In my long list of things to learn, finance has got to be up there. I haven’t (yet) been caught out by anything in particular, it’s been hard to shake a worry that I might be, because I’ve accidentally overlooked something. The longer I do this, the easier this gets but I think I’ll need to complete a full year of freelancing before I feel more certain I’ve got everything covered. There’s a pretty long list of things I’ve learnt so far, either through diligent research or by utilising my husband’s knowledge. My summary so far is something like this:
Charges
Set your day rate on real life – know what you need to live on as a minimum. While you might have to be flexible in the early days as you build experience, set boundaries about the work you’ll take on based on this day rate (or however else you’ve worked it out) and stick to them wherever you can. Bottom line – know your value and don’t underestimate yourself (I’ve already upped the day rate I set myself 3 months ago).
Value Added Tax (VAT)
Realistically probably something you don’t have to worry about. You only *have* to charge tax if you’re large enough to have met the threshold to become tax-registered (you can actually register to be VAT registered at any point but for me it just feels like unnecessary extra complication). At the time of writing this was if your sales (or taxable turnover – see HRMC for more details) are more than about £85,000 a year (or you’re going to reach that in a month – well done you!!). Thankfully, one thing I’m not having to worry about right now.
Bank Accounts
It’s worth setting up a separate account. As a freelancer I’m a sole trader, rather than a limited company, so don’t need to have a specific business account, which is handy because they generally come at a cost. However, what I have got is a separate current account to keep my business incomings and outgoings really separate. Yes, it’s another card, and another phone app but its been incredibly helpful to keep money separate. It means my “profit” is able to sit separately from my day-to-day current account and isn’t in danger of getting mixed up/spent accidentally. I just generally feel more in control. Plus it makes it a lot easier to separate out tax and have quick oversight of what I’ve got in and out from a business perspective, rather than hunting for it in between personal spending. Also, its interesting how different banking apps are, and this other one almost has me converted.
Financial Accounts
You need some way of keeping track of said incoming and outgoings. There are a range of accountancy software options, from big hitters like Xero, Sage and Quickbooks to freebies like Zoho and Crunch (outlined by this handy article by Startups on accounting software options). Some have useful functions like creating invoices which help with admin, but it’s interesting to debate the cost versus return question, and the fact that it’s another account to manage (and possibly another cost). At the moment, I’m sticking to my Excel spreadsheet in part because I used it from the get go so I’ve got confidence in it and partly to keep costs down as I get established. At the end of the day, as a one-woman band, either works provided you keep careful notes of all expenditure and income.
The other thing here is ideally have a tax account – I’ve just used an easy online saver account with my current bank so minimal extra work but again its been a huge help to physically separate out that money and not have it get caught up/spent/missed in day-to-day life.
Expenses
Allowable expenses – this is something I’ve heard people with businesses talk about a million times but I’d never actually tuned in enough to know the detail (not least because it involved tax and all I started to hear was white noise). But a few months in and a bit of research and I’m now clearer that certain things are deemed “allowable expenses” which means that you can take these off your profit (up to a certain amount), and then only pay tax on the remaining amount. And you can do this when self-employed, not just when you have a company. For instance, if you earn £10,000 but you’ve paid £1,000 in travel, office supplies, insurance etc, then you only pay tax on that remaining £9,000. I guess this one is a great example of why keeping good records is important so you can actually outline what expenses you’ve had and prove why some are allowable. This feels a bit of a bonus find while I’ve been trying not to cry over separating out big chunks of money for my upcoming tax bill.
Income Tax
Speaking of which, the big one. Income tax. When I started out, it was one of my biggest question marks – how on earth you handle income tax, what was the process, how does it work, when, what do I need to keep back in readiness? What I’ve learnt so far is goes something like this:
What to pay
You can currently earn about £12,500 a year (at the time of writing https://www.gov.uk/guidance/rates-and-thresholds-for-employers-2022-to-2023) tax free as part of what’s called your “personal allowance.” After this, you’re charged at different tax rates for the amount of money you earn over this allowance. If I aim to earn a max of £37,700 it’s simpler to work out as you only move into the first tax bracket of paying 20% tax on anything you earn over your personal allowance.
