Managing your finances when you're self-employed

Angellica Bell: Hello, and welcome to Rewirement, the podcast where we help you make the right connections to create your brightest financial future, brought to you by Legal & General. I'm Angellica Bell, and during this series I'm trying to find the answers to as many questions about managing money as I can. To do that, we found people from all over the country and from different walks of life who need information about their finances. Asking things like, how much should I be paying into my pension? Where's the best place to put my savings? Or what kind of insurance do I need for peace of mind? We've paired them up with some top financial experts to give them some guidance. And we get to listen into those conversations, which means I hope that we all learn something along the way.

Now, if you work for a company, big or small, the chances are that you get paid annual leave and sick leave, you'll be enrolled in a pension scheme, you might even get private healthcare. All your national insurance and tax payments are calculated for you. And if you think you'd like to buy a house, you have a nice collection of pay slips to prove your salary. But more and more people these days are working for themselves, freelancing in the gig economy, starting their own business and being their own boss.

Now, it can be exciting and rewarding, but there is a downside. All the benefits of having an employer disappear, no company pension scheme, no payroll and if you don't work, you don't earn. Sometimes people are so busy keeping their business going, they don't have time to make sure they've got their own finances sorted. Today we're meeting someone who might identify with that problem. So let's welcome, Jessy, hi.

Jessy: Hi.

Angellica Bell: So tell me about your business. What is it and how's it going?

Jessy: It's going well.

Angellica Bell: Which is great.

Jessy: Yeah, minor blip with COVID, but we're doing well. So I run a travel consultancy, helping small hotels and travel companies get their name out there.

Angellica Bell: So you seem like a real entrepreneur then, as I understand it. But you have a few worries, because obviously you are working on your own and getting your business out there. And like you said, we had a few blips in life, so you never know where things are going to be.

Jessy: Yeah. COVID was a big blip. Obviously, travel got shut down within 24 hours. I lost all my clients within 24 hours.

Angellica Bell: Oh my God. How did that make you feel?

Jessy: Didn't made me feel great. I'm not going to lie. It was a real shock to the system. We'd obviously just got the business to a really strong place. It was way worse for my clients than it was for me. Obviously my income stopped immediately, but I didn't have loads of overheads. But I was suddenly completely unemployed, needed to figure out how to pay my rent and it was like that probably for about five to six months.

Angellica Bell: And I think this is what we're highlighting with this. When you're working for yourself, something happens, you don't know what's around the corner. Then all of a sudden, all that business, all the forecast you're expecting for the next few months, gone.

Jessy: Completely gone.

Angellica Bell: Okay. Well we're through that, and business is in a good place. It's obvious that you're very entrepreneurial, you are driven and you're successful. You got that bit sorted. But there's another side that you haven't got sorted, which lots of people feel the same about, but don't necessarily admit.

Jessy: Yeah, absolutely. I mean the business is doing well. Creatively I'm really confident. If you want to open a hotel, I'll tell you exactly how to do it.

Angellica Bell: I'm going to call you when I do.

Jessy: Yeah, please do. But, I'm 33 years old. I own my own business. A lot of my friends are a lot further ahead than me owning their own houses. They've got investments set up, and I'm just not in that position. It feels like everyone seems to know the answers, but I absolutely don't and a lot of people are giving me different advice from all over the place. It's just a bit confusing. Be really good to have some advice that can just help me along the way.

Angellica Bell: Well, Jessy do not worry because help is at hand. We found someone to give you some guidance on finding your way through the money maze. Peter Komolafe is a YouTuber, a podcaster and TV contributor, and a qualified financial advisor. He's really, really good. And when you met, he started with some reassurance.

Peter Komolafe: Look, it's completely natural for people to feel as though I have no idea where to begin. We don't get taught it in school. This is where I'm going to give you hopefully a little bit of clarity around some of your areas. So savings, pensions, property. Do you have a priority among those three? Which one pulls you the most?

