THE number of people opting to leave employment and branch out on their own has nearly doubled to about 5m in recent years, according to figures out last week.
Advances such as faster internet connections and e-mail services mean that those keen to escape the rat race can work from where they want, when they want. Every year hundreds of thousands of workers are taking advantage of this to flee the cities and take control of their own destiny.
Matthew Knowles of the Federation of Small Businesses said: “Modern communication methods have made it much easier to be self-employed, and people are also attracted by the thought of a better quality of life. Going it alone is not easy, though, and many find they have to return to employment.”
One way to avoid having to return to the workplace is to get your finances in order. So we’ve put together a personal-finance guide for the self-employed.
Tax
One of the first things the newly self-employed should do is inform Revenue & Customs of the change in their tax status.
John Whiting at Price Waterhouse Coopers, an accountant, said: “You have to tell the Revenue within three months of becoming self-employed, mainly because the self- employed pay Class 2, rather than Class 1 National Insurance contributions (Nics). Class 2 Nics cost about £2.10 a week, but most self-employed people also have to pay Class 4 Nics, meaning they pay about the same as their employed peers.”
Another sensible step is to consider whether to register yourself for Vat. Self-employed people earning £61,000 or more a year have to do this, but those earning less can choose not to.
Whiting said: “People who are registered for Vat can claim that back on their expenses, which is an advantage. However, registering may not be the best option. Journalists might choose to register for Vat because the companies they are billing can claim the Vat back. But hairdressers would probably not want to register because they work for individuals, for whom Vat simply bumps up the price.”
When it comes to income tax, self-employed people pay the same rates and benefit from the same allowances as employees. But they have to pay the full amount owed in two instalments, made in January and July. One common mistake is not putting enough money aside.
Whiting said: “Remember to save some of your profits to pay in tax. Lower-rate taxpayers should save about £30 of every £100 they make, rising to £40 for higher-rate taxpayers.”
You can, however, cut your tax bill by offsetting expenses against it. The Revenue states that anything used “wholly and exclusively” for business purposes can be offset against tax. Qualifying items could include a computer, stationery or use of your home as an office.
Mike Warburton of Grant Thornton, an accountant, said: “Producing annual accounts helps you run a successful business and keep on top of tax.”
Pensions and investments
Becoming self-employed means that you will not have an occupational pension. Advisers therefore recommend setting up a personal plan instead.
The pension regime changes that were introduced on April 6, including the advent of more flexible self-invested personal pensions (Sipps), have made this easier — as has the introduction of low-cost stakeholder schemes.
Philippa Gee of Torquil Clark, an adviser, said: “Historically, fluctuating earnings meant the self-employed could not make the maximum possible regular contributions to a pension because their policies would not allow any variation. With stakeholder plans, there is much greater flexibility.
“I would suggest setting a fairly low monthly investment level and then reviewing it at the end of each year to see whether they should make a lump-sum payment.”
As well as setting up a pension, advisers also recommend that the self-employed put aside money for a rainy day.
Gee said: “Ideally, they should hold a reasonable sum in an instant-access account, as well as siphoning extra money into an account when the business is at its strongest, to compensate for the almost inevitable weaker times.”
Only once there is enough readily available cash to cover any problems would Gee advise investing in higher-risk assets such as equities.
Even then, she warns against duplicating the risk you are taking by setting up on your own by then investing in the sector you operate in — such as a plumber buying construction shares.
Insurance
One of the main disadvantages of going it alone is that you miss out on employee benefits such as paid holidays, sick pay and private medical insurance (PMI).
Nick Homer of Norwich Union, an insurer, said: “We sell a lot of PMI to self- employed people, partly because they do not have an employer to provide it and partly because they recognise that speedy treatment for any ailments is important to prevent them losing money through being unable to work.”
Self-employed people can also protect themselves against loss of earnings through illness by taking out income- protection insurance.
Homer said: “You can choose a policy that begins paying out anything from four weeks to two years after you stop being able to work, and the price varies accordingly.One way to keep the cost of cover down is to build up enough savings to see you through a few months off work.”
Another benefit that employees generally enjoy is a “death-in-service” payout.
This is not much of a problem if you are single, as life cover is only really necessary for those with dependants.
For people with children, advisers usually recommend taking out life cover of up to two or three times your annual income, to be paid to your family on death. But anyone with a large mortgage, or children at private schools, is likely to need more than this — perhaps up to 10 times income.
You should also consider whether your general insurance — for motoring, household contents, and so on — will cover you if you work from home.
Mortgages and borrowing
Until recently, self-employed people generally had to take out mortgages on a self- certification basis, whereby the lender took their word for the amount they earned, with proof that they had been trading for a certain period.
The rates on self-certification loans tend to be about one percentage point higher than on standard deals, however, so brokers advise searching the mainstream mortgage market first.
David Hollingworth of L&C Mortgages, a broker, said: “Depending on the deposit available and the size of the loan, lenders may require only one year’s, rather than three years’ accounts. And even if you do not have this, it is still worth looking at mainstream loans first.”
Mortgages are not the only type of borrowing that can cost the self-employed more.
Stuart Glendinning of Moneysupermarket, a comparison website, said: “Self-employed people generally pay more for credit. They will not, for example, generally qualify for the headline rate on personal loans.”
PIC AND MIX
SHARON WALLACE, 40, has been self-employed since leaving her job as a newspaper photographer 11 years ago.
She spent the first five-and-a-half years as a freelance photographer, before taking on a photography shop franchise in 2000.
Wallace, who lives in south London, said: ‘I always wanted to be my own boss and I like the fact that I can split my time between photography and running the shop — although I only take on about five photography commissions a month at the moment.
‘I know a lot of self-employed people complain about tax, but I think it’s mainly a matter of being organised and remembering to put aside enough money to pay the bill.
‘It also helps to have a good accountant and a good mortgage broker because banks will generally push self-employed people towards expensive self-certification home loans,’ she said.
