Step-2: Prepare

Let's assume that the previous steps screamed loud and clear that this is the right time for you to start self employment. Next you need to prepare yourself for this big change. A well-planned preparation will help make this transition much smoother.

If you are currently employed then you're probably used to many perks and benefits, such as paid vacation, health insurance, disability insurance, 401K match, job stability etc. (even though I really believe that there is no such things as a "stable job" anymore).

When you are self-employed, you are on your own on these. Here are some ideas and resources to analyze the adjustments you may have to make in your lifestyle and financial aspects.

  • Financial Health

Perform a critical analysis of your financial health. Look at your –
- Assets (Savings, Investments etc.)
- Debts (Mortgage balance, School loans, Car Loans, Credit card balances etc.)
- Income from different sources
- Monthly Living Expenses
Do you feel like you are in a strong financial footing? You should have positive net worth (more assets than liabilities). Look at what expenses are necessary and which ones are discretionary.
You probably already know that everyone should stash away three-months worth of living expenses into an emergency account for unforeseen career gaps, i.e., in case you get laid off, get into an accident or otherwise take time off. My suggestion is if you are self-employed then you should have at least six months to one year worth of living expenses stashed away.
Use your discretion. If you are single and don't have a lot of liabilities then a six month savings should be okay. If you are married and your spouse is employed with a decent income (that can cover the essentials such as mortgage/rent, food etc.) then a six-month savings should suffice. However, if you are the sole bread-winner for your family then you should have enough savings for a year's expense.

I am not suggesting that you won't be unable to find a contract for one year. But even when you are on the bench (without a billable project) for a month or two, you deplete your savings. And as you know, replenishing that lost savings will take you several months. Having a decent savings cushion will allow you keep your moral and confidence high and will enable you to say no to assignments that don't match your criteria.
  • Stability

Like I said before, there is no such thing as a "stable job" anymore. So, I will interpret this as "continuity". You know you will come back to the same job everyday, until you decide to quit.
This doesn't happen when you are self-employed. Companies hire you for a set period of time and/or for a specific project. However, the good thing is that you know what that period is and you can plan for it. Here is how.

  1. Speak with some self-employed folks in your line of work and in the same geographic area, to find out -
    - What are typical contract durations and
    - The average bench period they face (that is the unpaid time between two assignments).
  2. Estimate the total hours you will be billable during the year. Use the following thumb rule -
    - Total work-days per year: 52 x 5 = 260 days
    - Less 10 days of Holidays: 250 days (250 x 8 hrs = 2000 work hours)
    - Less number of sick days
    - Less number of days you will be un-billable
    - Less number of vacation days you would like to take
    This becomes your estimated billable days.
    Tip: A smart move will be to take vacation during the time between assignments. You shouldn't have much problem doing that, because you already know when your current contract ends. All you have to do is plan your vacation immediately after that. When you are looking for your next assignment (towards the end of your current one), you can inform the next customer about your start date which will be right after your vacation.
  3. Use your average billable days and rate to calculate your annual compensation opportunity.
  • Health Insurance

The best option is to be on your spouse's health insurance, i.e., if (s)he works and has an employer provided health insurance. Else, you just have to buy your own self employment health insurance. My recommendation is NOT to go for the COBRA option even if your previous employer offers one. They are usually very expensive. That's because you are now responsible for paying the employer part of the contribution. You are better off buying one yourself.
My COBRA cost came to about $1200 a month for a family of four. I went to eHealthInsurance and bought my own. It cost me about $350 a month. The coverage was not the exact replica; but my total out of pocket medical expenses for the year came about the same. The premium price has gone up since then. But you got the idea.
Most of the insurance providers offer health insurance for the self-employed. To get the special pricing for the self-employed, make sure to chose the individual option when you ask for the quote; not the small business health insurance.

I am a non-partisan; but one thing I like about President Obama's Health Insurance Legislation is that it will hopefully offer better choices on affordable health coverage for self-employed and small-business owners.

  • Disability Benefit
Many of the companies that offer life insurance products also sell disability insurance and other self employment benefit programs. You can find insurance agents who shop for you with several companies and get the best rate for you. My agent Rene helped me find a short-term disability that costs me about $55/month for $4000/month coverage with a 60-day waiting period. I think it is a good deal.
  • Life Insurance
Many employers allow you to carry the group life insurance they offer when you leave the company. You can check with the provider to see how much it will cost you. You can also shop in the market for better rates. Again, as in the disability insurance, you can find an agent who will shop for you and get a suitable quote. Rene found me 20-year term for $500K for a premium of just under $70/month with an AAA rated provider.
  • 401K
Obviously you won't have an employer sponsored 401K plan or employer match to your contribution. However, there are several options for retirement savings that are discussed in Financial Preparation section. The cost varies from zero dollars to a few hundreds a year.
  • Other Perks
Take into consideration any other benefits or perks that your current employer offers; such as contribution to a pension plan, computer to work on, free training, discounts to purchase of products/services through a partner program (home/auto insurance, computers, office supplies etc). You will have to pay for them now.
  • Taxes

Your employer is responsible for withholding your income taxes and depositing them with the IRS. Now that you are paying yourself, you are responsible for that. You are also responsible for paying the self-employment tax, which is about 7.65% of your gross income. You will find more details on this in the Operate section.
Use these numbers to calculate your estimated Self Employment Income. Divide them with your estimated billable hours (or days). That's the minimum rate you need to charge to maintain the current life-style.

Is the market rate more than that? It better be; if not then you should probably think about keeping your job.


Start Self Employment: Plan->Prepare->Launch