Jessy: I obviously get advice from a lot of my friends. Most of them own property and they're all financially quite savvy and I don't, I rent a property, and it was always meant to be property, I think. And then obviously you sit next to someone at dinner and they go, you haven't got a private pension, have you lost your mind? And you start panicking.

I don't think I even have a state pension, but for me it was always savings that were for a property. And then it was also going to be sorting out a private pension. But then recently I've been told, why are you worrying about a pension, pensions aren't going to exist when we are old, put your money into property. That's the cleverest thing to do.

Peter Komolafe: That gives me really good insight. There are a lot of misconceptions when it comes to pensions. And oftentimes the conversation that people will have is, you do property or pension, one of the two. I think you can do both. And there's nothing wrong with doing both. It's going to be about prioritising, which one is the most pressing thing for you? I think the main questions then become, that you'll be asking is, okay, so how do I get a deposit? Can you get a mortgage as a self-employed person? How does that all work?

Jessy: Can I ask, am I self-employed? As a director of my own business, does that technically still qualify me as self-employed?

Peter Komolafe: Well, technically you are employed because you're employed by your own business. So you'll be employed per se, but you are a director of your business, so you're taking dividends, and getting an income as well. The mortgage side of things, you will be able to get a mortgage, no problem, even if you are taking dividends. But I think the key difference between being a self-employed business owner and employed is the fact that when you go and apply for a mortgage, from an income point of view, what they do is they take your salary, and they times that by a multiple.

As a business owner, if you're taking dividends and income, then the same principle applies, but it's looked at and treated differently. So typically how it works with mortgages is you will take your earnings per year, and you will times that number by four, there are some lenders that are doing more.

Now you've got some lenders that are doing seven times your salary, but there's a distinction here within salary and dividends. So salary is what you get paid. Dividends will be accounted in a different way, but depending on what you are taking from the business and how you're taking it, it shouldn't be a problem, but it may need some pre-planning and some pre-work to make sure that from a salary point of view, you are taking enough with dividends being accounted for as well. So the mortgage companies will want to see a track record.

So they will typically ask for about three years in evidence of salary income. So again, this is where if we are planning this and we are putting a marker in the sand for this to happen in X amount of time into the future, the groundwork needs to go into it with all of those considerations as well.

The dividends can count towards it, but it depends in what shape you're basically taking it. And this is where your mortgage advisor will be able to guide you in exactly how to actually structure it. So maybe this is a conversation as well to have with the accountant and say, look, this is the plan I want to buy property. I know that I need to show more income. I still want to be taken dividends, which can be accounted. How do I structure this correctly in order to do that? But if you're going to have maybe a one or two year timeline to actually make this happen, it's putting the groundwork with all these considerations in mind as well.

Jessy: I think also just from a self-employed point of view, the thing that I've really struggled to get my head around, I don't really have any personal savings, but I have got about 35 grand in the business, which is just sitting there. And where I struggle is obviously it's my business, it's my service. And it's my turnover, in my head, I'm like, but that's my money. Why can't I use that money to get on the property ladder? So it's understanding as a self-employed person, that real difference between why that money needs to stay there, and I can't use it from a personal point of view.

Peter Komolafe: As a self-employed person. One of the things that you have to start thinking about, and this is something I've had to make a clear distinction on, my accountant has hammered it right into me is, the business entity is my business, but the business entity is an entity of its own. So whilst the money might be in your business account, yes, it's your business, but the money is the business entity's money. And in order for you to transfer out of the business into your personal account, there needs to be a transaction that takes place. And when that transaction takes place, tax also needs to be paid upon that as well.

It's a very, very difficult thing to come to terms with. And I look at it sometimes and think, do I really want to pay tax on an amount of money that I want to take from the business when I've worked so hard for the business, for it to get the money that's in the business, it could be quite jarring in that way. And I think as well with that, you also need to think about how you're going to use the money to actually make more money in the future, and actually grow that money from a business point of view.

