For the 4.4million people in the UK who are self-employed, everything to do with finance is just a little bit harder. I know this because I recently joined their ranks, leaving my full-time job at a newspaper to dive into the world of freelancing.
And while I love the flexibility and variety of my new working life – which also means spending more time with my dog, Daphne – I am all too aware of the many financial luxuries I have given up by coming off the payroll.
So long steady income, goodbye employer pension contributions, and toodle-pip to someone else working out my tax affairs – suddenly, I’m on my own. Here’s what I’ve learned about getting your finances in shape and how to avoid expensive mistakes.
Keep the paycheques rolling in
Most workers base their financial life around payday: the salary comes in and the bills go out. But self-employed income is best described as ‘lumpy’. Payments may take weeks to arrive, and do so in dribs and drabs, and that makes budgeting harder. That’s difficult when you have regularly monthly outgoings.
To tackle this, I replicate the effect of having a salary.
The best first step is to set up a new bank account, where all work payments and expenses can be directed. Separating business and personal monies makes it easier to keep track of everything than trying to spot an invoice payment on your bank statement among the food shop and dozens of other everyday outgoings.
I take my business expenses, such as travel and phone costs, from this account.
Then, at the same time each month I transfer a regular sum into my usual current account. This allows me to plan my outgoings, cover my living expenses and know that any personal direct debits – Netflix and the car insurance, for example – will be paid.
Holly Mead (pictured) says the first step is to separate business and personal monies, by setting up a new bank account just for your work
‘A good tactic is to keep your tax money in a separate account so you don’t start to think of it as your own,’ says Holly
I also move some money to a savings account, and some into a separate account towards my tax bill.
Expect to dip into your savings while you’re starting up, though – those first payments can take a while to come through.
I’ve opted for a bank account with Monzo. It’s an online bank highly rated for its easy-to-use app and fee-free overseas spending. It also allows you to divvy up your money into different pots, which helps me to budget. When I transfer money into my account, I have set it to automatically split it into pots, for example, for household bills and saving towards my tax bill.
Tax
Gone are the days when the payroll department would sort my taxes. It’s time to get the calculator out.
My first tax bill isn’t due until January 2027, which sounds like a great thing but actually makes it easy to overspend and leave yourself short.
A good tactic is to keep your tax money in a separate account so you don’t start to think of it as your own. You could opt for a high interest savings account to earn a bit more in the meantime, but I prefer Premium Bonds, where the money can be easily accessed and there’s always the chance I could win a £1million jackpot. You can buy these with a minimum of £25.
How much should you set aside for tax? Nimesh Shah, from the accountancy Blick Rothenberg, says: ‘At least 30 per cent of your earnings, and ideally do some proper maths and calculate how much you need to account for tax.’
‘You may need to pay advance payments on account for the following tax year, so your first tax bill could be painful,’ he adds.
The usual tax deadline is January 31, but a so-called payment on account is also due by July 31. This is designed to spread the cost of your tax bill, so you don’t have to pay the whole sum at once.
But a quirk in the system means you’ll likely fork out more in your first year of trading. When paying that first January tax bill, you will also need to front up 50 pc of next year’s expected tax bill to cover the next six months.
The July instalment – the payment on account – is effectively an advance payment of tax, based on what you expect to earn. This is usually based on whatever you earned in the previous tax year, but can be adjusted if you expect your income to be higher or lower. If you end up overpaying, it is possible to claim a tax refund by contacting HMRC.
Holly opted for a bank account with Monzo – an online bank highly rated for its easy-to-use app and fee-free overseas spending
A payment on account spreads the cost of your tax bill to make it easier to manage, but it also means you pay some in advance based on what you expect to earn, which may be problematic if your work is seasonal or an expected contract falls through.
Do bear in mind that all of this is quite different if you have set up a company, rather than registered as a sole trader. For example, with a company you will need to pay corporation tax, which is currently 25pc on the business’s profits, and file accounts each year.
Think carefully about the structure you choose, Mr Shah warns: a company may suit those with plans of world domination but it comes with extra admin, costs and tax headaches so is best avoided if your work is relatively simple.
The government website is a good resource for those who are undecided: https://www.gov.uk/set-up-business
Staircase your savings
When your income is unpredictable, having a safety net is even more important. Pete Chadborn, director at the advice firm Plan Money, says: ‘Your revenue stream can feel like feast or famine, so get some cash reserves behind you and keep them there.’
Experts typically recommend having three to six months’ of outgoings in an easy-access account in case of an emergency, but for self-employed workers Mr Chadborn suggests six to 12 months’ as a minimum.
I adopt what’s known as a ‘staircasing savings strategy’, where I split my money, leaving some in an easy-access account and tie up other chunks for longer periods to secure a higher interest rate.
