Financial Planning Tips for Self-Employed

Being self-employed gives you much flexibility. You can choose to work on what you are passionate about. You don’t have to deal with a difficult boss. In many cases, you can even choose your working hours.

Sounds rosy?

Well, there are many drawbacks too. There is no salary at the end of the month. The cash flows can be erratic.  There is no mandatory EPF deduction. An illness or an injury affects you more than a salaried professional. And you may still have to deal with a difficult client/customer. For self-employed, No Work may mean No Pay. For instance, if a doctor does not see her patients for any reason, she will not earn anything.

Who is Self-employed?

Merriam Webster defines self employed as some who earns income directly from own business or profession rather than by working for someone else.

You meet so many of them during your daily lives. Local doctors/dentists, shopkeepers, Chartered Accountants, insurance agents, mutual funds distributors, trainers etc are all self-employed.

Is financial planning any different for self-employed?

Though many of the financial planning aspects would remain same for salaried employees and self-employed, there are still a few adjustments that you need to make if you are self-employed.

Let’s look at a few of these aspects.

1. Purchase life insurance under Married Women’s Property Act

That you need to purchase life cover does not require much convincing.

But your profession may require you to take loans from banks or other creditors. In event of your demise before paying off such loans, your creditors may lay hands on your life insurance proceeds.  So, you may have purchased life cover to take care of your family. However, your business creditors will lay claim over the money to settle their dues.

In such cases, it may make sense to purchase the life insurance cover under Married Women’s Property Act, 1974. If you purchase life cover under MWP Act, creditors won’t be able access your life insurance proceeds. The proceeds from such life plans will go only to your family.

There is a caveat though. If the life insurance plan has been purchased with the intention to defraud creditors, then creditors can challenge such policy.

Another point to note is that you must also include your business liabilities while calculating your life insurance requirement.

Must Read: Purchasing life cover under Married Women’s Property Act

Tip (My opinion): Purchase term life cover under Married Women’s Property Act. You can invest in ULIPs or traditional life insurance plans too under MWP Act. However, the creditors can accuse you of diverting money to invest in your insurance plans for family and take the matter the court. However, in case of term plans, it will be difficult for your creditors to make such allegations. They can still take the matter to court but their case will be quite weak.

By the way, even salaried professionals can purchase life insurance plans to tide over succession issues.

2. Purchase adequate health cover

For self-employed persons, a prolonged hospitalization can be a double whammy.

Not only do you have to spend for the treatment, you also lose out on the income during the hospitalization period (if you were to get hospitalized and not a family member).

You do not have employer provided group health cover to take care of your medical expenses.

Therefore, health insurance is a must for self-employed. By purchasing adequate health cover, you can at least ensure that expensive hospitalization can be taken care of.

3. Have adequate emergency corpus and medical fund

An adequate heavy cover will take care of hospitalization expenses.

But, will you be able to earn any income during hospitalization and recovery period?

If you are an employee, you can take medical leave and continue getting salary while you recover from illness. However, in case of self-employed, there may be a complete loss of income during recovery period.

You need an emergency corpus to make up for the loss of income. Build up 6-8 months of monthly expenses in emergency corpus.  Do not just consider your household expenses. Consider your business expenses too such as office rent, license fee etc.

Additionally, have a medical emergency fund to take care of expenses that wouldn’t otherwise be covered by medical insurance.

4. Purchase personal accident cover or disability cover

If you are working as a freelance programmer, fracture in both the hands will compromise your ability to work completely. There will no income during the recovery period.

In my opinion, you must have adequate emergency corpus to tide over such short term loss of income.  However, in case partial or permanent disability, your earning ability may be compromised for medium/long term or may be even permanently. Emergency corpus will simply not be enough.

A personal accident cover will be useful in such cases. A personal accident cover typically comes with many conditions but that is the best you can do.

You must assess how an accidental injury/disability is likely to compromise your earning ability (and the impact) and purchase a cover accordingly.

Read: Should you purchase a Personal Accident Cover?

