As Freelancers our monthly intake varies wildly month to month, so we must set up a structure that allows us to live without day to day concern for those fluctuations. In Part 1 we discussed budgeting. Part 2 dealt with salary. In Part 3 we explored emergency funds. Now we move on to targeted savings accounts. Targeted savings accounts are an important part of a solid personal finance base and critical for freelancers.
Targeted savings accounts come in two flavors. One has to do with large annual or irregular expenses, such as insurance payments, dental visits, holiday gifts, or a new computer. The other are regular expenses that fluctuate strongly and thus are difficult to budget for in the traditional sense. In all these cases the matter comes down to averaging the expenses. This is the same process we do to address salary. Since many freelancers see fluctuations by as much as several hundred percent in their incomes from month to month, the only reasonable way to approach this is with averages.
Remember, emergencies are dealt with in emergency funds as outlined last week. What we are talking about is known irregular expenses. So on to averages.
How does this averaging work? Well, let’s take our first example, the large irregular purchase. These are the ones that trip people up the most. Because they are not planned they often surprise, despite the fact that some amount of unplanned expenses happen every few months. This month it may be the car, but six months down the road it may be the computer. Then there is the one that gets everyone on April 15th, TAXES.
Let’s say you know you will need to buy a new computer in about a year. The computer that you want retails for around $2,400. Most people tend to wait until they want to buy the computer then when the time arrives they throw the whole thing on a credit card and pay it off in installments. However with this model you end up paying closer to $3,000 or more with interest. Instead what we do is set up a savings account specifically for the purchase of that new computer. Every month we put $200 into the account. At the end of a year, we have enough to buy the computer and with the interest earned cover taxes on the machine.
Simple.
There are also medium to large expenditures that occur regularly but more spaced out than, say, rent. The dentist is a perfect example of this. A regular checkup with my dentist is in the range of $120. I am supposed to go every six months. As such I have set up a savings account that I deposit $20 into every month, thus giving me the $120 when it is time to go.
These averages are included in my budget. So while I might not “spend” the money each month, it is accounted for and taken out of my salary. And my salary in turn is composed of both monthly expenses like rent and groceries but also these irregular expenses.
One of the most difficult for most people is Taxes. However, after freelancing for a few years you get a rough sense of what your real tax rate is going to be. As a lighting designer I have very high overhead. As a result my deducible expenses are correspondingly high. While I could save 40% of my income “just to be safe” I know that realistically I only pay 10% of my gross income. As such I put that much away into a targeted account just for taxes. If I have any left over it is usually not that much and I can just roll it over for the next year.
On taxes, since I have over 5 years worth of data I am basing this 10% number on my own specific situation. Yours may well be different and certainly if you have less overhead you will pay at a higher rate relative to your gross income. If you only have a year or two worth of data being overly cautious can’t hurt.
I then have a generalized savings account for regularly budgeted business expenses. While I budget for what I typically spend in a month, some months are a little more and some a little less. If I budget $15 a month for stationary but only spend $10 this month I put that extra $5 in a generalized account. That way in two months when I spend $20 I have that covered without upsetting my budget.
From reading all this you might think I have 20+ savings accounts with various banks. In fact I have two. One is my primary account from which I pay myself a monthly salary. The other is with an online bank that allows me to create as many “sub-accounts” as I want. A good, and deeply sarcastic, explanation of this sub-account system can be found here.
With a little advanced planning we freelancers can create a smooth life for ourselves despite the economic vicissitudes of our work. By implementing this system of targeted savings accounts it fast becomes possible to deal with the little bumps caused by irregular expenses that would otherwise trip us up or cause us to plunge into debt.
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