How to pay
You need to complete a self-assessment tax form. Technically anyone can complete them but thankfully I’m somehow married to an accountant.
When to pay
You need to register in October and complete an online return in Jan while paying the tax you owe, which gives me about 5 months to get my head around everything (and ensure I’ve got my tax money ready to go)
Income Tax Part 2
As if crunching the numbers yourself and physically moving money across to your dedicated tax account ready to pay the bill you owe isn’t painful enough (its somehow worse to do it yourself rather than just see it gone long ago on a wage slip) – there’s a bonus bill! This one would massively have caught me out if I hadn’t had insider-intel via my husband and that’s that there’s also something called payment on account. It’s basically pre-emptying what you’ll be earning for the next financial year and paying this in two instalments (Jan and July) across the year. This feels brutal. I’ve heard grumbles about this from other freelancers – partly from a logistics point of view, that you’re paying tax on money you haven’t yet earnt (so how are you meant to have the money to pay?!), and also because of the fluctuating nature of freelance – if you have a good year, you’re effectively penalised and could be hugely out of pocket if the following year doesn’t match the last, and you’re likely in for a long wait on a rebate. For that money you didn’t have to start with.
Tax Summary
So if I aim to earn a maximum £37,700 in a year, I would bank £12,500 ish without paying tax, and then I would pay 20% tax on the amount above my personal allowance. £37,700 income -£12,500 personal allowance = £25,200 taxable.
20% of £25,500 is = £5,040 tax bill for this year
If I hope to earn the same amount again next year, I need to bear in mind I’ll have to pay 50% of that in January on top.
50% of £5,040 = £2,520 pre-payment on my tax bill for next year
Maximum pending tax bill in Jan = £7,560. Ouch.
National Insurance
Done through the same self-assessment process for income tax. It seems that as a self-employed person I’ll be liable for Class 2 national insurance at £3.15 a week and Class 4 which is profit-based of 10.25% on profits between £11,909 and £50,270.
So if I stick with my £37,700 figure, my national insurance liability is likely to be 9 months x 4.3 weeks = 39 weeks @ £3.15 = £122.85 for Class 2. Then let’s just call the £37,700 pure profit for ease, 10.25% of £37,700 = £3,864.25.
Maximum pending national insurance bill in Jan = £3,987.10
Pension
To match my previous employment conditions of 11% of my income going into my pension between myself and an employer seems terrifying. I’ve factored it into my income ambitions, even if it might take a little while to fully match it. Pension contributions are tax-deductible, which means you don’t pay tax on them. So if I’m able to pay in, I get full benefit of that money, rather than having it as profit which will be taxed.
Something else on the to-do list is to work out where to keep my now multiple pensions, whether to amalgamate, whether to do passive management or pay for active management at more of a premium but potentially higher returns. It’s an important one on the to-do list but I don’t know when I’ll have the emotional resilience anytime soon to properly research and decide that one.
Readiness for January
There is a bit of a complication that I’ve been employed for a chunk of this financial year and so have used some of my personal tax allowance. I need to interrogate my P45 and establish what’s left in my “tax-free pot.”
For now, I’m going on some basic numbers of:
- Maximum pending tax bill in Jan = £7,560.
- Maximum pending national insurance bill in Jan = £3,987.10
- Total = £11,547.50
This is based on quite a lot of “ifs” and I’ve erred on the side of caution and gone with what I think will be maximum amounts just in case. What’s useful day-to-day is that the total bill I’m facing works about at almost exactly 30% of the income I’ve based the calculations on. Bearing in mind, that tax bill will be reduced by my allowable expenses, I’m going with 25% from each invoice is going over to my tax account in readiness.
Crunching all the numbers has felt quite a big task but with the “whole knowledge is power” perspective, I now feel I at least understand the basic tenants of what I have to do to stay inside the law, pay what I owe and be able to stand up to scrutiny. Even if the bill feels toe-curlingly painful right now.