Personal accident covers come in multiple variants i.e. the coverage under different plans may vary significantly. Do understand coverage properly before purchasing a plan.

5. Build contingency in your business

Another way to tide around break in work due to illness or injury is to build up a small team or hire an assistant who can continue the work in your absence. The team can continue relationship with your existing clients or even new clients while you are unable to work.

This may not be possible for everyone. It also depends on the nature of your profession. However, do consider this option.

6. Purchase professional indemnity cover

This may not be applicable to all of you. However, if you envisage a scenario where your customer can file a law suit against you claiming damages, it is better to purchase a professional indemnity cover.

Such cover will indemnify you against any liability due to advice offered or service rendered.

For instance, if you run a nursing home, something or the other may inevitably happen where a disgruntled patient or patient’s family will drag you to court and seek damages. A consultant may get into trouble because of misplaced data of client, copyright violation etc.

A professional indemnity cover may turn out to be extremely useful in such cases.

You can go through this post on SecureNow Insurance Brokers website for more on Professional Indemnity Insurance.

7. Retirement Planning

One good part about being self-employed is that is no forced retirement. Hence, nobody can force you to retire at say 58 or 60.  You can continue as long as your health and desire permits.

The flip side is that the nature of your profession (or the regulations or industry level changes) may make you obsolete at a much yourself age. You must keep yourself relevant.

For instance, if everyone starts purchasing insurance online, insurance agents will be left without work or at least their business will witness an adverse impact.

A physician may keep working even till the age of 70 or even more while a surgeon may find it difficult to perform surgeries even after age of 65. However, the surgeon may subsequently stop performing surgeries and start seeing patients on out-patient (OPD) basis.

A trainer may find it difficult to stand and deliver day-long sessions once he breaches say 55 (or 60).

You know your profession better. You must do what is needed to keep yourself relevant. You must plan in advance. Develop alternate skills so that you can continue to work longer if required.

For instance, a trainer may build shorter training modules which he can continue even as he grows old.

8. Investments

When it comes to investments, there is not much to differentiate between a salaried professional and a self-employed person. However, a self-employed may face an issue with systematic investments. Your cash flows may be erratic.

Hence, putting everything in automatic mode may not work as well.

You may be able to save Rs 50,000 in a good month and Rs 20,000 in a not-so-good month.

You can take two approaches.

Under Approach 1, set up your SIP (or automated investments) for only Rs 20,000. Make lump sum investments as and when you make more money. Hence, in a month when you can save only Rs 20,000, there will be no additional investment. In other months, when you are able to save more (say Rs 50,000), invest an additional Rs 30,000 lump sum.

Under Approach 2, settle for middle ground i.e. start SIP (or automated investments) for Rs 35,000. Keep a small investment corpus. Contribute to it when you make more money. When you make less, draw from the corpus to bridge the deficit. So, when you save Rs 50,000 in a month, you put the excess Rs 15,000 in a separate corpus (bank account or liquid fund). When you make less, draw from the corpus to bridge the deficit.

Salaried professionals make a few investments such as EPF without even realizing.  Their employer also contributes to their EPF corpus. Self-employed do not have the comfort of EPF or defined benefit pension schemes. If you are self-employed, you need to be more proactive with your investments.

9. Other financial planning tips

Almost all these tips will apply to salaried professionals too.

1. Start investing early. Get the power of compounding behind you.
2. Spend what is left after investing (and not the other way round)
3. Get adequate life, health and accident cover.
4. Have decent emergency fund and medical emergency corpus.
5. Do not chase returns. Chase your financial goals. Asset allocation must be on the basis of your financial goals.
6. Select equity heavy portfolio for long term goals and debt heavy portfolio for short term goals.
7. Diversify your asset base. It is easy to get overexcited during bull runs and deeply frustrated during bear phases. No matter what happens, always diversify your asset base.
8. Focus on asset allocation (break up of your assets among different asset classes)
9. Review and rebalance your portfolio at regular intervals.
10. Do not mix investment and insurance. Purchase a pure term life cover.