Jessy: Because realistically that pot of money is money that I've earned, and that I want to use to secure my future. If so is it better for me to start drawing more dividends out month by month and taking that money and putting it straight into a personal savings account or leave it there to continue to accumulate money in the business. And then when I'm ready, pull it out.

Peter Komolafe: It really depends on whether you feel that you are going to need capital within the business. So are there any capital intensive projects or anything else that you know, for a fact that there might be a little bit of capital that you need to have in the business?

Jessy: No, I would never draw it all out, but the thing that I can't get my head around is the fact that it's there and that I can't use it, when I'm sitting here watching all my friends buying houses and I'm like, oh, I've got that money there, surely it should be doing something clever, and it's not, it's just sitting there.

Peter Komolafe: Look, the tax petition is the biggest thing to consider. If you take it all out, are you happy with the level of tax that you're going to have to pay, because that's going to be the main consideration.

Jessy: And would it be a really hefty amount of tax?

Peter Komolafe: Well, that depends on how you take it. Whether you take it as salary, whether you take it as dividends, you need to have a look at the scenarios with your accountant, to say, look, if I increase my dividends by X amount per month, in order to be able to draw this money out of the business, what does that look like from a tax point of view? If you can take it all out, and it's going to cost you, I don't know, a couple of thousand pounds versus maybe a few hundred pounds, it's a big decision to make because it's a big difference. And you need to know what those numbers look like. If you saw a property that you were like, I absolutely want this and you could take the money tomorrow.

Would you? Maybe, if it was something you were really, really bought into, like, I really like this property, it's an opportunity, I want to do it.

Jessy: Quite like to buy a camper van, but I don't think that's going to make me any money.

Peter Komolafe: I don't know. Used vehicles these days, the market for those are very, very healthy.

Jessy: Because then I'm like, well, it's a camper van and I work in travel. So it's a travel cost.

Peter Komolafe: Could you do it as a business expense? Possibly. That's a conversation to have with your accountant. One thing we haven't actually spoken about is the fact that at the moment you are mid-30, so there is actually help out there via the government. So for example, things like a Lifetime ISA. Lifetime ISA will help you as a first time buyer to get to a deposit a bit quicker. So essentially how this works, is with a Lifetime ISA, you can contribute 4,000 pounds every single tax year. And for every 4,000 pounds that you put in, you're going to get a thousand pounds free from the government for the purpose of your house deposit.

There are some limitations around where you buy and property prices. I think the max property value you can buy is 450,000 pounds, within the London area. It's a good vehicle to use as a potential to get you towards a house deposit a little bit sooner.

And obviously when it comes to pensions, one of the unfortunate things is that as a business owner, you don't have the automatic cover that you're going to receive than if you worked for a business. You walk into a business, a pension is offered to you. As a business owner, it's your responsibility to provide that for yourself. And it's something that a lot of business owners have to really be intentional about setting up. But it's a really important thing to make sure you have set up within the business.

It can be a business expense, so it can help you reduce your corporation tax essentially. Okay, now there is something called, (inaudible) was introduced and that's where if you were an employer, if you've got employees in the business, technically speaking, according to legislation, you should be paying in a certain amount into your pension every single year.

So the number is 8%. So that is 3% from the business, from the company, then 5% from you as the employee within the business. So that is the minimum that you could start with. Your retirement may not be for 30, 40 odd years. So any money that goes into a pension, you want it to be working as hard as possible for you. And obviously it is an investment. So your investment will go up. It will go down over that period of time.

As long as you're happy with the notion that over the long-term, it should perform better and get you really, really good returns over that long-term piece. You're able to manage the investment risk in how you look at it. You can review it every single year if you need to, but doing it via the business does make sense, because it can help you reduce your corporation tax.

Jessy: Because I've just hired my first employee, literally 10 days ago. But so am I right in thinking that from the business, I need to look at a pension twofold. So I need to look at it in terms of my private pension that I set up, that's going to be the one that's working really hard and I put most of the money into. And then, and did you say auto- enroll-

Peter Komolafe: Auto-enroll.

