Evaluate your performance against your goals. At the beginning of this year (or the end of last year), you made a few financial goals – how much money you wanted to save, what you wanted your gross income to be, to pay off a certain amount of debt, etc. The end of the year is the time to see whether you met those goals or not. Don’t beat yourself up if you fell short; maybe your goal was too aggressive or maybe something happened this year that kept you from accomplishing everything. Just take it as a lesson learned and use the information to set your goal for next year.

Organize your receipts. Boring, but totally necessary. Ideally, you’ve been categorizing receipts throughout the year. If you fell off the wagon mid-year and starting tossing them all in a shoebox, now’s a good time to get them organized again. Categorizing your receipts makes it easier to take tax deductions for certain business expenses like office supplies, internet, equipment purchases, etc. Not only that, knowing what you spent this year will help you make a budget for next year.

Check your insurance coverage. Now is a good time to review all your insurance policies – life, health, auto, disability – to make sure you have the right amount of coverage. Health insurance may be the only insurance that you can’t change right away – because of open enrollment times, but the other insurances typically let you make changes at anytime during the year.

Consider a raise. Employers rarely increase rates on a “just because” basis and neither should we. If you decide to charge a higher rate next year, make sure you can justify the increase to your future clients. You also have to decide whether the rate goes up for all clients or just new clients. Jenn mentioned this recently, but it’s worth repeating – use the writing rate calculator to help you decide what your hourly and per word rate should be if you decide to increase your annual income.

Create a business budget for next year. Your 2010 receipts will help you figure out where you spent money on your business. Before you spend any money on your freelance writing business in the new year, you should decide how much you’re going to spend and what you’re going to spend it on. Having a plan in place will cut back on unnecessary spending. You still have to be smart with business expenses, even if they are tax-deductible.

A special move for 2010, only: Pay your January health insurance premiums in December. This year only, self-employed workers don’t have to pay self-employment taxes on health insurance premiums. We always get to deduct this amount from our Federal income taxes, but this year there’s a special provision to extend the deduction. Paying your January premiums in December lets you get a savings you wouldn’t get if you wait until 2011 to pay that premium.

Let me start by saying that you can easily become overwhelmed with the amount of information available about each retirement option. I can’t possible cover all the details in a single post so the condensed version may feel a little heavy. It’s ok. Read through this list a few times. If you use one, you can talk about these options with your financial planner who can give you insight into which option is best for you.

IRAs

There are a few types of IRA, or Individual Retirement Accounts, but the gist is that you can deposit a certain amount of money and receive a tax benefit. With a traditional IRA, the tax benefit is on the front-end. Your deposits are tax-deductible (or made pre-tax if done through an employer). Your earnings and deposits are taxed at withdrawal.

A Roth IRA requires you to contribute post-tax money, but allows you to withdraw your deposits and earnings tax-free as long as you wait a certain amount of time. There are contribution maximums for both the Roth IRA and traditional IRA and income phaseouts for Roth IRA. That means your maximum contribution limit is reduced as your income reaches a certain amount depending on your tax filing status.

The SEP-IRA allows you to contribute up to 20% of your freelance income (or 25% if your business is incorporated) or a maximum of $49,000. The drawback is that you may have to change plans if you later decide to hire someone.

The SIMPLE IRA, available only to employers who don’t have another retirement plan, allows you to contribute both as your employer and the employee of your business. You can contribute a maximum of $11,500 to a SIMPLE IRA and you’re required to contribute up to 3% of your employee’s (that includes you) compensation every year no matter what your business makes.

Both the SEP-IRA and SIMPLE IRA have pre-tax benefits and have higher maximum contribution limits than the Roth and traditional IRAs. But the Roth and traditional IRAs, which have a maximum contribution of $5,000 in 2010, are simpler, easier to understand, and can be contributed to even if you’re not fully self-employed.

Solo 401k

The solo or individual 401k is for individual freelancers (not corporations) who don’t have employees and is available in traditional and Roth versions. A traditional 401k would provide tax benefits upfront and tax your withdrawals, while the Roth 401k contributions are made with post-tax income and retirement withdrawals not taxed.

You can play two roles when you contribute to an individual 401k – the employer and the employee. As the employee, you can contribute up to $16,500 each year and as the employer you can contribute as much as 25% of your income, but not more than $49,500. There are no minimum contribution requirements, so in the years when your income is low, you don’t have to deal with required contributions.

If you ever decide to hire someone that’s not your spouse, you’re no longer eligible to contribute to an individual 401k and you’ll have to convert to another (usually more cumbersome) type of plan.

