The Ultimate Guide to Securing Your Finances if You’re Self-Employed
Self-employment is on the rise once again.
In the UK alone, around 4.4 million adults are classed as self-employed – still considerably lower than the figures at the start of 2020, just as the coronavirus began to disrupt life as we knew it.
There are plenty of benefits to self-employment, and it’s not hard to see the appeal of working for oneself. From higher earning potential to flexible working hours and a better work-life balance – two things that have grown in significance for many people in the wake of the pandemic – the prospect of being your own boss holds plenty of appeal.
But there are of course some downsides too. Around 47% of self-employed women and 37% of self-employed men frequently worry about their financial circumstances. Without the certainty offered by a contract of employment and a monthly (or weekly) salary guaranteed, the pressure is on the individual to ensure that they are working enough to pay the bills and save for the future.
Put simply, there are fewer securities. That’s not to say, however, that self-employed people can’t feel secure in their financial circumstances (and future) – provided they understand the options available, and which solutions are best for them.
Getting the right financial advice is imperative. If you’re self-employed – or even just considering it – then read on for our full guide to financial security below.
What do we mean by financial security?
The phrase ‘financial security’ can mean different things to different people. Ultimately, we are referring to a sense of stability – a peace of mind that can only be experienced when our finances are in order, both for the present and for the future. It’s not just about having enough to pay the bills now and shift a portion into our savings each month – it’s about working to optimize your income so that it makes long- and short-term sense.
It also means addressing the worst-case scenarios, and making sure a failsafe plan is in place in case life suddenly (and unexpectedly) changes.
So, financial security requires a mix of things. It involves protecting and safeguarding your income, investing savings into the right places, planning for the future – not just the best case, but the worst, too – and feeling that, despite the relative unpredictability of self-employment, you’ve secured yourself against the risk of a dip in income.
If you’re a sole trader, then it’s likely that you’re simply working from a single, individual account rather than separating your business finances from your personal finances. There’s nothing inherently wrong with this, but there are some benefits to separating your money between the two accounts.
For one thing, keeping track of incomings and outgoings is much easier if they are separated between what counts as business-related and what counts as personal. When it’s time to calculate tax and national insurance, having those records separate can be a real time-saver, and avoid any inadvertent oversights or mistakes.
That way, you can keep a tab on your income tax without needing to balance those figures in your head each time you look at the balance in your personal account.
With a business account, you can also start paying yourself a salary, rather than all your incomings going straight into your personal account. This is just better organisation, particularly if you need to invest a certain amount into materials, production, or any other costs of the job.
Claiming on expenses
If you’re self-employed, one of the best ways to streamline your finances is to stay up to date on the allowable expenses that can be deducted from your taxable profit. That way, you can offset the tax you pay against your operating costs.
From the cost of office staples, like computer software and printer ink, to the costs of travelling, clothing yourself, and training, plenty of expenses can be detracted from your income.
The more organised you can stay throughout any given tax year, the easier you will find it to reclaim those expenses and reduce the tax you’re required to pay.
The government provides a full list of allowable expenses that self-employed people can deduct from their profit, but it’s always worth talking through the specifics with your financial advisor, who can ensure your finances are as tax-efficient as possible.
As with anything related to our finances, forward planning is the key to feeling secure and happy. The more you can foresee (and address), the better.
Creating a workable budget is important whether you’re a sole trader or a full-time, salaried employee. At its most basic, it’s there to avoid any nasty surprises each month, and to ensure that, whatever you’re earning (and whatever you need to finance), you’re living well within your means. It’s all too easy to overspend, no matter what your financial circumstances are.
A good budget covers all necessities, and, ideally, sets aside a good portion of your incomings to be saved and invested into your future.
If you’re self-employed, it can be a little harder to make (and stick to) a workable budget. If your monthly incomings vary depending on how business is going, then you’ll probably need to return to the drawing board more often than someone on a fixed income. This doesn’t need to represent a drain on your time and energy, and talking things through regularly with your financial planner will mean that you never feel at-sea as your financial circumstances ebb and flow.
As we mentioned above, giving yourself a monthly salary from your business account can be very useful. This figure should be enough to meet all the necessities, and leave you enough to maintain your quality of life. If you happen to have a better-than-average month at work, that extra figure can be poured into your savings and investments.
Budgeting begins with the basics: bills, rent or mortgage payments, groceries, and car payments. After that, being able to set aside a strong percentage of your income – ideally, around 20% – to boost the contingency fund, and bolster any savings.
Any good budget has a certain amount of flexibility factored into it. Life is full of unpredictable (and, at times, costly) U-turns, and the most secure finances are those that are ready to cope with a certain amount of sway. Self-employment demands a little more flexibility, but, with the right approach, this doesn’t need to feel like a burden.
Planning for the distant future is just as important as planning for the next few weeks. One of the (potential) downsides to self-employment is the fact that you don’t have an employer making regular contributions to your pension pot – but, so long as you start mitigating this early in your career, it needn’t be a problem. The trouble is, the majority of self-employed people aren’t making contributions to their pensions and retirement plans.
In fact, in 2018, just 16% of UK adults currently in self-employment are making contributions to a pension.
This is a precarious position to be in – and one that fails to take advantage of the tax relief on pension contributions. Most people can expect to see 25% returned by the government on each pension contribution. A £100 investment into your pension pot, for instance, will get a £25 boost from the government. This relief is available up to the equivalent of your yearly earnings, or up to £60,000, if that’s the lower of the two.