Jessy: Pension, and I need to set that up for both me and Laura, and I need to put 3% of our salaries into that. And then Laura can opt in as to whether she adds 5%.

Peter Komolafe: That's right, yeah. So if you are having conversations with your account, your account can guide you around how you set that up. A lot of businesses will just do something like Nest for example. It’s a really, really simple way to get it done. They are very, very helpful, low cost. It's a good place to get started. My limited company, I pay into a Nest pension because I had set one up for myself, but I also have a private pension as well.

Jessy: With who, who should I set up a private pension with?

Peter Komolafe: There are lots of providers out there. I mean, it depends on what you prefer really and what you like in a provider. One of the bigger things that you really want to be looking at is, fees, cost. Those will be a really important point for comparison. Some will be more expensive than the others. Although there are caps on how much providers can actually charge you, but how they also invest the money in a pension as well might be really important to you. If you have certain ethical views, some providers will have that, others won't.

So when we talk about state pension, you've worked at places previously, you're running a business currently, you will be accumulating national insurance years, that will go towards your state pension. So it's just really important for you to continue to make those contributions and acquire national insurance contribution years towards that state pension.

Jessy: We've nailed the pension. Apart from I guess, my most obvious blunt question is realistically, how much should I be putting into a private pension per month?

Peter Komolafe: So try and work to the minimum. So 8%.

Jessy: Of my turnover or my salary?

Peter Komolafe: Of your salary. I would say in terms of maximums, it's really up to you. Pensions are such that you can be flexible now, so you can pay in monthly. But also if you have a really good year in the business, you want to throw in 5,000 or 10,000 here and there. You can also do that.

Jessy: When I was saying earlier, oh, everyone was saying that pensions aren't going to be a thing when we're older, surely any money that I have saved into a private pension pot, that's my money. And I will get it at some point?

Peter Komolafe: Absolutely, yes you will. There's a lot of misconceptions about them saying that it's not going to be around, and it's going to be a waste of time. I always say to people, it's best to have it as your back-up plan. It's not going to hurt you if you pay in a hundred pounds, 200 pounds, whatever that minimum might be in per month, just trundling away, working away for you over the course of 30, 40 years, because that will amount to a pot of money. First and foremost, under the current legislation, you hit 55.

If you have a hundred thousand pounds in your pension pot, you can take 25 grand completely tax-free and people will either use that to pay off their mortgage or go and buy a deposit for a rental property, depending on how big your pot is.

But with this as well is pensions, people often think that your pension is going to die with you. Like you can't pass it off to family and you know, kids and beneficiaries, actually, that's not true. You can pass it on. And for the most part you can pass it on without inheritance tax up until a certain age. So 75 is the main point that where it cuts off.

But if you imagine you have a business that you might sell or you have other assets that you might sell, most of those things will be part of your estate for inheritance tax if you become inheritance tax liable, but your pension sits outside of that. So it's a really nice tax efficient vehicle to actually use. And like I said, as a plan B, there's nothing wrong with having it, just trying it along in the background to give you that back-up plan, if you will.

Jessy: But plan A should be to buy a house.

Peter Komolafe: I think for you, plan A because it is so immediate, it will come quicker than retirement. And think about it this way. When you get to retirement age, you probably don't want to be in a position where you have to think about rent, and be thinking about the inflationary rate of rent as well. You don't want to get to 60, you've got to pay 800 pounds per month in rent, the following year, it goes up to 850. You don't want to be in that position. You probably want to be in a position where you have no mortgage. You own your property outright. It's an asset that if you wanted to downsize, you can release some cash from it. It will give you more options later on than not doing it at all.

Jessy: So I guess my final question is based on the fact that I'm obviously self-employed, so that doesn't cover anything like sick leave, paying my team's salaries if anything was to go wrong with the business, I don't have business insurance. Should I have business insurance?

