A common financial challenge many self-employed individuals contend with annually each spring is the struggle to come up with enough cash to close out the previous year’s taxes, fund their retirement contribution for the prior year, and begin making estimated tax payments for the current year. This all to frequent scenario includes writing checks to pay any federal and state taxes owed for the prior year, making quarter 1 estimated tax payments for the current year to the IRS and the state, as well as funding their self-employed retirement plan (SEP-IRA or solo 401k) – all due by April 15. And it’s also not uncommon for many self-employed individuals to go on extension, allowing them to fund their retirement plans as late as the extension the filing due date in October, essentially buying time to get everything paid and completed. Budgeting and making payments for estimated taxes on a monthly schedule would ease the quarterly and annual cash flow crunch. While funding your retirement plan contributions monthly as well, would allow self-employed taxpayers to take advantage of the benefits of investing in their retirement plan earlier in the year while also seeing a financial benefit resulting from “dollar cost averaging”.
Instead of making your estimated tax payments quarterly, consider making your estimated tax payments monthly by going on-line to the IRS website to make the payment via EFT from your bank account using the IRS Direct Pay option at https://www.irs.gov/payments/direct-pay. And if you find your income is significantly higher than normal for a month, then you can easily increase the estimated tax payment being made for that month to correlate with the increased earnings for that month. And vice versa for a down month. States offer this same on-line payment option too.
And by funding your retirement plan contributions on a monthly basis, you can better manage your monthly cashflow – making it less financially “painful” than needing to write a large check on April 15th to fund your entire retirement plan contribution for the prior year in full at that time. And because you have until April 15th to fund your prior year retirement in full, when funding occurs periodically throughout the year, you can still fund any smaller remaining amount to your SEP-IRA or solo 401k by April 15th once the max amount is determined when meeting with your tax preparer to prepare your previous year tax return forms. Additionally, as noted above, funding the plan regularly throughout the year via dollar cost averaging, taxpayers will realize the following investment-wise benefits:
- Being disciplined to budget and manage cash flow more efficiently.
- Reducing investment risk from large market swings and poor market timing
- The opportunity of buying more shares of an investment at a lower price vs waiting until the following April when the per share market price of an investment may have increased from earlier in the year.
- Being set up to make automatic monthly transfers from your bank account, and having one less item to think about