self-employment and your finances...self-employment and your finances | 3 the office for national...

SELF-EMPLOYMENT AND YOUR FINANCES

2 | Self-employment and your finances

CONTENTS

03 Working for yourself

04 Thinking differently

05 Savings, pensions and investments

08 Paying for your home

09 Taking out insurance

11 What if you get into debt?

11 Your tax affairs

13 Succession planning for your business

14 Getting a helping hand

This guide is provided by Alliance Trust Savings for general information only. It is not a recommendation to buy or sell. It is provided solely to support you in making your own investment decisions. If you have any doubts as to their suitability you should seek expert advice.

Tax treatment depends on individual circumstances and may be subject to change in the future.

Laws and tax rules may change in the future without notice. The information here is our understanding in September 2018.

Self-employment and your finances | 3

The Office for National Statistics estimated that 4.76 million of us were self-employed by August 2018. That’s around 14.7% of all people in the UK in work at that time. And there’s been a marked growth in recent years, up from 3.3 million self-employed in 2000.

WORKING FOR YOURSELF

Alliance Trust Savings does not give financial or investment advice. We offer what’s known as an ‘execution only’ service. This means that we only do what you ask us to do. We won’t offer an opinion on the suitability or merits of a particular fund or trade. If you feel you need advice, you should consult a financial adviser.

Self-employment can bring flexibility, independence and job satisfaction. In fact, research by the Department for Business, Innovation and Skills (BIS) published in February 2016, suggests relatively few of us who opt for this route want to change our working status, with 84% of us saying our lives are better for being self-employed.

But being self-employed does mean thinking differently about your finances.

In this guide we’ll explain why and outline some practical tips on making the best of self-employment. From putting a safety net in place and providing for later life, to navigating the tax landscape and getting expert advice.


THINKING DIFFERENTLY

Being an employee typically provides a stable, predictable income and often comes with valuable benefits like paid holidays, a pension, sick pay and even insurance cover.

In contrast, income from self-employment can be unpredictable, with a tendency for ups and downs that can make it hard to judge what future cashflow might look like. There’s also the absence of the assurances that employee benefits typically bring.

There can be extra responsibilities to account for as well.

For instance, in the event of a dispute over a job you’ve done or a service you’ve delivered, if you’re a self-employed sole trader there’s a potential for issues around personal legal liability. That creates a need for extra insurance to cover possible legal costs.

Then there’s the vulnerability to other businesses who might be a bit slack when it comes to paying suppliers, freelancers and contractors on time. A late invoice or two could make all the difference to your cashflow, creating risks when it comes to crucial payments such as mortgages.

This underlines how the flexibility that makes self-employment attractive can also be a source of challenges. However, with a little financial planning, you can find ways to overcome these challenges. Let’s take a closer look.

SAVINGS, PENSIONS AND INVESTMENTS


Make sure you’re covered for emergencies

Building a rainy day savings pot is among the must-do tasks for anyone embarking on self-employment. While it’s important to have insurance in place – and we’ll come to this later – you can still have some peace of mind from being able to fall back on savings reserves should cashflow ever become an issue.

Typically, experts suggest an emergency cash fund sufficient to cover three to six months of expenditure. Returns on cash accounts are thin in today’s low interest rate environment, but decent deals can still be found.

How much you need to put aside will depend on your personal circumstances of course, as will the right savings product for you. But there are a couple of tax breaks it’s worth bearing in mind when deciding the route for you.

Cash ISAs offer shelter from both income and capital gains tax on any interest earned. Basic rate and higher rate tax payers also have a tax-free savings allowance (the Personal Savings Allowance) of £1,000 or £500 respectively that can offset against any interest earned on savings outside of an ISA. Additional rate tax payers do not qualify for this allowance. If you live in Scotland and pay different rates of income tax, the rates for the rest of the UK are used for working out your entitlement to the Personal Savings Allowance.

Also bear in mind that when you take out any type of ISA, you are doing so as an individual in your own name and not as a business. ISAs are designed specifically for personal use. The Personal Savings Allowance is also, as its name makes clear, for personal use.

