As a contractor, knowing how to manage your finances will be a major factor in determining your long-term success. Although contracting offers increased control over your schedule and working practices, this often comes at the expense of a predictable paycheck and the safety net of employment benefits such as sickness pay. This makes it crucial for contractors to budget, so that they can ensure that they meet their baseline expenses, while also making provisions for unforeseen time-out and retirement. By keeping your finances in good order, this is one less factor to distract you so that you can focus on your work. In this article, Umbrella Exchange looks at three basic areas that you should pay attention to when managing your finances.
- Tracking your expenditure
Whether you have your own limited company or work through an umbrella company, in order to budget effectively, you’ll need to start tracking your expenditure.
- Limited company: If you are working through your own limited company then you will need to put aside funds to cover your taxes. This will allow you to budget for baseline living expenses such as rent/mortgage, food and utilities before factoring in your business expenses. Limited company contractors are able to claim back allowable expenses against the cost of running their own business. These could include mileage and the cost of equipment or training, providing they are purely for business purposes and receipts are provided.
- Umbrella company: Recent changes in IR35 legislation have considerably reduced the expenses that contractors can claim for when working under an umbrella company. This is because contractors are classified as employees for tax purposes, therefore costs such as mileage are treated as ordinary expenses and are not eligible for tax relief. An exception to this may be travel and subsistence costs if you are required to undertake a business trip. Although dispensations will vary from one umbrella company to another, contractors should be aware that many umbrella companies do not allow business expenses other than those specifically agreed through the agency.
- Factoring tax into your contractor budget
If you’re paid via an umbrella company or agency PAYE, your tax and NI will be automatically deducted at source. For contractors operating though a limited company, the following deductions should be taken into consideration when budgeting.
- Corporation tax
- Income tax via a Pay As You Earn (PAYE) payroll
- Employee’s National Insurance Contributions (NICs)
- Employer’s National Insurance Contributions
- Value Added Tax (VAT) collected on behalf of the government
Limited company contractors their allowable business expenses to offset their corporation tax. A company tax return and personal self-assessment tax return must be submitted annually. On IR35 exempt contracts, you will receive the option to elect dividends. The dividends are taxed in bands that align with the income tax bands. Paying the right taxes can be a complex and time-consuming process for contractors with changes to the off-payroll rules only adding to the difficulty. In order to minimise the risk of not paying the right taxes, contractors should consider using a specialist accountant with expertise in this area.
- Budgeting for sickness, holiday & time between contracts
Unless you’re working under an umbrella company, contractors aren’t entitled to employment benefits such as statutory sick pay and holiday pay, so you should do some basic calculations to factor these into your budget and allow for contingency funds. Contractors should have a minimum three-to-six month cash buffer to cover their personal and business costs in case they can’t find work, or can’t work due to short-term illness or family emergencies. Contractors can also choose to buy a specialist income protection policy that will provide an income if they have an accident or long-term medical condition. Although employment rights for independent workers are currently under review, the fact that there is no “mutuality of obligation” between employers and contract workers places independent contractors in a separate category. If you work through a limited company, you should avoid accepting any employment benefits offered by the client as this could go against you in an IR35 investigation.
Although research suggests that contractors take fewer holidays than employees, taking time out is essential if you intend to make contracting a sustainable long-term career. Without time to recharge and remind themselves of what they’re working for, contractors can become caught up in the continuous pressure to find new work, leaving them prone to stress and burn out. Amongst other things, breaking from your daily routine can reinvigorate your approach to work and give you both personal and professional perspective, so it’s worth factoring holidays into your budget.
In order to do this, do some basic calculations so that you know you’ve covered your time out - this will give you peace of mind and allow you to fully enjoy it. There are around 252 working days in the year minus weekends and bank holidays. The average amount of holiday entitlement for employees is around six weeks, which leaves around 220 working days, which is 44 working weeks. This means the income from 44 fee-earning weeks should be spread over 52 weeks of the year.
Umbrella Exchange provides guidance and support on the full range of contracting issues – to talk to a member of our team, call us on: 0203 393 3881
