Thinking of becoming self-employed? Here are some financial considerations

Thinking of becoming self-employed? Here are some financial considerations

Published: 17 Nov 2020 Updated: 13 Jun 2022

It is fair to say that 2020 hasn’t panned out as many of us expected. The Covid-19 pandemic has resulted in a staggering number of job losses which has forced many people to reconsider their career choices. Some people have moved away from being employed by a company and have taken the opportunity to make the leap into self-employment. This could be an exciting time, but there are lots of factors to consider to ensure that your personal financial situation remains sound while your business grows.

What does being self-employed mean?

Put simply, being self-employed means working for yourself, but this can take a number of different forms depending on how you choose to operate. You can set up your own limited company, partnership or operate as a sole trader. The option you settle on will determine what tax you pay and how you pay it.

Self-employed sole traders are not paid through the Pay As You Earn (PAYE) scheme like employed workers are, so you are responsible for ensuring that you pay the right amount of tax and National Insurance, and making sure it is paid on time via self-assessment. If you set up a limited company there is greater flexibility around how you are remunerated, with the option to be paid via salary and/or dividends. This additional flexibility also brings more complexity which will usually require professional advice. When running a limited company you will need to file your accounts with Companies House and your company tax return with HM Revenue and Customs. This will require the assistance of a qualified accountant unless your company qualifies for an audit exemption.

What financial provisions do I need to make before becoming self-employed?

There are a great deal of benefits to becoming self-employed. You have the freedom to run your business and diary how you want to, you can decide which price point you operate at and there are various tax benefits available. However, there are a number of other points you need to consider and the onus falls very much on you to ensure that your personal financial situation does not inadvertently suffer as a result of being self-employed.

The importance of pension contributions

If you become a sole trader, you will not benefit from employer contributions into your pension. You are personally responsible for ensuring that you are saving sufficiently for your retirement and will need to set up a personal pension in order to make pension contributions. It will also be necessary to reclaim higher and additional-rate tax relief on contributions made via self-assessment. If you become a director of your own limited company, you will have the option to make employer pension contributions as well as personal pension contributions.

When starting out as a sole trader or building your own business, making pension contributions can be considered an additional expense and they are sometimes stopped altogether. In fact, there are 4.8 million self-employed people in the UK (equating to 15% of the workforce), but only 31% of them are paying into a pension*. Making pension provisions is essential to retirement planning and pensions have significant tax benefits. A financial planner can demonstrate the most tax-efficient way to save into a pension and use cashflow modelling to show exactly what you need to save in order to meet your retirement objectives.

Making National Insurance contributions

When you become self-employed, the way in which you pay yourself can determine how much National Insurance you pay, particularly if you have your own limited company. This is because as a director of your company, you can decide how you are paid. You do not pay National Insurance on dividend income and therefore you need to ensure that you are paying sufficient National Insurance to build qualifying years for your state pension.

Your employer will have previously paid National Insurance on your behalf automatically. Once you become self-employed, this will become your responsibility. It is worth noting you will need 35 ‘qualifying years’ of paying National Insurance contributions to qualify for the full State Pension. As an employee, you will ordinarily pay Class 1 contributions, with your employer also contributing Class 1A/1B. For individuals who are self-employed, they instead pay Class 2 and Class 4 contributions.

Sick pay and income protection when you’re self-employed

Many employers will provide sick pay in the event that you are unable to work but if you are self-employed and can’t work, it is highly unlikely that you will get paid. It is absolutely critical that you have in place adequate insurance to protect and support you and your family. This might involve setting up an income protection policy that will provide you with an income in the event you are off work for a period of time. When considering an income protection plan, you need to look at the deferral period. Plans with a longer deferral period tend to have cheaper premiums, but you need to consider if you can afford to go without pay for a longer period of time. It might be better to take out a more expensive plan that pays out immediately following a claim.

Having life insurance is vital for self-employment

Your previous employer may have provided you with a ‘death in service’ benefit, which would pay a monetary amount, usually a multiple of your salary, to your named beneficiaries in the event of your death while you still worked for them. They may have also provided you with critical illness cover which could provide either a regular income or a one-off lump sum in the event of being unable to perform your ordinary duties following the diagnosis of a critical illness. You should take some time to understand the benefits you are relinquishing when moving from being an employee to self-employed. You could take out critical illness cover personally and pay for the premiums yourself along with life insurance, which pays out a lump sum in the event of your death.

Business protection for your company

In addition to sales and operational risks, there are many other business risks to protect yourself against, including losing a key person (if you are in a partnership or employ staff) and repaying debts. Think about what would happen if you or a key member of your team were unable to work for a period of time or passed away. Could the business continue to function without them? If you have any business debts, how would these be repaid if the person who has guaranteed any loans died? There are a number of different ways to protect against these types of risks and a financial planner can help you decide which options are right for you and your business.

An emergency fund

Having cash in the bank is vital when you are self-employed or have your own business. At Tilney, we have seen that some of the business owners who have survived during the Covid-19 pandemic are the ones who have cash reserves. This money covered their expenses while they had a reduced income or none at all and most importantly, bought them time — the time they needed to come up with a new business plan. An emergency fund could also help cover any loss of income if you are off work due to sickness or injury.

Business and personal finances

For many self-employed people, the line between business and personal finances often becomes blurred, as personal money is often poured into their business. It is important to consider the potential pitfalls that may arise as a result of this and take professional financial planning advice on how the business can help fund you personally in the most tax-efficient way whilst maintaining a clear line between your personal and business finances.

Speak to Tilney

Tilney’s experts are committed to help people realise their dreams of becoming self-employed and running their own business. To find out how we could help you, book a free consultation or call us on 020 7189 2400.

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* Source: The Money Advice Service, 2020

Important information

The value of an investment may go down as well as up, and you may get back less than you originally invested.

Prevailing tax rates and reliefs depend on your individual circumstances and are subject to change.

Issued by Tilney Financial Planning Limited.


This article was previously published on Tilney prior to the launch of Evelyn Partners.