I’m regularly asked how I set myself up as a freelancer. There’s a bunch of things you can do to maximise your income and minimise any payments you need to make. All of these things are legal, and within the framework set out by the UK government. You should use these to their maximum potential.
Over the years I’ve gathered this info from all over the net, so rather than repeat myself it’s here in black and white.
If all the facts and figures confuse you, consider this factually correct comparison showing your freelance options;
|Sole Trader||Ltd Company|
|VAT Registered (+20%)||N/A||+£6,000.00|
|VAT payment to Govt (-13%)||N/A||-£4,680.00|
|PAYE i.e. Tax and NI(-29%)||-£8,700.00||N/A|
|Corporation Tax (-20%)||N/A||-£6,264.00|
|You walk away with…||£21,300.00||£25,056.00|
Get an Accountant
If you go self employed and set up as a Sole Trader it is possible to do all the legal Tax Return paperwork yourself, send it off to HMRC and then pay a large sum of money for your hard work down the line. However an Accountant will know a heck of a lot more than you about how the system works. The tax system is a beast, afterall. For example, you might have mislabeled something in your own paperwork or assumed you weren’t entitled to something. An Accountant might know to move some of your figures into a different category in order to maximise certain tax breaks or levies, etc. Although an Accountant can be expensive (ask other freelancers who they use and don’t be afraid to shop around) you will most likely still save money at the end of the financial year due to their knowledge. In the long term, an Accountant is worthwhile. Of course, this depends on the industry you’re working in and how many different places you end up working for as a freelancer.
Set yourself up as a Limited Company
Some freelancers start of as Sole Traders. There’s no problem with being a Sole Trader. It can be the “easy option” when it comes to figures and using your brain. Plus you only have to submit one Tax Return, and some people can do this themselves. However, if two people earn the same amount of money with one as a Sole Trader and the other a Ltd Company, the Ltd Company will end up with more money at the end of the year for having done nothing more. Money for nothing (chicks for free). More on this below…
Use a Flat Rate Scheme
On average, PAYE and Sole Traders pay around 27-29% of what they earn on National Insurance and Taxes. So for a Sole Trader earning £10’000, they pay out £2’900 on National Insurance Contributions and Tax, and walk away with £7’100. Whereas a Limited Company on a Flat Rate Scheme, most people will pay an absolute maximum of 20% on any profit (sometimes less, depending on your industry). Using the same numbers as above, a Ltd Company making £10’000 would only be taxed £2000, and therefore you would walk away with £8’000 profit, and your “Company” doesn’t pay National Insurance Contributions. So that’s £900 more than a Sole Trader. Moreso, that 20% tax deduction is only on “any profits”. So, in theory if your Ltd Company made £10’000 but you spent £2’000 on a business laptop and a further £1’000 on petrol over the year, that means the company only profited by £7’000 due to expenditure. Therefore you’d only pay 20% of that, and therefore pay £1’400 Flat Rate Corporation Tax. The more expenses your company submit, the less Corporation Tax you pay. Pay less, keep more. And there’s a few more expenses coming up…
Register for VAT
A LOT of people don’t do this, but you should. Legally you have to register for VAT if you earn more than £79’000 per year in sales. This is known as the VAT Registration Threshold, and it changes each year (£79k was 2013). But there’s still a good reason to register if you earn less than that. Basically, your Accountant will contact HMRC and get you “VAT Registered”. You’ll get a VAT Number to add to your invoice. It means for every invoice you submit, you add 20% more. So what’s the benefit of that? Well, the government only ask you to pay back 13% on the overall invoice (and only 12% for your first year!). So for £1’000 worth of work, you’d invoice for £1’200. The government ask you to pay £144 (12% of £1200). The Ltd Company keeps the difference. In that example you’d make an extra £54 on a £1’000 invoice. For nothing more than being VAT registered. Not a lot, I guess. But if you earned £2’000 every month, that’d be an extra £1296 over 12 months. So that’s your accountancy fees? A holiday? A new car?
