The allure of being self-employed and running your own business is strong!! The freedom to follow your passion, start and scale a business in the way you see fit, manage your day-to-day activities, take time off when it suits you, and generally shape your own destiny is undeniably attractive.
But with that freedom comes significant responsibility: managing not just your own financial well-being but that of your business too. Whether you’re a sole trader or trade as a company, the onus is on you to make sure your affairs are in order and well managed. And that can take some getting used to!
This is something I’ve been thinking about a lot recently; my wife has recently set up her own business and with it, the need to be aware of how things might change financially and what needs to be considered from a financial standpoint has come to the fore.
In this piece I’ve outlined the main considerations as I see it, although there will be others and everyone’s situation will be different.
Tax
Self-employed people must handle their own tax affairs, including filing a self-assessment return annually. For limited company arrangements – the director(s), also need to manage and report on Corporation Tax, PAYE (if you pay yourself a salary), and possibly VAT, if you need to be VAT registered.
Knowing what expenses you can legitimately deduct is also vital. Home office costs, business travel, software, internet and phone bills, and even training courses can all be claimed as business expenses. For example, if your total business expenses were £4,000, including a portion of your rent, utilities, and equipment, then you can take £4,000 directly off your taxable profit.
You may also be able to claim for depreciation in the value of assets.
The structure of your company also impacts the tax and liabilities position. As a sole trader, you’d likely pay around 20% income tax plus 9% Class 4 National Insurance on profits above the relevant thresholds. Sole traders are also personally responsible for their company’s assets and liabilities. But a limited company structure means the liability is with the company, not the individual, so should the company fail, the individual would not be liable to pay off company debts.
Many directors of limited companies optimise their tax by combining a modest salary with dividends to optimise their tax position.
For example, a salary from £125 per week helps preserve State Pension credits and minimises employee national insurance contributions for the director. Recent changes in the October 2024 budget (in effect from April 2025) have resulted in the employer NI tax threshold being lowered to £5000. Employer NICs are now payable on any employee earnings above £5,000 rather than the previous threshold of £9,100.
The dividends come from post-tax profits (after Corporation Tax) so no national insurance is due on this income
The first £500 of dividends are tax-free, and the rest are taxed at 8.75% for basic-rate taxpayers, 33.75% for higher-rate, and 39.35% for additional-rate taxpayers.
Corporation tax rates vary from 19% to 25% according to the level of profits a company generates.
Whilst running a corporate-based strategy has benefits in paying less tax personally, you should be aware this could adversely affect you if you apply for mortgage or credit in the future. This is because some providers do not include dividends within their affordability calculations.
It’s also important to note that dividends do not count as ‘relevant UK earnings’ for the purposes of tax relief on pension contributions that you make yourself. There may be other ways to make use of your pension allowances, and these should be discussed with your advisor or accountant.
Another consideration is being VAT registered, which is a requirement once your annual turnover exceeds £85,000 in a rolling 12-month period. If you need to register, you will charge 20% VAT on most sales but can reclaim VAT on business expenses. For example, with £100,000 turnover, you’d collect £20,000 in VAT from clients and reclaim £5,000 on expenses, if appropriate, paying £15,000 to HMRC. Being VAT-registered can also make your business appear more established to some clients.
It is important to consider whether you will earn over the threshold and if so, this cost should be incorporated into your invoicing or retail prices so that you don’t have to raise by 20% unexpectedly at some point along the line.
A qualified accountant can help you work out which method of payment is most tax efficient for both you and your company – as this can be quite convoluted.
Protection
In addition to tax and potentially VAT, self-employed people need to think more broadly about issues that can arise around their ‘financial safety net’. This sort of thing can come within an employee benefits package in some shape or form, but the self-employed don’t automatically receive income protection, critical illness cover, or death-in-service benefits.
Income protection insurance typically replaces 50% to 65% of your gross earnings if you can’t work due to illness or injury. It is usually paid tax-free until you recover or reach the end of the term of the policy. You can get “own occupation” cover, which pays out if you can’t perform your specific job.
Critical illness cover, meanwhile, pays a lump sum on the diagnosis of serious conditions like cancer, stroke, or heart attack. This can help cover medical bills, household expenses, or debts and provides valuable breathing space should you suffer from a period of ill health.
Life insurance policies pay out in the event of your death. There are many types available, and it’s worth looking into what level of cover you might need. Life policies are paid with post-tax income, but a relevant life policy is paid through your company’s accounts and is tax-deductible. It does not trigger a P11D benefit-in-kind tax either. For example, a £200,000 Relevant Life Policy for a £50,000 salary might cost £800 a year, saving your company £152 in Corporation Tax. The payout goes to your beneficiaries tax-free.
Pensions
Unlike employees, who are automatically enrolled in workplace pension schemes, the self-employed must manage their own pension arrangements. You can contribute up to 100% of your annual earnings, capped at £60,000 (for 2025-26). But once your income exceeds £260,000, the allowance tapers gradually.
Personal pension contributions also receive 20% tax relief at source, with higher-rate taxpayers able to claim an extra 20% or 25% through their self-assessment return.
For company directors, employer pension contributions are especially attractive, as they’re treated as a business expense, thus reducing Corporation Tax. And they don’t attract National Insurance liability either.
For instance, if your company contributes £10,000 to your pension, that saves £1,900 in Corporation Tax and boosts your retirement savings in a tax-efficient way.
You may also be able to carry forward unused pension allowances from the previous three tax years to make larger contributions.
Balancing freedom with responsibility
In summary, self-employment potentially offers immense freedom, but it also demands discipline. From managing invoicing, cash flow and tax to setting up the right insurance and pension plans, there’s a lot to think about and be aware of.
An accountant is invaluable for compliance and tax efficiency, and a financial adviser can help you design a robust protection plan and pension strategy.
With careful planning, you can enjoy the rewards of self-employment while securing your future, both professionally and personally.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
The Financial Conduct Authority does not regulate cashflow planning.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
Note that life insurance plans typically have no cash in value at any time and cover will cease at the end of the term. If premiums stop, then cover will lapse. Cover is subject to terms and conditions and may have exclusions. Definitions of illnesses vary from product provider and will be explained within the policy documentation.
If this article has raised questions for you, feel free to get in touch!
Andrew Smith
Independent Financial Adviser