Being self-employed (or freelancer) has a number of advantages, like being your own boss, setting your own schedule and accepting the projects of your choice, but it also means having an irregular cash flow. It takes discipline to make deductions from your own income. Here are our tips on estimating how much to set aside when you are self-employed.
Making a budget is a pretty good place to start. Why? Because it will give you a better picture of your income and expenses and be a good foundation for allocating your income between obligations and savings. Creating a budget isn’t complicated; you just have to take the time to do it.
It’s critical to separate your personal finances from your work finances, so you can differentiate between what can or can’t be included as a deductible expense for your work.
It’s a good idea to open a bank account and get a credit card just for your work, to be used exclusively for business purposes.
For source deductions, a self-employed worker has the obligations of both an employee and an employer. When a client pays you, the amount you receive is like a gross salary. No taxes have been withheld, but you will have to pay income tax on the amount, and it is important to anticipate how much. You’ll also need to consider source deductions, such as employment insurance, the Quebec Pension Plan in Quebec, and the Canada Pension Plan in the rest of Canada. Good tax planning at the outset will help you avoid headaches and know exactly how much money you have available for your personal finances. The good news is that you can pay less income tax by deducting your business expenses. Let’s take a closer look.
Tax planning means determining how much you will have to pay in federal and provincial taxes with the help of a financial professional, such as an accountant or a tax specialist. Since every worker earns a different income, the tax payable varies from person to person. However, tax schedules are the same for employees and self-employed workers. Those schedules will help you estimate your taxes.
Instead of paying in one lump sum at the end of the year, you can pay your income taxes in instalments to the Government of Canada or your provincial government, depending on where you live. These payments are made every three months. In some cases, advance payments are mandatory. How do you know? It depends on your province of residence and the amount of net tax you owe.
When you pay in instalments, you will avoid spending money that does
not belong to you and you will spread your tax liability over the
As a general rule, if you are a self-employed worker earning $30,000 or less for four consecutive months and you are not registered for GST/HST, you should not have to collect and remit taxes to the government.
If you earn, or expect to earn, more than $30,000, you may have to
pay taxes back to the government on your income. The taxes payable
vary depending on the place of supply, that is, where you offer your
goods or services, and the types of goods or services you provide.
Your goods or services may be taxable, zero-rated or exempt. It is
therefore advisable to find out which category you fall into. Whatever
taxes you have to pay, you must pay them annually, quarterly or
The good news is that if you have to charge taxes on your goods or
services, you may be able to take advantage of an input credit on
certain eligible taxes paid on your expenses. It might be a good idea
to take the taxes you have charged, deduct the taxes you have paid on
some of your expenses and set aside the difference. That way, you’ll
be ready to pay the government when you need to.
In Quebec, there is also a quick calculation method on the Revenu Québec website for small businesses, such as self-employed workers. Find out what option is best for you.
Since you do not have source deductions, you have to contribute to government social programs. If you are self-employed in Quebec, you will have to contribute to the Quebec Pension Plan (QPP) and the Quebec Parental Insurance Plan (QPIP). If you live elsewhere in Canada, you will have to contribute to the Canada Pension Plan (CPP) and parental benefits. Note that some contributions are higher for self-employed workers than for salaried employees because you will have to pay the employee and employer portions.
How do you pay less tax as a self-employed worker? That’s something everyone wants to know. The first thing to do is deduct your business expenses. Any work-related expense is likely to be partially or fully deductible. Be sure to keep your receipts.
Eligible expenses include those for:
You can only claim expenses for a home office if it is your primary place of business and you see clients there. In addition, certain expenses are limited. Find out more.
Good to know: It is tempting to deduct as many expenses as possible to reduce your taxable income and pay as little tax as possible. But the more you reduce your taxable income, the less RRSP contribution room you’ll have. Since you can contribute up to 18% of your previous year’s income to an RRSP, the less you earn, the less you can contribute. Also, the lower your income, the harder it will be to convince financial institutions of your ability to borrow (and pay off a loan), such as for buying a house.
In addition to putting money aside for your tax obligations, you need to save for short-term contingencies, plan for retirement in the long term and have cash flow. Let’s look at how.
Building an emergency fund for the unexpected
Try setting aside 6 months of living expenses in an easily accessible emergency fund, such as a high-interest savings account or TFSA. This will give you a little cushion for unexpected expenses or slower times. You’ll have access to the money right away, and you won’t have to borrow. When you’re self-employed, you don’t always know when the money will come. And not all self-employed workers are entitled to employment insurance.
Working capital is used to quickly pay your bills when they come due while protecting you from a cash crunch. It’s a good idea to put 2 to 4 weeks’ worth of expenses into an easily accessible account, such as your business chequing account.
Retirement may be a long way off, but you should still prepare for it as soon as possible. Why? Because you won’t have a pension plan from an employer, unlike many salaried workers. The responsibility for putting aside the money you need for a comfortable retirement and financial freedom is entirely in your hands. It would be very wise to call on a financial planner to guide and assist you in securing your future.
You can make the maximum contributions to your RRSPs and
TFSAs to save for your retirement. Contributions to your RRSP will
also lower your taxable income so you owe less tax.
Your RRSPs and TFSAs are not your only options. You can invest in
other types of non-registered investment accounts or, if you have
children, you can contribute to an RESP for their
education. Your strategy will depend on your personal situation
If you have debt, you could prioritize paying it down. If you have high-interest debt
that is not tax deductible, you may want to pay it off first.
Saving money is critical for both unexpected events and for your
retirement or other plans. To make sure you save regularly, take
advantage of systematic savings. You will put money aside
without even having to think about it.
Every self-employed worker is different. When you work for yourself,
it’s important to get good advice and information. Call on an
accountant and a financial planner to help manage your finances and
find out how much money you should set aside. We’re here to answer
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