Get a Business Bank Account
Keeping your Ltd Company income separate from your personal affairs is a bonus. It makes it so much more easier to keep track of your money, and easier for your Accountant when you sit down to do your books at the end of the financial year. Some Business Banking comes with fees, but the majority of the big names will waiver these fees for one or two years. A couple of banks won’t charge you anything at all. When I say “fees”, I mean for example a bank transfer may cost you 10 pence. Some banks give the option of being all digital, or having paperwork. It appears the all digital, all online, options mean there are no charges.
Set up a separate Business Savings Account
This is one of my secrets. I hear from far too many people who’ve spent every penny of the money they’ve been paid. They’ve forgotten to take into account that not all that money belongs to them. Some of that money belongs to the Tax Man. They find themselves scrambling for work in order to pay the lovely people at HMRC who kindly sent a letter stating how much they owe. Here’s the secret; I transfer 33% from EVERY invoice that my Business Account receives into a Business Savings Account and forget about it. That way when it comes to paying my VAT (every 3 months) and Corporation Tax (annually), it’s all been safely tucked away in another account that I wasn’t even looking at. What’s left in the Business Account after transferring over 33% is effectively your money, and you pay your salary from it. Plus you earn a tiny bit more on top of the Business Savings Account, depending on the savings percentage offered by the bank. You’ll also find there’s probably money left in your Business Savings Account after all yours bills have been paid, as the 33% put away is more than required. Bonus! Transfer the money out the Business Savings Account at the beginning of your financial year (pay yourself a “dividend”, more below) and start again!
Pay yoursef a Minimum Salary
Everyone is entitled to a Personal Tax Allowance. This is the amount of income you can earn that’s tax free. Each year there’s a different Personal Tax Allowance. Your Accountant will tell you what that amount is, and you’ll use that number to divide into monthly payments that you pay to yourself. By not going over the limit you are still eligible for Statutory Pension but don’t have to pay NI contributions. Not to mention your “salary” is a company expense, and once again reduces the amount of Corporation Tax you’ll pay at the end of the year (hence why you go right up to the maximum limit).
Pay yourself with Dividends
A Dividend is effectively a payment from your Ltd Company (after tax) to shareholders on any profits made. As you are the Director of your Ltd Company and the only employee (and therefore shareholder), you can “pay” yourself up to £24’000 worth of Dividends out of your Ltd Company profits. What does this mean? It means you earn a low value “salary”, but you top up your income with an additional £24’000 worth of Dividends which aren’t further taxed. As an example, if the Personal Tax Allowance is £10’000, that works out to be a monthly salary of £833. But if you’re monthly outgoings are £1’500 you can pay yourself a Dividend of £667 to make up the difference. Dividends have to be “declared” and written into Company Minutes, although these Dividend Counterfoils will likely be completed by your Accountant at the end of the tax year. It’s not difficult (once you know).
Set up a Pension
When you leave the safety of fulltime employment, it’s likely you’ll no longer be paying into the pension scheme you set up with your old employer. That investment will still stand when it comes to your retirement, but you’re no longer paying any money into that pot to help secure further finances. By setting up a Pension you are giving yourself financial security for when you retire. The contributions will come from your Ltd Company, and are therefore an expense (which in turn lowers your Corporation Tax. Again). It’s possible to be eligible for tax relief too. This can be anything up to 49%, which means for every £100 invested into your Pension, you’re only paying £51 and the government make up the difference. Shop around for pensions. Stakeholder Pensions are popular as you can vary the amount you pay in each month, starting with a minimum of £20.
Using the above tips you’ll be a Director of your own Ltd Company. You’ll earn the maximum amount of money you are entitled to, and pay the minimum amount of tax as required by Law. You’ll still be entitled to the state pension, and have your own pension being paid from your company. You’ll have an accountant who’s fees are covered by the savings you’ll make by being a Ltd Company, and you’ll make a few percent more on top of your invoices by being VAT Registered. You’ll have a Business Savings Account that holds more than a chunk of your income to pay the bills and VAT, and after all payments are made will leave you with a small bonus each year.
It’s a winning formula!
If you have any further tips, feel free to leave a comment.