Peter Komolafe: This is one of the biggest challenges that a lot of self-employed business owners actually face. If you don't work, the business doesn't work really. And it's a big, big risk. Insurances are there to help with that. There are things like key man insurance, it covers the key person in the business. You can pay for it via the business account. So it's a business expense and what that does, it covers you as the key person within the business. So for example, if you're unable to work, accident, sickness, that kind of stuff, it can then step in to cover the financial hit that the business would take for you not being there.

It's slightly different to general business insurance, which is more about if you're going to a public exhibition. And one of your stands falls on someone. That's more about public liability. These are very specific insurance policies to look at. What would be the impact of say for you for example, Jessy, not being able to operate within the business now with a staff member, keeping the business afloat, so it doesn't die.

Jessy: And that would pay, for example, my staff salaries.

Peter Komolafe: You can have policies set up where actually the payment comes into the business, how you then use that payment is down to you.

Jessy: Okay.

Peter Komolafe: It is worthwhile exploring those kinds of things. Particularly if you are worried about the fact that look, if I'm not in the business for a month or two months, how am I going to replace the income? How is the business going to survive?

Jessy: And roughly what are the costs for things like that?

Peter Komolafe: It all varies depending on what level of cover you go for.

Jessy: Right.

Peter Komolafe: So oftentimes a lot of these will have a monthly premium that it will, say for example, if you are responsible for 10,000 pounds worth of income in the business, you can have an equivalent of that basically covered. So it depends on what level of cover you essentially need. They're not always as expensive as most people think they are, and if you're going to do it via the business, it becomes a business expense. So again, it's deductible, it will help you reduce your corporation tax as well.

Angellica Bell: Well, Jessy, you and Pete covered a lot of ground. And I know you also spent some time talking about saving and investment options as well, but what were the main things you took away from that session?

Jessy: Oh, so much. And I'm so grateful. One of the things that the conversation gave me is a little bit of confidence that I actually do basically know what I need to do, but it's just having the confidence to be able to go and do it. I think also a big thing for me was really defining what I need to do for a personal point of view and also what I need to do with the business. And the fact that I can start paying into a private pension out of the business. That's amazing, so yeah, I've got homework and I need to get to it quite quickly.

Angellica Bell: Well, brilliant. Listen, thank you so much for telling us about your financial journey. There are so many people who have learned a lot from hearing your conversation with Pete, and also your own story, which I know is going to continue to grow.

Jessy: Aww, thank you. Hopefully.

Angellica Bell: Good luck.

Jessy: Thank you so much.

Angellica Bell: Being your own boss, running your own business. I mean, there's so much to think about. It can be quite overwhelming and to give us some key pointers on how to handle your own money when you're self-employed. I'm joined now by Matt Frain, a director at Legal & General Financial Advice. Now, Matt, hello.

Matt Frain: Hi Angellica. How are you?

Angellica Bell: Yeah, really good. And I'm really interested in this topic because I'm self-employed myself. So can you tell us what are the key points we can learn from Jessy's story?

Matt Frain: This is a really interesting and really important topic. The UK has nearly 5 million self-employed workers, of which you're one, which is around 15% of the total workforce.

Angellica Bell: I mean, that's a high stat, I didn't think it was that big.

Matt Frain: It is. And I think there's been a move towards that in recent years, especially with COVID, a lot of people wanting to be their own boss, so that figure has increased. So there are a significant amount of people who will be in a similar position to Jessy and will resonate with the things that we're talking about here and picking up from Pete and Jessy's conversation. The first thing I want to talk about is emergency funds.

You should always have some form of emergency fund in place. Now these should be readily accessible funds, so money that you can get your hands on easily, that are available to you at short notice. This is really important for everyone, but arguably more so for the self-employed.

Angellica Bell: Yeah, just a pot where you don't touch it and gives you that security, especially when you aren't getting work all the time, if it's up and down.