Consider a pension

State Pension aside, the self-employed are less likely than employed workers to belong to a pension scheme. Just 14% of self-employed people save into a pension, down from 30% just a decade ago, according to the most recent data from the Department of Work and Pensions, covering the period 2007 to 2017.

A key question to ask yourself is, what can you do to safeguard yourself for the future? The tax relief available on pensions makes them the obvious place to start when setting up some form of retirement provision.

A range of pension options are available to choose from. From Stakeholder Pensions (where the government sets product standards, including a maximum charge of 1.5% of the fund value for the first 10 years and 1% after) at one end of the scale, through Self Invested Personal Pensions (which will offer more investment choice but potentially come with higher charges), to more complex arrangements designed specifically around you and your business.

What works best for you will depend on your own personal needs and circumstances as well as how your business is structured. If you employ people, for example, you may be required to provide them with a Workplace Pension, and joining that yourself is then an option you could consider. NEST also offers a scheme that is open to self-employed workers.

It’s worth noting too that, if you’re making the transition from employee to self-employed, it could be a good opportunity to consolidate any pensions you’ve previously opened with different employers. This can make your pensions easier to monitor, engage with and manage overall. It can also help you identify and move money out of expensive schemes.

Tax rates and allowances

Use our latest Tax Tables to check on the main tax rates and allowances that may be available to you. Our Tax Tables document can be downloaded from our website at alliancetrustsavings.co.uk.

SAVINGS, PENSIONS AND INVESTMENTS (continued)

Don’t discount other investments

Another way to help provide for your future is to consider investing through a Stocks & Shares ISA. You can currently invest up to a total of £20,000 across one or more ISAs each tax year. There are four types, including a Cash ISA and a Stocks & Shares ISA and you can pay into one of each type each tax year.

With an ISA your investments can grow free of income and capital gains tax and you can take money out at any time (in contrast to a pension where you can’t usually take money out until you are age 55). Collective investments such as Funds and Investment Trusts are a popular choice for ISA investors. They can help you diversify across different assets (such as Equities, Cash, Fixed Income and Property) to reduce risk.

Remember, whether you are investing through a pension an ISA or in any other way, that investments go down as well as up and you may get back less than you put in.

Make a plan and keep it under reviewHaving a plan covering your savings, pensions and investments and keeping it under regular review is generally a good idea for anyone. Arguably though it is particularly important for self-employed workers who wish to maximise the benefits of good years for their business and smooth out any adverse effects from years when things don’t go so well.

You may find it helpful to work with a professional financial planner or adviser who is experienced at working with the self-employed. It can also be helpful to gather all your pensions and investments together into one place, such as an online platform, where they can be easily monitored and managed.

Whatever you do, remember to stay diversified, review your savings, pensions and investments at least once a year and keep in mind that investing is for the long-term.



An increased affordability emphasis since the 2008 financial crisis has deepened the ‘computer says no’ culture among major lenders, making it more difficult for borrowers to meet often strict criteria. They include self-employed workers who may be unable to prove they earn a certain amount each month. The problem extends to the private rental market too, where self-employed renters may be turned down by landlords who are uncomfortable with tenants who have an unpredictable income.

So how can self-employed borrowers and tenants maximise their chances of securing a loan or a tenancy? One important step, which applies to anyone applying for a mortgage, is to ensure your affordability case is presented as strongly as possible. This means getting all the documentation you can showing your income and your ability to manage your finances, as well as checking your credit record is up-to-date and accurate.

Self-employed applicants are likely to be asked for their SA302 documents from HMRC, which show evidence of your earnings for the last four years and which can also show an overview for any one year. Go to www.gov.uk/sa302-tax-calculation for the details.

It may also be worth looking at smaller, specialist lenders (such as regional or local building societies) when searching for a deal. As a self-employed borrower you may particularly benefit from seeing a mortgage adviser/broker who knows the market well and can identify the mortgages most suitable for your circumstances. Going it alone might be tempting, but if your circumstances mean that mainstream mortgages could be hard to secure, you may find yourself with a lot of rejected applications, risking a negative mark on your credit record.