Withdrawal Requirements

You generally have to wait until age 59 ½ to start withdrawing money from a retirement account. Withdrawing your money too early can result in early withdrawal penalties in addition to any taxes you have to pay on your withdrawal. There are some exceptions that will allow you to avoid the early withdrawal penalty, but not the taxes, e.g. to pay for certain medical expenses or to buy your first home.

Which one is best?

I am not a financial advisor and I don’t have any financial certifications. I’ve simply done years of research on this stuff. Based on my understanding, traditional and Roth IRAs are good if you don’t have a lot money to put into retirement right now, i.e. less than $5,000 per year. A traditional IRA is a great way to reduce your tax liability because you get an above the line tax deduction.

SEP-IRA and Solo 401k plans are good if you have more money to contribute, but plan on being the only employee of your business forever. Otherwise, you’ll have to convert to another plan if you eventually hire someone else. There are no minimum required contributions.

The SIMPLE IRA doesn’t allow you to contribute as much as the SEP-IRA and Solo 401k, but it’s more accommodating for a business that hires employees. Furthermore, as long as your business offers the SIMPLE IRA, you’ll have to contribute something (between 1-3% of their compensation) to your employees’ IRAs.

Too confusing?

Don’t put off retirement savings just because you don’t completely understand this list. Putting your retirement money into a special retirement account has obvious tax and interest advantages, but just for getting started, you can start putting retirement savings in an ordinary savings account. Then, when you have some money saved up and understand your options, you can transfer your money to a retirement account.

As you consider the move to becoming a full-time freelance writer you should also think about how your other expenses will increase.

Your utility bills will probably go up. You’ll be at home more hours during the day and you’ll be using your computer, lights, and the television more often. If you typically adjust the thermostat on your heating and cooling system before you go to work, you won’t keep getting these cost savings if you don’t continue to make the adjustment once you start working from home. The same thing goes for your water usage.

You may spend more money on food. You’ll probably be eating more meals at home, so your grocery bill may increase. Of course, this all depends on what you spend on lunch right now. If you switch from eating breakfast and lunch out everyday to eating those meals at home, your food expense may decrease. The opposite can happen if you typically eat at your work’s cafeteria where meals may be cheaper.

You must purchase your own office supplies. When you work for someone else, the employer typically pays for things like paper, pencils, etc. As a freelance writer, you bear the cost of these expenses. I wouldn’t expect to spend a tremendous amount on office supplies, but this all depends on how you work.

Regular household expenses might increase. You’ll be at home more throughout the day, so it makes sense that you’ll consume more of those everyday items like tissue, paper towels, and trash bags, which your employer furnishes. You should increase your budget for these items.

Fortunately, the increased cost of working from home can be deducted on your income taxes. You can count things like office supplies and the internet as business expenses. You may also be able to take the home office deduction, which helps compensate for the increase in utilities you face from working at home.

Which of your expenses have increased since you started freelancing full-time?

While most of my bills are paid by the 5^th of the month, I have a few that aren’t due until later. It’s those stragglers that can throw off my spending. Until the 22^nd of the month when everything is paid, I’m constantly checking my account balance, subtracting the bills that haven’t been paid, to figure out how much spending money I have left.

I can solve that problem by tracking all my spending on my budget and reconciling it with my checking account, but for the past few months I’ve been too lazy to do that. Note: if I were having troubles with overspending and needed to get my budget under control, laziness would be a nonissue. I’d budget anyway.

The plan

Keep one checking account that’s used to pay all bills and household expenses (including groceries).

Open a second checking account that will hold my non-bill money. This money will be used for gas, eating out, entertainment, and other discretionary spending.

The benefit

Having the second account should make it easier to decide whether I can afford to spend more money on non-essentials.

I don’t have to worry about spending the money for my cell phone or electricity bills because it’s in a separate account.

If you have a spouse, you might open two separate checking accounts for discretionary spending to avoid bumping heads on spending. There’s always the question of how much money should you each have in your separate accounts – an equal amount or some other amount based on how much you earn or spend.

Drawbacks

There’s another password to remember, another bank statement to check, another check card to keep up with, another set of checks to keep safe, and yet another set of funds to keep out of overdraft.

Budgeting is still required

Having multiple checking accounts doesn’t eliminate the need for a budget. It simply makes managing a budget easier. Even with another checking account, I still need to budget my income to figure out how much money goes toward bills, savings, and other spending.

