When Douglas Kurn quit his 15-year career in sales to strike out on his own at the age of 32, he was taking a leap of faith to pursue his passion for photography.
However, it also meant leaving behind all the benefits of being employed by a FTSE 100-listed company — from the pension to sick pay and access to a cycle-to-work scheme.
Kurn is one of 4.85m self-employed people in the UK, according to the latest data from the Office for National Statistics (ONS) — up 88,000 over the past year. Accounting for 15% of the entire workforce, their ranks have been swollen by the growing number of people in the “gig economy”, who work for companies such as Deliveroo and Uber.
He has also had some knocks along the way. When he was starting out, his flat was burgled and thousands of pounds’ worth of photography equipment was stolen — before he had got round to taking out contents insurance. This year one of his clients went out of business, leaving a £2,000 invoice unpaid.
If, like Kurn, you are thinking of becoming your own boss, here are some points you should be aware of — and suggestions for how you can replicate some of the benefits of being employed.
Whether you work for a company such as Deliveroo or are self-employed in a more conventional way, you need to inform HM Revenue & Customs of your status and register for a self-assessment tax return and national insurance. You will need to pay class 2 national insurance if your profits are £6,025 or more, and class 4 if they are at least £8,164.
It can be a culture shock to go from having all your income tax and national insurance deducted at source by your employer to having to set money aside yourself. Kurn said he manages this by putting a third of his income into a separate account, earmarked for tax.
You must pay tax twice a year — by January 31, for the preceding tax year, with a further payment on account (usually half your estimated tax bill for the following year) by July 31.
If your turnover is more than £85,000 a year, you must register for VAT.
Obtaining a mortgage
When Kurn moved house four years ago, he found it much harder to get a mortgage than it had been during a previous property purchase when he was employed. The lender wanted his most recent three years of accounts; the problem was that the first year had been immediately after the financial crash and showed a substantial dip in income.
“I had to ask my accountant to write a letter explaining it was a one-off,” said Kurn. “The mortgage was eventually approved but the process took months.”
As lenders tend to scrutinise self-employed applicants extra carefully, you should have all your paperwork in order. One or two years’ accounts may be accepted but three years is the norm.
Lenders more inclined to look favourably on the self-employed include Santander, Metro Bank and Kensington, according to mortgage broker Anderson Harris.
The absence of sick pay is one of the drawbacks of being self-employed, but income protection insurance can cover a proportion of your lost earnings over an agreed period — usually three or six months. Your monthly payments are calculated according to factors such as age, health and whether or not you smoke.
You can compare quotes for policies on the comparison site incomeprotectinsurance.co.uk, or find a broker on the website of the British Insurance Brokers’ Association (biba.org.uk).
“Income protection could be critical if workers find themselves unable to work for a length of time due to illness,” said Karen Brolly of the financial adviser Hymans Robertson.
Not everyone chooses to go down this route, however. Kurn, for example, decided against it; the nature of his work made him think it would be difficult to demonstrate how much he had lost by being off on a certain day.
Maternity pay and childcare
Company employees on maternity pay are entitled to 90% of average weekly earnings for the first six weeks. The government had floated the idea of extending maternity and paternity pay to the self-employed, but appeared to ditch the idea this summer.
However, with the state-paid “maternity allowance”, self-employed women can receive a maximum £140.98 a week as long as they have paid 13 weeks of class 2 national insurance contributions before applying for the benefit.
Although self-employed parents are not entitled to childcare vouchers, unlike those in employment, they can take advantage of the government’s “tax-free” childcare scheme. For each child under 12, they can put up to £8,000 a year into a special account and the government will then top it up by 20% — up to £2,000 per child.
One of the main benefits lost when you are self-employed is a workplace pension to which employers contribute. You can and should, however, take out a self-invested personal pension (Sipp). For every £100 you put in as a basic-rate taxpayer, you receive a further £25 in tax relief. Sipps are even more advantageous for higher and top-rate taxpayers.
While the number of self-employed people contributing to a pension was 500,000 in 2011-12, that figure fell to 350,000 in the 2015-16 tax year, according to data published last week by HMRC.
If you are self-employed, you will lose out on some other perks often enjoyed by those who work for large companies, such as subsidised gym membership or cycle to work or salary-sacrifice schemes.
That said, the self-employed do pay lower national insurance. When chancellor Philip Hammond tried to raise class 4 contributions from 9p to 11p in the pound, he was forced by a backbench rebellion to drop the measure.
You can also claim back “allowable expenses”, or work-related costs. If you use your home as an office, you can deduct a proportion of your heating bill, council tax, internet costs and so on, reducing the amount of income on which you must pay tax.
The Institute for Fiscal Studies has estimated that the lower national insurance rates equate to £1,240 a year for the self-employed. However, even though Hammond looks unlikely to revive his reform, other measures have reduced the attractiveness of self-employment. For example, the “flat-rate” VAT scheme, which can be used by those whose turnover is between £85,000 and £150,000, has been less generous since April.
Should you set up a company?
While many self-employed people operate as sole traders, others choose to set up a limited company. This can be advantageous — as a shareholder in your company, you can reduce your tax by paying yourself in part in dividends. The government is making this less generous, however: at present, the first £5,000 in dividends is tax-free; from the next tax year, the annual allowance will drop to £2,000.
Working through a company has other advantages, though. For example, it is a separate legal entity — so the company, rather than you, will be liable for debts if things go wrong.
Yet there are downsides. Sarah Coles of the financial adviser Hargreaves Lansdown observes says you will have to pay both employee’s and employer’s national insurance on any salary you pay yourself. “As a rough rule of thumb, this usually means it’s worth considering once your net profit reaches the higher-rate tax threshold,” she said. “However, it is worth taking specialist tax advice.”
The extra filing requirements also mean extra work. A small accountancy firm will typically charge between £1,500 and £2,500 a year to take care of all the administration required.