While most large, mainstream lenders require at least two years of accounts – usually three – and have narrow definitions of what constitutes a self-employed income, some specialist lenders are more flexible and will accept just one year of accounts.

PAYING FOR YOUR HOME

Being self-employed can make it harder to get a home loan. For example, research in 2016 by Nottingham Building Society found that one in eight self-employed borrowers had been rejected for a mortgage or a remortgage, despite nearly half of those surveyed saying they were earning at least the same as they were in full-time employment.


TAKING OUT INSURANCE

For your personal protection

Insurance is an area that no one in self-employment can afford to ignore. There’s no sick pay when you’re self-employed, and illness or accidents could make for a long time without getting paid. The life insurance that many employers provide can also be taken for granted, and may need replacing (depending on your circumstances).

The absence of support such as sick pay means that some form of safety net is essential to cover costs such as mortgage payments/rent, groceries and household bills in the event of not being able to work. While your rainy day savings pot may be able to cover short periods, it may prove insufficient if you’re off work for more than a few weeks.

Research in 2018 by LV= found that one in three self-employed people would struggle to stay afloat financially for more than three months if they lost their income.

This is where Income Protection Insurance can come into play. These policies typically pay out between 50% and 65% of your stated income if you’re unable to work. Crucially, this is in the form of a monthly income and it will usually pay out until you retire or are able to return to work. The policies primarily provide cover if you’re unable to work because of illness or an accident, but it is possible in some cases to include unemployment as an “add-on”.

Another form of protection is Critical Illness Insurance. This pays out on the diagnosis of a serious illness, although the list of conditions covered can vary widely between different insurers. The payment is in the form of a one-off, tax-free lump sum.

Private medical insurance is an additional option to replace what some organisations offer as an employee benefit. These plans provide insurance that covers the costs of private medical treatment – up to a certain limit and for certain treatments – and can be especially valuable for those anxious about time off work while waiting for treatment.


TAKING OUT INSURANCE

For your business

From the perspective of your business there are additional considerations. These will depend on certain factors, such as where you work, whether you have employees (and how many) and the assets you need to protect.

If there are employees, the most obvious requirement is for employer’s Liability Insurance, which would pay out in the event of an employee suffering an injury in the process of doing their job. Where businesses rely heavily on particular individuals and would suffer losses as a result of them dying or being unable to work, key person (or key man) insurance can prove valuable.

Another option for some small businesses is Relevant Life Cover. This is insurance that allows employers to provide individual death-in-service cover for employees, paying a lump sum if the individual dies while still employed (and during the length of the plan). However it’s not available to sole traders or partnership companies and it has to be written into trust to ensure the proceeds go straight to the individual’s family or financial dependents.

This means it needs to be taken out through a financial adviser, but there are tax benefits as a result of the policy being paid by the business (i.e. there are no NI contributions due on the policy payments).

People working from home may well have office equipment on which they rely to do their job properly. It may be covered by normal household insurance, but not always – it’s worth checking, especially if people visit the home for business reasons.

Self-employed professionals, such as solicitors, accountants, financial advisers and business consultants, should have Professional Indemnity Insurance in place to protect against claims made by clients you provide a service to.

Additional forms of cover could be relevant depending on the type of business being run, such as legal expenses insurance, motor insurance and credit insurance. Where it’s unclear what would be useful or even legally required, it’s worth consulting an insurance broker.

Almost four in 10 self-employed people have personal debts to manage, according to the LV= study, compared with less than a third of employed workers.

For most people in employment, your main tax affairs tend to be in the hands of your employer. But if you are self-employed, responsibility for tax and national insurance contributions rests firmly on your own shoulders.

WHAT IF YOU GET INTO DEBT?

YOUR TAX AFFAIRS


Having an irregular income and dealing with hefty business costs can both be reasons why self-employed workers find themselves vulnerable to debt.

If you do find yourself in debt it’s vital to seek help. Agencies such as StepChange Debt Charity and Citizens Advice offer free advice on debt management, while the Money Advice Trust runs Business Debtline (www.businessdebtline.org), which offers practical support to small business owners and the self-employed.