I also realize that having a separate account just for spending doesn’t give me the freedom to spend as I wish. That money has to last until the end of the month, so smart spending is required.

Any of you use multiple accounts to help manage your money?

You need to be able to pay all your current bills and expenses. So, add up what you spend today – rent/mortgage, food, utilities, internet, credit card bills, student loans, auto insurance, etc.

Then, you’ll have to pay taxes. Right now, your employer deducts your income taxes from your paycheck before you get it. The exact opposite will happen when you start freelancing. You’ll pay your own income taxes on a quarterly basis out of the freelance money you’ve made. Calculate your estimated taxes so you have an idea of what you’ll need to send the IRS.

Think about whether you’ll keep health and dental insurance once you stop working. You can shop for some quotes with private insurance companies, but if you have a pre-existing condition that prevents you from getting private insurance, you might consider using COBRA (which can be quite expenses). I don’t recommend going without at least some type of basic insurance. Even if you’re healthy, you never know when an accident might put you in the hospital. Insurance can help offset those medical expenses.

Add the cost of taxes, health insurance, and your other monthly expenses and you have an idea of what you need to make each month to support yourself completely on freelancing.

If the numbers – your expenses and your current writing income – don’t quite match up, that doesn’t mean you can’t afford to freelance full-time yet. You may have to scale back on certain unnecessary expenses until you make more money. Look over your current expenses again and see what you can cut out.

When I left my full-time job, my freelance writing income wasn’t enough to completely support me. Fortunately, it only took a month to bring my writing income to a level that would pay all my bills. Just in case it didn’t, I had enough money saved up to support myself for six months.

Honestly, if you wait until the numbers are right to start freelance writing full-time, you may never make the leap. Of course, every freelance writer is the different, but you may very well able to afford full-time freelance writing if you:

1. Can cover a portion of your expenses with your current freelance income
2. Have enough money in savings to supplement your freelance income for at least six months
3. Have a marketing plan and know where to get new clients

You need to have all three things before you decide to make freelance writing your career. Without solid finances, you could end up taking on jobs you hate or worse, you could end up back in the working world.

At my last corporate job, allowed us to buy an extra week of vacation. Payroll simply deducted a one-twelfth of a week’s salary from my monthly paycheck and each paychecks were the same each month no matter when I took vacation days. For example, if I made $62,400 a year, a week’s salary would be $1,200 and I would have an extra $100 deducted from my paycheck each month to pay for the extra vacation days.

If you haven’t been taking vacation because you can’t afford to, “buying” a week of vacation is how you can afford to.

How Much Do Your Vacation Days Cost?

The cost of your vacation days depends on your income. Divide your annual income by 52 for weekly income or divide it by 253 for daily income (assuming you don’t work weekends and you take 8 holidays during the year). That’s how you can tell how much a week or a few days of vacation will cost.

Example: If I’m projecting $48,000 gross income this year, my weekly income is about $923 ($48,000 / 52). My daily salary is about $190. If I wanted to take 4 days vacation this year, I could buy it for $760 (that’s $190 x 4).

Planning Your Vacation Purchase

If you’re buying vacation a year in advance, divide the cost of your vacation days by 12. That’s how much you need to set aside each month for vacation. Based on the example above, I’d need to set aside $78 each month for the next 12 months to take some vacation days next May. But if I want to take vacation sooner than that, say in November, I need to set aside $154 ($923 / 6) aside each month for those vacation days (assuming I haven’t been saving already).

Once you decide to buy some vacation days, you need to factor it into your budget. You’ll be putting this money away just like other savings, so your budget is key in making sure you can afford it and adjusting your spending as necessary.

You can buy your vacation in two ways:

1. Pay yourself less. If you give yourself a salary each month, you can reduce your pay by the amount of your vacation. Remember to leave your vacation money in your business account (or whichever account you use to pay yourself). The month you take vacation, pay your normal salary.

2. Put your vacation purchase in a separate savings account. You’ll pay yourself a regular salary or transfer your income as you normally do and put your vacation income in a separate savings account each month. Then, the month you take vacation, transfer your vacation savings into your primary checking account.

The money you set aside for a month of vacation isn’t necessarily the money you use to pay for the vacation itself. This is really a way of making sure your income doesn’t drop in June because you’ve decided to go to the beach with your family.

During retirement, you’ll need anywhere from 70% to 95% of your annual pre-retirement income. Of course, that depends on your financial situation when you retire. You’ll need more money during retirement if you still owe a mortgage or car loan, credit card, or student loan debt. Planning is key.

