You’re on your own when you work for yourself, so it’s crucial you establish and follow good financial habits. Rachel Lacey uses her experience to explain how it’s done.
There are many benefits to being self-employed. You’re in charge and have far more autonomy over your working week. There’s no clock-watching, fewer meetings (for me anyway) and a lot more flexibility.
Three years down the line, I’ve got no regrets, but there is a trade-off; you’re never sure how much you’ll earn from one month to the next and there are no employee benefits. Pension contributions is the big one, but you’ll also get no life insurance or sick pay when you’re ill. Then there’s the dreaded tax return (not to mention the bill) to contend with.
All this can make building and protecting your wealth more complicated, but it needn’t be impossible. In some cases simply being aware of the challenges you’ll face can be the prompt you need to start tackling the problem.
1) Get your tax sorted
Tax is always a chore for the self-employed. Tax returns for sole traders shouldn’t be overcomplicated. You don’t necessarily need to pay an accountant, but it might be handy if you’ve got overheads and multiple expenses that you might be able to claim relief for. Whether you use an accountant or not, the key is to be organised. Keep your accounts up-to-date, keep records of your expenses and make sure you can evidence them. And, every time an invoice is paid, deduct an appropriate amount of tax and National Insurance and pay it into account that’s for tax and tax only. Mix it in with your own savings and confusion will inevitably ensure. With your tax money ring-fenced, it’s also much easier to see how much you can afford to save or invest.
2) Pay into a pension
If you’re employed, you’ll be automatically enrolled on to a workplace pension, but it’s down to the self-employed to make their own arrangements. It’s hardly surprising then that without an employer to provide access to a pension, or make compulsory contributions to it, less than a third (31%) of self-employed people have one, according to research from IPSE.
Yet despite this, interactive investor’s own Great British Retirement Survey found that self-employed people are more likely to worry about running out of money in retirement, than their employed counterparts (43% versus 40%). They’re also more likely to regret not saving more (35% versus 28%).
Even without employer contributions, there’s still a logic for using pensions. That’s because pensions offer something no other product can offer - tax relief on contributions. This effectively means that it only costs basic-rate taxpayers £80 to invest £100, while higher-rate taxpayers only need to pay £60.
Only basic-rate tax relief is paid automatically by pension providers though, so it’s important to fill in your tax return properly. This means declaring how much you’ve paid into your pension, plus the value of 20% tax relief. This is your ‘gross contribution’.
It’s your call how you pay into your pension. Some self-employed people prefer to pay in lump sums as and when they have the money. I’ve gone for a regular monthly direct debits. For me it removes the discipline required to make pension contributions as well as the quandaries around whether it’s the right time to invest a lump sum. By investing each month, I get the benefits of pound-cost-averaging - buying units at an average price over time - and I don’t run the risk of losing a lot fast if I invest at the wrong time.
It's not a perfect solution though, and because my income is inconsistent my contributions aren’t as high as they probably should be. Of course, I can always pay in lump sums when finances permit, but again that takes a degree of discipline that I don’t claim to have.
3) Take advantage of ISAs
Each year you can invest £20,000 into ISAs tax-free. Even if you can’t get anywhere near that, it’s still worth investing whatever you can spare.
The benefits of regular investing don’t just apply to pensions, and drip feeding your money into the stock market can be a great way to harness the powers of compound returns and build your long-term wealth. If you were to invest £200 a month and achieved 5% a year, you would have £27,500 after 10 years, rising to £48,922 after 15 years or £76,385 after 20.
- Eight easy ways to boost your ISA returns
- My first four years as an ISA investor
- Five ISA lessons that nobody taught you at school
Even if you start small and invest £50 a month, with so many other calls on your cash, you may well end up better off than you would if you wait until you can afford a lump sum.
ISAs can be a great way of saving for medium-term expenses – say five to 10 years down the line. But the more I write about retirement planning, the more I realise ISAs can also be the perfect complement to pensions. As all proceeds are tax-free they can be a great way of delivering lump sums in retirement and topping up your pension income.
4) Keep a cash buffer
You don’t just need cash on hand to pay your tax bill, it’s also a good idea to keep three to six months' expenses in an instant access account. That means if there’s a disaster or unexpected bill you don’t have to raid money you’ve invested for the future or borrow.
Cash makes us all feel comfortable, but it’s not necessarily wise to keep too much of your money in cash over the long term. Not only will your money be eroded by inflation but it might fail to deliver the returns you need too.
5) Get protected
If you’re employed, you’ll likely get death in service cover that’s a multiple of your salary. So if you’ve got a partner or children that depend on your earnings it’s a good idea to ensure you’ve got some life insurance that goes above and beyond paying off your mortgage.
Life insurance is pretty cheap, particularly if you don’t smoke and are in reasonable shape.
You might also want to consider how you would pay the bills if illness or accident stop you working. Critical illness can be bolted on to your life cover and it pays a lump sum if you suffer one of the listed conditions on the policy (for example, a heart attack, cancer, multiple sclerosis or a stroke). Or, you could consider income protection, which pays a portion of your earnings if you cannot work due to ill health. These latter two policies are more expensive than life cover – as there’s more chance you’ll claim – but in the event of a disaster they could provide a lifeline for those who rely on you.
Please remember, investment value can go up or down and you could get back less than you invest. If you’re in any doubt about the suitability of a stocks & shares ISA, you should seek independent financial advice. The tax treatment of this product depends on your individual circumstances and may change in future. If you are uncertain about the tax treatment of the product you should contact HMRC or seek independent tax advice.
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
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