Based on the US Chamber of Commerce's survey medical insurance cost approximately 15% of an employee's salary. However, employers also cover the cost of many other forms of insurance. They include
-Dental
-Vision
-Health
-Life
-Disability
-Unemployment
-Long Term Care Insurance
-Workers Compensation
You might be thinking that you pay premiums for these products already. Even if you do, your employer is most likely paying the bigger share of the cost. Not to mention that many times the premiums you are paying are using pre-tax dollars. This means you end up paying less in taxes because the amount of your premium is deducted prior to calculating your taxable income. Also keep in mind that the cost for health insurance has been going 10% per and more for the last 4 years. A number that is most likely to stay in the double-digits.
When you own your business not only are are you going to be responsible for the full cost of all forms of insurance using after-tax dollars, you are going to be responsible for self-employment taxes, too. Self-employment taxes include the employer paid portion of Social Security and Medicare taxes. This means your bill for these taxes will most likely double. Instead of paying 7.65% of your income for these, you will now pay 15.30%.
And don’t forget about having to pay estimated taxes. You will have to file and pay taxes 4 times a year now, instead of just once per year. Keep in mind that not paying taxes properly in advance will eventually come back as a boomerang in form of late fees and penalties. Not only do your taxes increase so do the headaches and the cost of filing! If you have not yet an accountant - it is time to think about this more closely.
If you have received an employers match to your 401K - this money will have to come out of your own pocket now. You might not even be eligible for a 401K and have to look into different forms of retirement accounts. A big learning curves lays ahead.
These are only a few of items that make up the 30 – 40% of your salary that will suddenly show up when you become self-employed. Then there are things like discounted shopping at car dealerships, banks, or certain stores. If you highly depend on these perks - keep this in mind and budget those numbers properly.
I hope you don’t think we are trying to discourage you from finally doing the big step to become self-employed. But this last step requires a little more than just walking into the boss's office and slap him with your letter of resignation. ;-)
Good Luck
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