The tax system can be challenging and the penalties for late or inaccurate filings are potentially very steep, underlining the importance of an understanding of tax affairs and good record-keeping. There may also be taxes that are new to you, like VAT and/or corporation tax, that you might need to consider depending on the size and structure of your business.

With those embarking on self-employment facing the decision of whether to register as a Limited company (Ltd), Limited Liability Partnership (LLP), partnership or sole trader/self-employed, and those decisions potentially tied up with the most effective tax, pension and insurance arrangements for you, the services of an accountant and a financial adviser can be well worth paying for.

A good accountant or financial adviser can help you maximise the advantages of self-employment too. The most obvious is that you can deduct a wide range of costs for tax purposes, with relief potentially available on items from certain equipment and travel to council tax and utility bills (the latter two available if you work from home).

If you set up a company there are some choices as to how you take income. Your accountant and adviser will also be able to help you work through which would be most beneficial for you in the context of your broader finances.

Otherwise, there’s the potential benefit from having to pay income tax just twice a year (by 31 January and by 31 July), rather than monthly. As long as it can be paid on time when it is due, there can be cash flow advantages to being able to hold onto earnings for longer, as well as the ability to earn more interest on earnings kept in a savings environment.


This might not seem a priority for the self-employed running small business operations. But for some it will be an important consideration, especially if it is a family business you have built up over a number of years or you have employees who depend on you.

SUCCESSION PLANNING FOR YOUR BUSINESS

One way to approach it is to think of it like a Will or an Expression of Wish for your pension savings, because it’s about aiming to make sure that everything’s in good hands when you’re no longer around.

What happens to a business when a key person retires or passes away can be a source not only of distress, but also disputes, especially in small family businesses.

A succession plan can make it clear what you want to happen to the business, who should run it, how the ownership should be distributed. It may also set out conditions for selling the business, whether on death or retirement. Many solicitors and accountants can provide advice on the legal and tax aspects of succession planning.


GETTING A HELPING HAND

If you already have a relationship with a financial planner or adviser, or are thinking of starting one, talking to them can be a good place to start.

Here are just some of the ways they may be able to help:

The range of issues that the self-employed encounter, especially in the early days, can be wide-ranging and complex.

Keeping your personal finances in shapeThis can be difficult when faced with the demands of self-employment. Advisers can take some of the strain, from arranging pension provision and setting up investments to helping you develop longer term financial plans and keeping them under regular review.

Offering insight on tax issuesThis includes getting tax affairs in shape and making the best of any tax reliefs and allowances available. Many advisers have relationships with accountants and/or tax advisers to whom they can refer clients needing specialist support.

Identifying and bridging insurance shortfallsIdentifying and bridging insurance shortfalls that can be created on leaving full-time employment. This includes making sure that sufficient protection is in place to cover costs in the event of being unable to work.

Many advisers run small businesses themselvesThey can often provide valuable insight and guidance when it comes to the details of running a business, including tax, insurance, property arrangements and succession plans.

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Alliance Trust Savings

Registered head office: PO Box 164, 8 West Marketgait, Dundee DD1 9YP

+44 (0)1382 573737

Lines are open 8am to 5pm Monday to Friday. Calls may be recorded for training and monitoring purposes.

[email protected]

alliancetrustsavings.co.uk

PS ATS GEN G 0035 (10649)

This information does not constitute investment advice or a personal recommendation for any particular investment and should not be used as the basis of any investment decision. If you are unsure you should consult a Financial Adviser before investing. The value of your investments and any income from them can go down as well as up and you may get back less than you originally invested.

Alliance Trust Savings Limited is registered in Scotland No. SC 98767, registered office, PO Box 164, 8 West Marketgait, Dundee DD1 9YP; is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority, firm reference number 116115. Alliance Trust Savings Limited gives no financial or investment advice. ‘Alliance Trust Savings’, ‘ATS’ and ‘AT Savings’ are all brand names of Alliance Trust Savings Limited together with the ‘Alliance Trust Savings’ logo are owned by and used with the permission of Alliance Trust PLC, the previous owner of Alliance Trust Savings Limited.

self-employment and your finances...self-employment and your finances | 3 the office for national...

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