The Sooner the Better

You’ll always have a reason not to save for retirement. Making retirement savings a priority in your 20s and 30s gives you much more time to save than when you’re in your 40s and 50s. For example, if you want to save up $1 million by age 65, you need to contribute $2,259 each year if you start at age 25; $6,079 each year if you start at 35; and $17,459 a year if you wait until you’re 45 to start. (Source: ClarkHoward.com)

Contributing to a retirement fund can be more difficult as a freelancer because you don’t get the advantage of having your contributions automatically deducted from your paycheck. Instead, it’s up to you to transfer money into your retirement plan or find out whether your plan administrator has an option to automatically draft the money from your checking or savings account. Then, you have to make sure you have enough money in your checking account to cover retirement.

If you can’t figure out how to add retirement savings to your current spending, take out your budget to see if you can make room for it. You may not be able to contribute the same amount each month, especially during famine months, but you can make quarterly or annual retirement saving goals.

Tax Benefits of Retirement Savings

You’ll also get a tax benefit for contributing to retirement. You can generally take an above-the-line-tax deduction for your contributions to a retirement plan. An above-the-line deduction can be taken even if you don’t itemize your tax deductions, but only your federal tax liability is decreased. Above-the-line tax deductions don’t decrease your self-employment tax.

How to Save for Retirement

You can research retirement plans and open one on your own, or you can hire a financial planner to explain each of the retirement options and help you decide which plan is right for you. Beware, there are some financial planners who make a commission based on the financial products you buy and may push you in a certain direction. Other financial planners are paid a flat-fee regardless of which financial product you invest in.

Stay tuned. The next post will discuss retirement options available for freelance writers.

A fluctuating income is just one of the facts of freelancing. It doesn’t mean you have to go back to your day job. Instead, we have to prepare for income fluctuations. One way is have an emergency fund.

An emergency fund is a savings – ideally three months to a year’s worth of living expenses – that you can tap into when an emergency comes up.

What’s an emergency?

Some people have broad definitions of emergency. These are some of the things I consider emergencies that are serious enough to dip into your emergency fund:

• A major car or home repair that’s not covered by insurance
• Car and home insurance deductibles
• Unexpected medical expenses
• Disability that keeps you from doing work
• Computer repair or replacement

What’s not an emergency?

• A broken television
• Medical expenses that you knew about in advance
• The latest iGadget

Why an emergency fund when I have a credit card?

An emergency fund keeps you from using credit cards to fund major expenses. You want to avoid credit card purchases, especially if you can’t afford to pay the bill in full, because they cost more money in the long run. Plus, it gives credit card issuers more control over your finances. Credit card issuers can raise your interest rates, create new fees on your account, lower your credit limit (which hurts your credit score), or cancel your credit card. If you don’t pay, they can send you to collections, trash your credit report, and even sue you. Use credit cards for convenience, not necessity.

How to Build an Emergency Fund

An emergency fund isn’t automatic. It takes time to build your emergency fund to the ideal level of three to twelve months of living expenses. To make it easier and keep your motivation, start building your emergency fund with a smaller goal in mind, like $500. Then, once you meet that goal, increase the amount.

I recommend putting your emergency fund in a high-yield online savings account like one from ING Direct or HSBC Direct for a few reasons. First, you’ll earn more interest on your savings than you would with many other traditional brick-and-mortar banks. Second, because it’s harder to access the money in the event of a spending attack. A bank transfer takes a few days. Finally, you can set up free transfers into your online savings account from your primary checking account. That means no trips to the bank are necessary.

Having an emergency fund is too important to procrastinate. Take a look at your monthly budget and decide how much you can afford to contribute each month. Let your emergency fund contributions fluctuate with your income. The months you make more contribute more. The months you make less contribute less.

Remember that an emergency fund is different from a regular savings account. This isn’t something you should use as a down payment on a home or for Christmas shopping. Instead, use that money for an unpaid expense that would lead to financial ruin.

There’s your financial lesson for the day! Any questions? Maybe you have an expense in mind and want to know whether it’s worth dipping into your emergency fund?

1. Evaluate your rates. As you think about your writing rates for 2010, consider how you fared last year. You don’t always have to raise your rates just because you have more demand for your services. The clients who wanted to hire you in 2009, might not want to pay your higher 2010 rates, which means you’ll have to look for new clients who are willing to pay those rates. Raise your rates based on the value you provide to your clients. If your value didn’t increase in 2009, your rates shouldn’t necessarily increase in 2010.

