It’s not breaking news that prices have been rising rapidly in the UK over the last year leading to inflation hitting a 40-year high, now comfortably sitting at 10.1%. This blog can’t do much to aid with the financial crisis the UK is facing, but we can provide some hope and advice regarding how we can help you minimise the impact. Contractor UK explored this topic in detail with our very own Jo Elwell from Brookson Financial.
Everyone is feeling the pinch, but contractors are particularly vulnerable.
Contractors with personal service companies are particularly vulnerable due to their personal finances often being intertwined with their business operations. This is where the first financial risk reveals itself. If you’re a contractor and your accountant or financial service adviser is not an expert on the legal framework and tax rules regarding the finances of the self-employed, you may receive inadequate advice. So, whether you’re new to contracting or have been doing this your entire life, make sure you have a financial adviser who is an expert in this area. It will save you the headache down the line.
So, what are the main personal finance beartraps and how can contractors avoid them?
Expenses and Energy
Before discussing income and savings, it’s worth discussing the pending hike in corporation tax. This increase in corporation tax only impacts profits over £50,000, if you fit into this bracket, then listen up, this is for you.
We would recommend offsetting any relevant rises caused by the current cost of living crisis through expenses. Business travel, will, of course always come under this, but a lot of contractors are still unaware of other opportunities to reduce profits. For example, claiming on energy bills for a home office, this may be worked out as a portion of the household bill, or if you happen to have an outhouse it could be worth installing a separate supply.
Dividends and Salary
One of the most tax-efficient means of taking income from the profits retained by limited companies is in the form of a modest salary (so as not to attract income tax) and dividends. At the time of writing, dividends have a tax-free allowance of £2,000 followed by a sliding scale of tax at the dividend rate. But most importantly, dividends do not attract National Insurance Contributions.
These are relatively tried and tested techniques for limited company directors, but there are other methods to effectively manage your total wealth position.
Should you cash in your limited company?
Many contractors will choose to leave any profit that they accumulate above their monthly needs to accrue in their company to avoid triggering personal tax charges. Some may even see this as a form of personal pension. This is sensible enough in a time of low inflation, but the current situation of high inflation means that cash left sitting in the business is likely to be losing value.
Contractor-directors need to think carefully about how to extract this money from the business in the most tax-efficient way, as well as considering how this money might be protected from inflation. Two of the most common routes are company-funded pension contributions and limited company buy-to-lets.
What’s the right way to approach pensions - including salary sacrifice options
Pensions still offer the biggest tax break for contractors in the battle against erosion. If you’re working inside IR35, you should look for salary sacrifice schemes via your umbrella employer, ensuring that payments are made prior to income tax. Not all umbrellas will be set up for this, so if you have any choice in a provider it’s a very good question to ask upfront.
If you’re a limited company director, the best route is to contribute directly from your business, as an expense deducted prior to the application of corporation tax.
It’s also worth thinking about your pension pots. Many contractors will have worked for multiple agencies or umbrellas, not to mention earlier employer schemes, and so you may find you have forgotten about older pensions sitting in low-interest investment vehicles or being subject to unnecessary annual charges. Combining these pension pots can offer efficiencies, and better visibility, in itself.
Busting contractor mortgage myths
The myths around contractor mortgages are mostly due to the fact that a lot of lenders and brokers don’t know how to access contractors’ income, leading to the high risk of unsuitable advice, delays and unnecessarily high repayment rates.
Of course, changes in base rates and interest rates rises are affecting changes in affordability at the moment, with many lenders pulling products from the market in the wake of the Mini-Budget (2022). If you’re coming up for renewal and your lender hasn’t understood your position, you may be at risk of being put into a higher rate – increasing your risk of becoming a mortgage prisoner.
The first myth is that, in the absence of a salary, you need two full years of accounts to secure a mortgage in the first place. If you work with a contractor specialist, with access to knowledgeable underwriters, your day/hourly rate could be taken into account in place of salary. In fact, you’ll find that you can often secure rates that are closer to high street rates.
The challenge with buy-to-let for contractors
It has been a turbulent few weeks for contractors, the entire contracting sector has been flung from the highs of an unexpected vow to repeal the off-payroll rules, sweetened with a series of limited company tax cuts on September 23, to the lows of the whole package being U-turned on October 17, with the cuts to income tax, corporation tax and dividend tax all being scrapped, culminating in a 180-degree turn on the IR35 reform repeal pledge.
With the current period of economic uncertainty, contractors need a provider that can offer them stability and flexibility. No matter what direction IR35 takes in the future, we want to help you stay in control of your income, With Flex.
The good news is that Brookson customers will be supported throughout this ever-changing landscape. Brookson’s Flex solution which gives you the ability to switch between both umbrella and limited working, as and when needed. We want to help you take back control and be as tax efficient as possible by ensuring you are prepared, protected and working compliantly, no matter your current or future situation.
Other investments you can make as a contractor
All the traditional savings and investment routes are, of course, still open to you as a contractor. Of these, ISAs are the obvious tax-efficient option, with Stocks & Shares ISAs often being a popular choice. But it is important that you don’t lose money on provider charges and keep an eye on the market to secure the best rates.
Whatever route you choose, a contractor specialist accountant working in tandem with a financial adviser will be able to ensure that everything is structured correctly and most tax-efficiently. Some providers, including us, which provide both accountancy and financial services offer free introductory financial reviews as part of their service, enabling you to get clearer visibility of your money before you make an informed decision about the best way to protect it from inflation.
We understand that rising inflation is a daunting prospect, but we want to reassure you that Brookson is on hand to help guide you through these turbulent times. Don’t settle for unsuitable, non-specialist advice. Speak to Brookson today.