Financial Planning for Self-Employed

Being self-employed gives you the freedom to work on what you want and how you want. You don’t have to deal with a rude boss and frustrating office politics. You may get to choose your work timings. Till now, everything sounds good.



However, self-employment can bring its own set of unique problems. There is no fixed salary at the end of month. There is no mandatory contribution to EPF. There is no health insurance by your employer. You may have to pay higher rates of interest for home loans. Hence, you have to plan everything on your own.

There were posts doing rounds in social media demanding ‘No Work, No Pay’ for Parliamentarians after opposition stalled Parliament for many sessions. The demand got subdued as the Parliament session got over. However, if you are self-employed, you may have to take these words literally. No Work may actually mean No Pay.

Who is Self-Employed?

Self-employment is an act of generating one’s income directly from customers through working, clients or other organizations as opposed to being an employee of a business (or person). – Wikipedia

You come across many of them in your daily life. Local doctors and dentists, lawyers, insurance agents, real estate brokers and shop keepers are all self-employed. Should the financial planning for self-employed be any different from financial planning for salaried professionals? I think yes. Though most aspects of financial planning will remain same, there will be a few unique issues based on the nature of employment. I have broken down financial planning for self-employed into three different aspects viz. insurance, investment and retirement planning. Let’s consider these aspects.

Insurance and Contingency Corpus

1. Health Insurance

Adequate health cover is a must for self-employed. Firstly, you are not covered under any group health plan provided by an employer. Hence, in absence of health insurance, the entire burden of the bill will fall upon you. Secondly, a prolonged hospitalisation can be a double whammy if you (and not the family member) were to get hospitalised. Not only do you have to worry about medical bills, you may have to forgo almost entire income during treatment periodIf you are an employee, you could have taken medical leave and got salary during the period. No such luxury for the self-employed. Remember No Work, No Pay. 

Hence, if you are self-employed, you need to make a few provisions yourself. You can start with a larger emergency corpus. For instance, instead of having emergency corpus of 3-4 months of expenses, keep 6-8 months of expenses in an emergency fund. Another way to work around this loss of income is to build contingency in your business. For instance, you can hire an assistant to help your clients/customers (and maintain business continuity) during your absence from work.

Purchase adequate health cover for yourself & your family and maintain emergency corpus. If possible, build contingency in your business.

2. Personal Accident or Disability Cover

You chose not to take up an offer from an IT company and decided to work as a freelance programmer. You are right handed and happen to fracture your right hand in an accident. How will you type the programming code on your laptop? A fracture may not require any hospitalisation or any major expense but just look at how it compromises your ability to earn. Same applies to a freelance blogger. Had you picked up a job offer, you would have continued getting salary during this period. If you are a programmer or a blogger, you may still be able to manage with your other hand? What about a surgeon? If you are a surgeon, how will you conduct surgeries with a broken hand?

An injury will affect your earning ability depending upon the nature of your employment. You need to assess the impact on your work and purchase adequate personal accident cover accordingly.

3. Life Insurance

Life insurance requirement for self-employed is not too different from salaried professionals. Calculate your life insurance requirement and purchase adequate term life cover. Do not forget to include the business loans/liabilities while calculating your life insurance requirementDo consider purchasing life insurance under Married Woman’s Property Act, 1974. If you purchase life insurance under the said Act, the maturity/death proceeds from such policy will be beyond the reach of your creditors. Do note there are a few caveats.

4. Professional Indemnity Insurance

This may not apply to everyone. However, if you are providing service under a contract, which may require you to indemnify the other party under certain circumstances, you may consider purchasing professional indemnity insurance. Sometimes, you may be dragged to courts even in absence of contracts. For instance, disgruntled family of a patient may seek compensation from a doctor. You may consider financial protection from such events by purchasing a professional indemnity cover.

Investments

A salaried individual has a much better clarity about cash flows. Hence, it is easier to automate investments. As a self-employed, you may not have such predictability of cash flows. 

For instance, your earnings range between Rs 80,000 (in a good month) and Rs 40,000 (in a not so good month). In that case, you may make buffer in the good months and use it in not-so-good months. Alternatively, you can have lower automated investments and invest manually when you have additional money. Let’s say your monthly expenses are Rs 30,000 per month.

Under Approach 1, you will start SIP (or recurring deposit or any other automatic investment) for, say, Rs 20,000.  Under the month where you make Rs 70,000, you will invest Rs 20,000 and remaining Rs 20,000 will go to a buffer (savings account).  In the next month when you make Rs 40,000 only, you can draw from the corpus to bridge the gap (Rs 10,000 = Rs 30,000 + Rs 20,000 – Rs 40,000).

Under Approach 2, your automatic investment will be Rs 10,000 only. In the month when you make Rs 40,000, you won’t make any additional investment. In the month when you make Rs 70,000, you can make additional investment of Rs 20,000 manually (in addition to SIP of Rs 10,000).

Since the cash flows are unpredictable, you may consider repaying loans aggressively (when you have excess cash).

Here are a few more investment tips you must keep in mind. By the way, these tips will apply to salaried individuals too.

  1. Start investing early. Let the power of compounding work in your favour.
  2. Do not mix insurance and investments
  3. Spend what is left after investing (and not the other way round).
  4. Avoid excessive debt.
  5. Diversify your assets. Focus on asset allocation
  6. Focus on goal based investing. Equity heavy portfolio for long term goals and debt heavy portfolio for short term goals.
  7. Review and rebalance your portfolio at regular intervals.
  8. Do not chase quick money through speculative investments. Do not act on stock tips.

Planning for Retirement

There is no such thing as compulsory retirement. Nobody will force you to retire at 58 or 60. You may continue working as long as your mind and body permits. If you are a doctor or a chartered accountant or own a shop, it may not be that difficult to continue working into your late 60s or early 70s. Who knows, perhaps even longer? 

However, it is not as if you can continue to work as long as you want. Depends on your profession too. It may not be possible for a physical trainer or a yoga instructor to impart training all day long. Though you may not have to entirely quit working, you may have to cut down on your working hours, may be as early as early 50s.

You must assess how long you can continue or how age will affect your ability to work. You know yourself and your profession the best. You may even think about acquiring additional/alternate skills to keep yourself relevant and work longer, if required.

There is no mandatory contribution to EPF. Through EPF, many of us build a small portion of our retirement corpus without even realising it. No such luxury for self-employed. Hence, you need to be proactive with your investments while planning for your retirement. There are many retirement calculators around on the internet. However, output of every calculator depends on the inputs you provide. Make an honest assessment about your retirement age and ability to work as you grow older.