Working as a contractor through your own limited company can be very rewarding, and not just financially. That said, it can sometimes be a bumpy ride. Carl Roberts, Chartered Financial Planner at RTS Financial Planning, looks at the main hazards and how to conquer them.
Choosing to become a contractor is a major decision, which can transform your career and your life – if you get it right. Most importantly, it can allow you to take some control back over your professional life by choosing where and when to work. Nowadays people are spending less and less time in one job, because they desire change on a more regular basis. So contracting, where you are your own boss and decide what work to take on and what to refuse, has many attractions.
Your basic income is likely to increase, due to the fact the company hiring you has far less to pay out in additional expenses (National Insurance, pension payments and holidays etc), and you can also reduce your losses to tax by taking your income a number of different ways through your limited company.
Those are the main advantages. But as always, there are major potential challenges to take into account too. If the life of a contractor appeals to you, then it’s important not to forget about what is lost when you choose to work for yourself, rather than for an employer.
The 3 biggest risks for contractors
Being out of work
Being a contractor means there is an end date to the work you do for a particular company. It could be 6 months, it could be 12 months but at some point the contract will end. You have fewer rights than an employee and you could even find the contract is terminated early.
There is also no guarantee of you walking straight into another contract. Truly seamless and uninterrupted work is hard to achieve.
Being unable to work
Usually it’ll be down to you and you alone to earn the money. So what happens if you have an accident or suffer an illness that means you cannot work for a long period? As an employee you’d be entitled to sick pay, but as a contractor you have no such right. This means that you yourself need to make contingency plans to provide for yourself during periods where you can’t work.
Worse still, if you were to die unexpectedly, how would your family manage? Many employers offer a death-in-service benefit as part of their overall benefits package – which again is something you miss out on by being a contractor.
Being unable ever to give up work
Recent rule changes for companies mean that every member of staff who is employed is entitled to be enrolled in a company pension. Companies even have to pay contributions towards employee pensions. This is a great way to support employees saving for retirement.
As a contractor you lose this valuable ‘free money’ as the company does not have to contribute to a pension for you. You will therefore need to have your own plan in place as to how and when you will retire, and how you’ll support yourself in retirement.
So now we have the three main risks in sight, what are the answers to each one?
The three safety nets you need as a contractor
1. Emergency fund
Once you have secured a contract, don’t get carried away by the inflated size of your short-term income. Consider a hefty chunk of that money already spoken for.
Be sure to allocate a regular amount of your income into a cash savings account that you do not touch except during periods when you are not working and have no reserves in your current account. This will then act as a safety buffer should you have to wait a little longer for your next contract.
It’s a good idea to keep around 6-12 months’ worth of household expenditure in this savings account so you can cope with any emergencies that come your way.
Don’t worry about the return on cash, as there are still ways to earn a decent interest rate; you just need to shop around and be clever with the use of regular saving accounts. Above all, be disciplined: don’t dip into this fund for unnecessary spending.
2. Protection for you and your family
Without employee benefits to protect you, you’ll have to make all your own arrangements. There are two essential types of insurance that can protect you and your family.
Relevant life cover is a cheap way to set up a lump sum life assurance payout in the event of your death. Monthly premiums can be paid via your limited company and are tax deductible – so that’s a double bonus!
Meanwhile, income protection insurance can pay you a regular income should you not be able to work due to accident or sickness. Again, it’s low cost and very valuable when the need arises.
3. Personal pension
Far too many self-employed people still lack any pension arrangements. You might think you’ll never have to retire, but your older self will most likely disagree.
Setting up a personal pension for yourself is only good sense. It means you’re planning for retirement, you don’t have all your eggs in one basket by relying on your limited company for the rest of your life, and you’re also getting free money from the government through tax relief.
Pension contributions are also a great way to reduce the taxes your limited company pays, as they are free from both the corporation tax and income tax you would otherwise have paid.
Better yet, pensions are now super flexible when it comes to making withdrawals. You can access them from 55 and can withdraw as much or as little as you want. You can take out a 25 per cent lump sum tax free, and the rest of your withdrawals will be subject to your marginal rate of income tax at the time. Not to have a personal pension is truly to miss out on one of the easiest ways to build your savings over time.
One final tip. If you are contracting, it’s important to get the right support network around you so that you make the best decisions at each stage. A good financial planner and accountant will ensure you mitigate your risks and increase the financial benefits of working for yourself.