Top easy-access options include the online bank Chip, which pays 4.56 per cent, and Kent Reliance, which pays 4.41 per cent, both with no restrictions on withdrawals. Cynergy Bank pays 4.5 per cent on a one-year fixed savings bond; you can get 4.42 per cent from JN Bank and Secure Trust Bank on a two-year bond, and up to 4.47 per cent if you are able to tie your money up for five years.
Get government cash for your retirement
It’s much harder to save for retirement when you are going it alone; those employer pension contributions really do make all the difference.
Just 21 per cent of self-employed workers are on track for a moderate retirement income, compared to 43 per cent of employed workers, according to research by investment platform Hargreaves Lansdown. Meanwhile, 23 per cent of self-employed workers are not saving anything at all for retirement, Scottish Widows found.
‘While I love the flexibility and variety of my new working life – which also means spending more time with my dog, Daphne (pictured) – I am aware of the financial luxuries I have given up by coming off the payroll,’ says Holly
I’ve been saving into a pension for almost 15 years and have been diligent about consolidating whenever I change job, so everything is in one place. But my last workplace pension scheme was expensive, with annual charges of about 1.7 per cent, so my first step is to move my pot to a cheaper provider.
Doing so can make a huge difference over the long-term. If you saved £200 a month for 40 years, with investment growth of 5 per cent a year, you’d end up with about £164,500 after fees of 1.7 per cent. If your fees were halved to 0.85 per cent you’d have £222,800.
I’m confident I can get mine even lower. Vanguard, the US investment giant, charges a 0.15 per cent platform fee plus investment charges of 0.22 per cent for its Lifestrategy range of readymade funds.
But you might be surprised to learn that I don’t plan to make any more contributions for a while. Instead, I have opened a Lifetime Isa.
Anyone aged 18 to 39 can open these accounts and pay in up to £4,000 a year, and all the gains are tax-free – though you do pay a penalty if you access the money before age 60, unless it’s to buy your first home.
Best of all, the government pays a 25 per cent bonus on your contribution. This effectively replicates basic rate pension tax relief or you might, like me, prefer to think of it as a generous substitute for an employer pension contribution.
You can keep contributing to a Lisa until age 50. If I subscribe the maximum for 12 years, I’ll save £48,000 and receive £12,000 in bonuses – a total of £60,000. Annual investment growth of 5 per cent could boost that to almost £90,000.
I’ll aim to start up pension contributions again in the future, but for now this seems like a good middle ground in case I need to access my money.
Get your own sick pay policy
Being self-employed leaves you vulnerable. As an employee, my company provided private medical insurance, sick pay, maternity pay, and a lump-sum to my loved ones if I died. These days I have no such protection.
Only 13 per cent of self-employed workers have redundancy cover, compared to 71 per cent of employees, according to Hargreaves Lansdown. And 33 per cent have sickness cover, compared to 95 per cent of employees.
Mr Chadborn says: ‘If illness or injury prevents you from working, then you are not earning. And forget state benefits; they are not easy to claim, not quick to obtain, and will certainly not maintain a standard of living you’d consider adequate.’
But replacing all of this cover is pricey, so you need to be realistic about what is most likely to be useful. Mr Chadborn suggests that Income Protection could be the best option for those who can’t afford multiple policies. This effectively replaces sick pay if you become too ill to work.
A typical policy could cost about £20 a month but it depends on various factors such as your age, occupation and the level of income you want to cover, and how long you want it to pay out.
A policy for a 40-year-old non-smoker, which would pay out £2,000 a month for up to a year, starting 60 days after they were first unable to work, would start from £15 a month, according to the comparison site Compare The Market. The actual cost will depend on various factors such as your age, occupation and the level of income you want to cover, and how long you want it to pay out.
It’s tempting to think, ‘it won’t happen to me’ and let this one fall down the to-do list, but I’m determined to make it a priority.
Get a mortgage broker with freelancer expertise
Securing a mortgage can be much harder when self-employed because banks like to see a steady income when they are accessing an application.
According to research by The Mortgage Lender, some 57 per cent of freelancers say their employment status has negatively affected their ambitions to buy a property.
Happily, I am already on the property ladder, but I’m aware there may be extra hoops to jump through when it is time to remortgage next.
To me, it makes sense to use an independent mortgage broker because they can scour the entire market for deals, and will know which lenders are more amenable to self-employed workers. They can also make suggestions to help your chance of being accepted.
For example, lenders normally want to see at least two years’ worth of accounts, but some may accept proof of future work such as signed contracts or purchase orders. Having a second person on your application helps. If your spouse is employed, it may make sense for them to be the lead applicant on the mortgage as they can prove a steady income, even if it is less than your own.