2. Estimate your annual income. You may not be able to predict the exact dollar amount you’ll make this year, you can estimate your annual income based on what you made last year and what you (reasonably) hope to earn this year. You need to have an idea of what you’ll earn this year so you know how much you’re able to spend. Plus, an income goal gives you something to work toward. You know when you need to pick up more writing clients and when you have enough work.

3. Create a tax plan. Having a tax plan early in the year will make life much easier next April. Use your estimated income from #2 to figure out how much you’ll owe in income taxes this year. Then, divide that by 12 to calculate how much you need to save for taxes each month. Include your tax savings in your monthly budget so you know whether you need to make more money for the extra expense.

4. Organize your financial records. This means putting away your invoices and receipts from 2009 (but not too far away, you’ll need them to file your income taxes this year by April 15). You should also create new files to store your 2010 invoices and receipts. If you didn’t have a functional filing system last year, now is a great time to start one since your invoices and expenses are few.

5. Set financial goals and make a plan to reach them. Besides make enough money to make ends meet, what do you want to accomplish this year with your finances? Some goals you should include on your list are: save more money, pay off debt, and contribute to a retirement fund. When you create financial goals, be specific about what you want to accomplish then decide what you need to contribute each month to make it happen. For example, if you want to contribute $2,400 to an IRA this year, you need to deposit $200 in your IRA each month. Make sure your budget includes your financials goals.

6. Update your business budget. Your freelance writing business should have a separate budget from your personal budget. From your writing income, allocate a certain amount each month for business expenses. Then, decide what you’ll need to purchase this year – web hosting, new domains, conferences, etc.

7. Update your personal budget. You’re not the only one evaluating your rates at this time of year. Every other business is doing the same thing. That means, you might see increasing rates on your services. Update your budget to include these price increases along with your estimated income, personal goals, tax savings, and regular monthly expenses.

You don’t have to wait until a new year comes to evaluate your finances. Every item on this list is something you should do periodically during the year to keep your finances on track.

What is Credit?

Credit is your reputation for paying your bills on time. Good credit means you’ve borrowed only what you can afford to repay and you’ve paid your bills on time. On the other hand, bad credit means you’ve fallen behind on your payments in the past.

What is a Credit Score?

Your credit is measured by your credit score. Credit scores generally range from 300 to 850 with higher credit scores being better. These days, you need a credit score above 720 to get approved for a credit card or loan, especially as a freelancer.

Your credit score is calculated using five things:

• 35% is how often you’ve paid your bills on time (paying on time is better)
• 30% is how much of your available credit you’re using (less is more)
• 15% is how long you’ve been using credit (longer is better)
• 10% is how much experience you have with different types of credit (credit cards vs. loans)
• 10% is how often you’ve applied for credit in the past year (fewer applications are better)

What is a Credit Report?

Your credit score is based on information in your credit report, which is a compilation of your credit cards, loans, and other credit-based accounts. Your credit reports are maintained by credit bureaus, agencies which collect your data and sell it to businesses who need to make a credit decision about you.

There are three major credit bureaus in the U.S. – Equifax, Experian, and TransUnion – and you have a credit report at all three of them. Your credit report could be different at all three credit bureaus because not all of your banks and lenders report to all three of the bureaus. You may have some accounts that appear on all three of your credit reports and some accounts that only appear on one.

How to Check Your Credit Report

It’s a good idea to check your credit report at least once a year. First, to make sure you haven’t been a victim of identity theft or credit card fraud. Second, so you know your creditors are reporting the right information. Finally, you need to know where you stand on all your accounts, even if you don’t plan to apply for a credit card or loan anytime soon.

You can check all three of your credit reports once a year for free by visiting AnnualCreditReport.com. You’ll go through a short verification process and then your credit reports will be given to you. This website was set up to give you the free credit reports granted to you by Federal law.

Be careful about ordering “free” credit reports from other websites, especially those that ask you to enter a credit card number. These sites typically enroll you in a trial credit monitoring program, then charge you if you don’t cancel within a certain period of time.

You can also pay for your credit report by ordering directly from the three credit bureaus. They have options for purchasing one or three credit reports.

How to Order Your Credit Score

Unfortunately, the government doesn’t give us a free credit score every year. But, can get a free credit score as part of a free credit report offer – one of subscription deals that you must cancel to avoid getting charged.

CreditKarma.com offers a free credit score from TransUnion (one of the three major credit bureaus). You don’t have to enter a credit card to get your credit score from Credit Karma.

Finally, you can purchase your credit score from any of the three credit bureaus or from myFICO.com.