Self employed? How much to save for tax and National Insurance

How Much Should I Save to Pay My Self-Assessment Tax Bill and National Insurance?

Most people who decide to take the plunge and become self-employed will have worked as an employee at some point in their lives.

This means that when you get paid, all the money is yours to do with as you wish. Income tax and National Insurance (NI) have already been automatically calculated and deducted via PAYE, and possibly pension contributions as well.

So, it can feel quite daunting to suddenly be in a situation where you’re responsible for paying your own taxes and NI through an annual self-assessment.

But, for most people, the process is actually very straight forward and when you’ve done it once you’ll realise it’s nothing to worry about and you don’t need to pay an accountant to do it for you.

How much should you save to pay your tax bill

Assuming your earnings are reasonably modest (ie under £50,000), squirreling away around 25-30% of your income is a great habit to get into. Obviously the more you earn the more you’ll need to save.

This way, you’ll be able to cover you tax bill and possibly have a little left over. You could do something sensible and use it to boost your pension contributions or invest it in your business.

Alternatively, you could just buy yourself something nice instead!

There are a few things you can do to make your Self Assessment far less taxing (ahem).

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Keep Accurate Records of Everything

I can’t stress how important accurate bookkeeping is to making life as easy as possible when it comes to Self Assessment time.

Keeping detailed records all your income and any expenses/business costs that you incur through your work really is the key. 

Not only does it make the process easier, but it gives you the peace of mind knowing that you’ve done everything by the book and have all the records to prove it if ever you’re challenged by HMRC.

In terms of expenses, you can find the full list of what you can and can’t claim on the Government’s website, but here’s an idea:

• Costs associated with running an office, such as rent, stationary, phone bill and utilities
• Travel costs, including petrol if you use a car, parking and public transport
• Bank charges, the cost of professional services, such as an accountant, insurances

Other Things to Keep a Note Of

In order to complete your Self Assessment you’ll also need a note or any bank interest or share dividends you’ve received throughout the year. 

This includes any dividends that you’ve received from a company that you personally have an involvement in, although for most people this won’t apply.

There’s also a section to fill in for any other employment you have. Some people have a regular job and their self-employment is a side hustle meaning they need to fill in sections for both.

If you pay into a personal pension you’ll need to record the amount you’ve contributed as well.

Save Every Month

You can make life a lot easier for yourself if you put aside your tax money at the end of every month. 

This way, there will be no big surprises when you come to pay your bill – the money will be sat there waiting for you.

Given the historically low interest rates right now, many people put their tax money into Premium Bonds for a year then withdraw it when it comes to paying their bill.

The logic behind this is that it’s possible to beat the rate of interest you’d otherwise get at the bank through any winnings you receive. 

There is no guarantee of course, but for most people it’ll only mean missing out on a few pounds if they don’t win, plus there’s a chance of scooping one of the bigger prizes that are handed out each month.

If you don’t like the idea of Premium Bonds and are considering how your tax money can work for you until the bill is due then your options are limited.

You could put it into shares, but this is a very risky strategy and a year is not nearly long enough to ride out any peaks or troughs in the market, unless you’re incredibly lucky. Most financial advisers recommend a minimum of five years for any stock-related investment.

What Tax Rate Do I Fall Into?

Here’s the tax rates that apply to both self-employed and employed people in the 2020-21 tax year:

• 0% – £12,500 or less
• 20% – £12,501-£50,000
• 40% – £50,001-£150,000
• 45% on income over £150,000

You need to account for your National Insurance on top of this.

What is the Financial Year?

The financial year, sometimes known as the fiscal or tax year, runs from 6^th April one year to the 5^th April the following year.

So, let’s say you’re completing your return for the 2019/20 tax year (April 6^th 2019 – April 5^th 2020) then the following applies:

• If you’re completing your Self Assessment online you have until January 31, 2021, to file your form. 
• If you’re completing a paper return the deadline is the end of October 31, 2020 to do so.
• The deadline for paying the tax you owe is January 31, 2021.

Help with Working Out What You Owe

The Government offers a useful ready reckoner tool to help you get a clearer picture of how much tax you’re likely to owe.

All you need to do is visit the page and enter your estimated weekly or monthly profit to get an idea of what will be due in income tax and National Insurance.

It’s a very simple tool and works fine for anyone whose financial circumstances are straightforward.

And Finally… Payments on Account

One final thing you need to plan for is what are known as a Payments on Account. 

Basically, this is a sum of money that the tax office will ask for in advance of your predicted bill for the following year based on your earnings in the previous year.

The downside is that you need to find the money up front, hence why it’s always a good idea to save more than you’re expected bill if possible.

However, the good news is that Payments on Account will offset your bill at the end of the next tax period so it balances out over time. The biggest shock comes in your first year when your bill is much higher than you expected because an extra 50% or so has been added on.

It’s possible to get the Payments on Account amount reduced or even cancelled if you are confident that you’ll be paying less tax than the previous year if your earnings have fallen.

Final thoughts on self-assessing when you work for yourself

Try not to be too daunted by the self assessment process.

There is a government helpline you can call if you do become confused or get stuck on any particular area. Filling out the form online is actually pretty straightforward and the guidance makes it clear.

The most important thing to do is be sure you are saving money throughout the year, so that your tax bill does not come as a nasty surprise when it comes time to pay it in January.