With this tax relief, a monthly contribution of £100 will add up to £1,500 each year – a great way to build your pension over the course of your career.
Those paying a higher rate of tax (40%) can claim any additional tax paid back via a tax return.
Some self-employed people may find that registering as a limited business, rather than a sole trader is most appropriate. If you choose this route, then you can make contributions to your pension via your business. It’s worth talking this decision through with an advisor, however, as operating a limited company is more complex (and time-consuming) than operating as a sole trader.
Planning for the future isn’t just about making regular pension contributions. If you have a family, you’ll also want to consider planning against inheritance tax as part of any long-term financial plan.
Many of the plans we make for the future are concrete. Retirement represents a clear and definitive point on the horizon, and planning for it is relatively straightforward (provided we start early enough, and don’t put it off).
But protecting your future should never just be about putting those concrete plans in place. Just as important are the plans that may never be called upon – plans we’ll wish we made if the worst does happen. This is what we mean by protecting and insuring your finances.
Individuals who are self-employed are more vulnerable to lost income. In the UK, employers are obliged to accept self-certification from employees up to 7 consecutive days. After that, provided the employee has a valid sick note from a medical professional, they are able to receive statutory sick pay and annual leave for any long-term illnesses that disrupt their ability to work.
Obviously, self-employed people don’t have that same safeguard against loss of earnings. And, while the occasional bout of flu or sickness won’t necessarily derail your budget and long-term goals, the risk of being struck by long-term illness or injury is ever-present, even if you’re careful to take care of your health.
In these instances, it really pays to have protected yourself against these disruptions before they happen. If tragedy strikes, it will be too late to secure your finances, and you’ll end up wrestling with two demons at once. The additional monthly cost of a strong insurance policy provides peace of mind – something the past few years have demonstrated to be more important than ever.
Critical illness cover and income protection
Critical illness cover and income protection insurance can be real lifelines to self-employed people. The former offers a tax-free lump sum payment following a serious illness (provided, of course, that the illness you have is covered by the policy), whereas income protection will offer regular payments that compensate for some of your lost earnings until the time when you are well enough to get back to work (provided it’s a long-term policy).
There are many, many different products out there, and some will offer more protection – say, mortgage payment protection – than others, and only a few policies will really work for your situation. The key here is to ensure that any advice you receive is independent, and not biased towards any particular company’s products. Restricted advice is, as the name suggests, limited; this can mean the recommended product is skewed in favour of the business (or businesses) that the advisor represents.
You can find out more about the importance of independent financial advice by clicking here.
At Perennial Wealth, this is exactly what we offer – impartial, experience-based advice that takes in the full range of options available to you, and whittles down that list to the products that truly meet your goals.
If you have a family, then securing your finances isn’t just about keeping yourself afloat, and planning for the future means planning for theirs as much as your own.
Life insurance is an important consideration, whether you’re self-employed or not. It’s there to ensure that, if you die unexpectedly, your absence doesn’t leave your family in a financially precarious position. Instead, they can receive a lump sum payment that covers them through that transition.
This is another policy you’ll want to talk about in detail with your financial advisor. There are so many different products available, and finding the right one requires a frank look at your finances, your dependents, and your long-term goals.
Investing your money is a great way to get more from your earnings – much more than you’d get from standard savings accounts, which tend to be very low yield – and to ensure that you’re oriented towards long-term goals for your finances and way of life.
Of course, investing is a highly personal pursuit. No two investors are exactly alike, and building a solid investment portfolio depends on you being frank with yourself about your risk tolerance, and how much you’re willing (or able) to part with right now. Some investors are looking to make quick and easy returns, while others are willing to play the long game – and, potentially, to cope with a much higher level of risk in order to (potentially) see much higher returns in the future.
There’s no ideal investment. Risk is rewarded, but low risk is far less of a burden on investors’ shoulders. Different types of investments operate over different time frames, and require different levels of investment.
Working out what’s right for you is something we can help you with. From deciding what sort of investor you are, to giving you practical advice on how you can get the very most out of your savings.
Keep in mind that a varied investment portfolio raises the importance of proper estate planning. Everything needs to be accounted for – not just in your will, but in how you work to mitigate the impact that inheritance tax has on your loved ones.
Keeping up to date
Staying up to date on inflation and other market updates is always important if you want to keep a firm grip on your finances but, without a fixed salary, keeping your finger on the pulse is all the more important.
Staying aware of how the current rate of inflation impacts your ability to save and invest – the cost of raw materials, say, or the impact the cost of living is going to have on your customer base.
It seems obvious but, in the day-to-day push and pull of running your own livelihood and managing your business and personal expenses, it’s easy for the bigger picture to slip into your peripherals.
Self-employment has so many benefits. From feeling creatively liberated to being free from the usual 9-5 routine, having the flexibility to mould your work around your life – rather than moulding life around work – and being able to earn money at your own pace, it’s not hard to see why the rate of self-employment is bouncing back from the dip of 2020 and 2021.
None of us can afford to loosen the reins on our finances, but self-employment places an additional demand on those purse strings. The best thing you can do is reach out to an independent financial advisor as soon as you make the move into self-employment – or business ownership – to ensure that, from every perspective, your accounts are working for you and serving your short- and long-term goals.
Whether you’re already self-employed, or considering moving onto a new phase in your professional life, get in touch with our team today to find out more about how we can help you optimise your finances and plan for the future.