Monday, April 9, 2012

Contingency fund: A must for the self-employed

We encounter many people who think financial planning is only for salaried people and not for businessmen and self-employed professionals. But nothing could be further to the truth than that. Financial planning is a must for everyone, including the self-employed. Financial planning is not a one-size-fit-all service, but rather the advice changes from person to person. Self-employed professionals and businessmen should keep in mind the following points:

Contingency fund is a must: Though a contingency is a must for everyone, it is even more important for the self-employed because unlike salaried people, they may not have a constant monthly inflow in the form of a salary. They may have a huge cash inflow whenever there is a major sale or deal cracked as in the case of real estate agents, chartered accountants, to name a few. But, sadly, fixed monthly expenses don’t wait accordingly. So, to take care of these, it is essential that you keep atleast six month’s expenses and EMI payments as reserve in liquid instruments to utilise in case of such contingencies.

Insurance: When we talk about insurance, we are not just talking about life insurance, but also general. If you have financial dependents, you may need life insurance. However, as a self-employed, it is general insurance, which is mandatory. A mediclaim and critical illness policy is essential as falling ill does not only have medical cost attached to it for you, but also cost of business lost due to ill health.

A personal accident policy too, is a must if your work involves a lot of travelling and physical strain. This works as income replacement insuranceincase of temporary injury and a lumpsum payment incase of permanent disablement.

Disguised retirement: Disguised retirement is what I call the retirement of businessmen and self-employed. Usually, they think retirement planning is not something they need. They say they will work till they can, as they have no stipulated retirement age as salaried employees. That all is true, but the fact is, that they too face a form of retirement.

A man of 70 years will not have the same energy and enthusiasm to get more and more clients like a 30 year old. So, though you are going to work, work is not paying the same as earlier.

The solution to this is to plan your retirement as if you are not going to have any income past a certain age. This will ensure that you have funds to take care of you if your business is not paying you as well as when you were younger.

Investments: Investments need to be made for achievement of goals as well as wealth creation. But, whereas, the SIP mode is the best method for most, many self-employed persons find it difficult to set aside a certain amount every month. This is especially true for professionals who get lumpsum payments few times a year.

In that case, the best way to proceed is to commit a certain part of your lumpsum cash inflow to invest.

Tax planning is your trump card: It is here where self-employed professionals have a certain edge over salaried employees. A salaried employee first pays tax on his income and then can spend the rest. A businessman can first spend from his income and then pay tax on what is left. This is something which can be used as well as abused by some people.

The ethical thing to do is ensure you show all expenses and income related to your business and draws your books of accounts. Self-employed professionals and sole proprietors come under slab rate category of Income Tax Act. So, unlike a company or partnership, which has to pay tax @30 per cent of profits, you need to pay as per your slabs.

Sharing important financial information with your spouse: It is essential that you inform your life partner about your work and financial details. Also, it is essential to update nominations and make a will for smooth transition.

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