Matt Frain: That's it. It's all about security. So it can be the unexpected things in life, like your boiler breaking for instance, but it can, especially if you're self-employed cover periods of time where you might have some form of income shortfall.

Angellica Bell: And Matt, a lot of people I know who are self-employed, always say ‘I don't have a pension, the house is the pension’ and stuff. So what would you say to that? And are there pensions that they should be putting money into?

Matt Frain: Thankfully personal pensions are very easy to set up, and payments can begin from a relatively low base. So they're pretty much accessible to all. They're also very flexible. So you can alter the contribution levels that you make, and you can also stop and start payments. Just a word of caution, if you are reducing or stopping payments into a pension, then there will be a knock on impact on your overall level of pension savings. But the important point here is that you do have the flexibility to do that to suit your circumstances.

The other great thing about pensions that can be really important to the self-employed in particular is the ability to make lump sum payments. When you're self-employed, as we've just discussed, you might not know how much money is coming in on a regular basis, how much you can comfortably commit to pensions until the end of your financial year.

So one strategy that you could employ is to make regular contributions at an easily affordable rate, the rate you are comfortable at and then make a single lump sum payment when completing your financial year end, essentially topping up the regular contributions that you've been making. Jessy also mentioned that she wasn't sure she qualified for the state pension. So I just wanted to touch upon that quickly. Now state pension entitlement is based on national insurance contributions or credits towards these such as being in receipt of child benefit.

Under current legislation, you need at least 10 years of those national insurance contributions to qualify for any state pension at all. And you need 35 years to get the full state pension. So you need quite a long contribution history. If like Jessy, you're not sure, you can check your current state pension entitlement by visiting the government website, www.gov.uk.

Angellica Bell: I'm going to get on that. One thing that stood out for me from that conversation was talking about insurance. You do need to be protected. It's vital, isn't it?

Matt Frain: Yeah, protection is a huge area, particularly for the self-employed. We heard Jessy and Pete talk about key man insurance, which is one consideration for the self-employed and for business owners in general, the other main areas of protection are life insurance, critical illness cover and income protection. Life insurance will pay out upon death and is generally used to clear debt such as a mortgage being the main debt that we normally have and all to provide money to loved ones.

So to make sure that your financial dependents are set up and can continue their standard of life. If you were to pass away, critical illness will pay out upon diagnosis of certain illnesses and is generally used again to clear debts like the mortgage, but can also be used to provide any adaptations needed due to the impact of the critical illness. So that could be things like putting in stair lifts, widening doorways or anything else that may be necessary. Or critical illness can simply be used as a cash buffer whilst you are undergoing treatment.

So it just provides that comfort that you're not short of cash at a time when you've got a lot of other emotional burdens. Finally income protection. So last, but definitely not least on the list, this provides a regular income stream if you are unable to work due to accident or illness. One of the key points to highlight here, Angellica is that these policies are designed to compliment each other, not to be an either or option. If you're self-employed, you won't have any form of cover from an employer and you are likely to be more susceptible to immediate loss of income if you suffered a period of ill health.

So I would strongly recommend that anyone who is self-employed looks into getting the right level of cover in place because it's that important. And if you're not sure what cover you need, then please speak to an expert about the range of options available to you.

Angellica Bell: Some great advice there, Matt, appreciate that. Thank you so much. And of course thank you to Jessy for sharing your story. Now don't forget that wherever you are in life, you can find lots more resources and information on Legal & General's website. Just go to legalandgeneral.com. For instance, if you're thinking of buying a property, like Jessy, there's the handy guide, what to consider when buying a house. There's also useful information if you're looking to set up your own pension, you can find links in the show notes.

I'm Angellica Bell and join me next time on Rewirement, when we'll be looking at the gender pensions gap, we'll be asking why is it that more women than men find themselves without enough money for a comfortable retirement and more importantly, what can they do about it? Follow this podcast on your favourite platform so you don't miss an episode and I'll catch you then.