The four bank accounts every freelancer needs

I usually like to keep things simple, whether it’s in financial planning, my business, or life in general. I’m not an engineer, but I do know that the more moving parts a system has, the more chances there are for something to go haywire.

That’s why it might seem odd that I’m recommending this. Four bank accounts for one person sounds excessive, right? But the fact is that each one plays a distinct role in making your overall financial life simpler and less stressful. With a minimum of extra effort, you can establish these bank accounts, link them together, and get them integrated in your business and personal life in no time.

#1: Business account

This is the account into which you will deposit all of your freelance income, and from which you will pay all of your work-related expenses. If you have a business like an LLC this might be an actual business bank account, but if you’re a solo freelancer it could just be a personal checking account that you’ve designated for the purpose. Either way, it is essential that you not mix in any of your personal expenses. Keeping this account for business purposes only will make it far easier to keep bookkeeping records, which will in turn help you with filing taxes and defending IRS audits as well as measuring your own business performance to see where you can improve and set goals for the future.

#2: Income tax account

Have you ever found yourself owing taxes at quarter end or year end that you didn’t have the cash to pay for? As someone who has experienced this before, I know that once you get behind on paying taxes it’s extremely difficult to catch up. The simplest way to to avoid this scenario is to do what traditional employers do and withhold your taxes from every paycheck. Instead of going to the IRS right away, those tax witholdings will go into the checking account that you’ve set up for this purpose until it’s time to make your tax payment.

It can be tricky to know how much to withhold from every check to cover your taxes. One simple way is to look at your tax return from last year and divide the total taxes you owed (line 63 on page 2 of the 1040 form) by your gross receipts (line 1 of Schedule C). Then do the same thing with your state tax return. Add the two percentages together and the result will be the portion of each paycheck that you’ll send to your tax account as it comes in. For a more precise measure, talk to a tax accountant who can help you work through the numbers.

#3: Emergency savings account

This is a must for pretty much anyone, freelancer or not. Unexpected expenses pop up, and most people don’t have enough cash available to cover them without putting it on a credit card or borrowing from a family member.

There’s no precise way to calculate how much you should save for these emergency expenses, since by their very nature they’re unpredictable. It’s more a measurement of gut feel: how comfortable are you with the cash you have available, given what can go wrong?

Your own life situation determines what you need to prepare for. People who own houses and cars will need to pay for repairs for those things from time to time; it’s almost a guarantee that there will be an expense in the thousands of dollars every couple of years. Computers and phones need replacing. Health issues pop up. You need to decide how much risk you’re willing and able to take, and what your options will be when the unexpected happens.

#4: Personal checking account

I saved this one for last because it’s the account that everyone already has, but there’s still a trick to this one for freelancers. Since you’re using your business account for business purposes only, you’ll need to transfer money over at some point to cover your personal expenses. How do you decide what to keep in the business to cover your expenses and reinvest, and what to transfer to yourself? Do you transfer money as needed, or right when it comes in?

I recommend that you pay yourself a salary. Figure out how much you need to cover your personal expenses, how much you need to cover your business expenses (not forgetting to account for taxes), and pick a number that lets you do both. Around the margins you can decide how much you want to contribute to your savings. But start by setting up a regular automatic transfer – monthly or semimonthly usually works best – from your business to your personal account, and build your budget on both the business side and the personal side around that number. If you have cyclical or unpredictable income, this will keep you from spending too much during the busy months so there is enough leftover to get you through the slow months (more on this in an upcoming post).

Once you have these four bank accounts going, you might want to add even more accounts to save up for other goals like buying a house or going on vacation. Thankfully it’s easy these days to set up and fund new accounts and transfer money back and forth easily and instantly.

So go and find a bank that you like – I don’t care which one; I promise you nobody is paying me to write this – and set up these four accounts. For the small extra effort involved, the clarity and simplicity it will bring to your life is priceless.