Personal Finance Planning Using W-2 and 1099
Budgeting becomes infinitely more complicated when W-2s and 1099s become involved.
Millions of Americans are bringing home multiple streams of income. A steady paycheck. A side gig. Weekend freelance jobs… It’s all funneled together. And it all needs to be invested wisely.
Here’s the problem:
Most individuals handle W-2 and 1099 income as if it was the same. Big mistake. These forms function differently and affect your personal finance differently.
Time to dig in…
Here’s the game plan:
- Why W-2 And 1099 Forms Matter For Your Finances
- The Big Differences You Need To Know
- Personal Finance Planning Steps
- Common Mistakes To Avoid
Why W-2 And 1099 Forms Matter For Your Finances
W-2 and 1099 forms aren’t just tax paperwork.
They impact every aspect of your financial plan. Whether it’s budgeting, saving or retirement, these documents dictate (to you and the IRS) how income is being generated.
Millions of people work in the gig economy these days. In fact, 70.4 million Americans freelance right now which is about 36% of the workforce. That’s a lot of people receiving 10 Ninety Nines.
If you are one of those employees, or someone who gets W-2 AND 1099 earnings, implementing a streamlined 1099 filing workflow is key to keeping your W-2’s and 1099’s organized. Trying to plan your personal finances without it is unnecessarily difficult.
Here’s why:
- W-2 income has taxes taken out automatically
- 1099 income does NOT have taxes taken out
- Both types of income affect your total tax bill differently
- Both types of income change how much you can save
Pretty different, right?
The Big Differences You Need To Know
Here’s the breakdown…
W-2 employees receive a generous, tax-free paycheck. The employer takes care of taxes, social security, medicare and usually benefits such as health insurance and retirement plans.
1099 workers? They’re on their own.
That means:
- You pay your own taxes: Someone is NOT withholding taxes from your paycheck. You pay THEM.
- You pay self employment tax: This is in addition to income tax and is 15.3%.
- You pay for your own benefits: There is no health insurance. There is no 401(k) match. There is no paid time off.
Sounds harsh, doesn’t it?
The good news is… 1099 workers can write-off masses of business expenses W-2 employees can’t. Home office, mileage, equipment, software licenses… It can all help to greatly reduce your taxable income.
And here’s another perk:
1099 workers have the ability to set their own hours, pick their own clients, and make far greater incomes than a W-2 employee. Factor in some good deductions, and it’s tax isn’t nearly as painful.
The secret is understanding how to leverage both kinds of income streams. Smart personal finance planning can help you do that.
Personal Finance Planning Steps
Want to learn how to create an actionable plan? Follow these steps for when you get W-2’s and 10-99’s.
Separate Your Income Streams
Never mix W-2 and 1099 money in the same account.
The reason is because when you make money via 1099, approximately 25-30% is owed to the IRS. Putting it all in your checking account leads to you spending money that needs to go towards taxes.
Open a separate bank account for your 1099 earnings. Withdraw money to your personal account after taxes have been deducted.
Set Aside Taxes Immediately
Every time a 1099 check comes in, do this:
- Move 25-30% into a tax savings account
- Move a percentage into an emergency fund
- Keep the rest for regular spending
Developing this single habit will protect you from huge tax bills in April. Just trust the process.
Build A Bigger Emergency Fund
W-2 workers usually get some form of unemployment protection. 1099 workers don’t.
Which means you’ll need a larger emergency fund. Especially since 1 in 5 Americans would be unable to pay for a $500 emergency expense if they arose tomorrow.
Ideally save up 6 months of expenses. If the majority of your income is living off of 1099- then try to save towards 9 or 12 months worth.
Track Every Expense
W-2 workers can pretty much skip expense tracking. 1099 workers absolutely cannot.
Miles driven. Software subscriptions. Coffee meetings with clients… These can all be deductions.
Pull out an app or spreadsheet and record expenses as they occur. Trying to remember during tax season is asking for forgotten deductions and lost money.
Handle Retirement Yourself
No employer 401(k) match means being extra intentional about retirement.
Great options for 1099 workers include:
- SEP IRA: Contribute up to 25% of net earnings
- Solo 401(k): Higher contribution limits than a traditional IRA
- Roth IRA: Tax-free growth on retirement money
Yes W-2 workers should definitely contribute up to the employer match first. It’s free money.
What if you have both W-2 AND 1099 income? THEN it gets even better! You can max out an employer 401(k) AND ALSO contribute to your own SEP IRA OR Solo 401(k). Double the tax shield!
Common Mistakes To Avoid
It’s true – even well informed people get tripped up. Here are some of the most common slip ups:
Mistake #1: Not paying quarterly taxes
The IRS expects you to pay taxes quarterly, not just April 15. Failure to make quarterly payments incurs penalties.
Mistake #2: Mixing personal and business expenses
Don’t mix anything. Charge business expenses on your business card. Charge personal expenses on your personal card. Easy.
Mistake #3: Forgetting about state taxes
Remember that there are also state (and sometimes local) taxes you must pay on W-2 and 1099 earnings.
Mistake #4: Ignoring the paperwork
W-2 and 10-99 forms must be filed properly. If they are not filed in a timely manner penalties will apply.
Mistake #5: Skipping retirement planning
The younger you start, the more compound interest can work for you. Start before age 40.
Bringing It All Together
When it comes to financial planning with both W-2 and 1099 income, it can be complicated. It doesn’t have to be though.
The trick is learning how each type of income works, then creating systems that allow you to effortlessly manage both. Dedicated accounts, automated tax savings, tracking expenses, and a fool proof retirement plan… Simple.
And remember:
- Set aside taxes as soon as 1099 income arrives
- Build a bigger emergency fund
- Track every business expense
- Don’t forget quarterly taxes
- Handle retirement contributions on your own
By following these steps, budgeting and personal finance with your W-2 and 10-99 forms will be a breeze. You will thank yourself later.
