Contractor Financial Planning: Top Seven tips for contractors in 2021
What are the best ways for contractors to consider financial planning in 2021? Below are the top tips to consider and ensure that you are making the most of the year ahead.
As the third lockdown of this pandemic continues, it’s hard to envisage a better opportunity for contractors to sit quietly and reflect on the year past and think about making more of the coming 12 months, in financial terms.
Now is the best time to review your finances as a contractor and make sure your company, take-home pay, investments, savings, tax breaks and much more are all in the best shape they can be for 2021. There’s also the coming new tax year to consider, which will likely be here before you know it, especially with private sector IR35 reform likely to dominate the contractor sector’s preparations.
The current assessment is that it’s more important this year than last year to not miss out on the available tax breaks as a contractor, because it’s almost certain that the future will bring an increase to tax bills. Next year will be too late to start looking.
So below are the seven top tips for contractors to help their financial planning - to make sure your money is going to go further at a time when every little is going to help
Working from home allowance
This allowance is something that has become the ‘new norm’ for many I talk with. But this relief isn’t available to those who chose to work from home – whereas it is available if working from home has been enforced upon you due to covid-19. If it has been, there’s some relief you can claim.
Broadly you can claim £6 per week from April 6th 2020 without the need to provide evidence of your extra costs.
The other great thing about this allowance is that it is available to all, regardless of how you work as a contractor. So whether you are limited company or work via a third-party payroll company, you can claim this allowance via your self-assessment tax return.
If you don’t complete a tax return and are not already claiming expenses from your employer, in your case your limited company or third-party party payroll company, then you can claim these online via a Government Gateway account.
Often overlooked, the marriage allowance allows a spouse to transfer £1,250 of their personal allowance to their spouse or civil partner. This saves £250 in the given tax year on taxes owed. Although this sum doesn’t seem like much, it’s definitely not to be sniffed at! After all; it could be exactly how much your tax bill is put up by the government as it starts to pay back the deficit, which has been worsened by the pandemic.
Be aware though, to be eligible to ‘gift’ some of the personal allowance, the lower earner must normally have income below the personal allowance.
So this may not always be an option for every contractor in normal circumstances. Yet with so many people spending most of the last year on furlough, this allowance could well be an option that is available to more people this year.
Every UK taxpayer has an allowance available to them every year that they can save into a pension of their choice of up to £40,000. In some cases this amount could even be higher if you have ‘carry forward’ available to you. For the self-employed, contractors or company directors, this can be a vital allowance that is particularly useful to use when you have income available that you have been reluctant to draw due to increasing your tax liabilities.
For incorporated business owners in particular, a pension allowance can be beneficial in reducing corporation tax liabilities. This is another deadline to be mindful of if you’d like to avoid a nasty sting in the shape of a penalty -- your company year-end.
Pension tax relief is available to you at your highest rate of tax and is considered one of the single most efficient ways of reducing your tax burden in any given year.
We mentioned it above so let me attempt an explanation. ‘Carry Forward’ will allow those individuals who are eligible to go back up to three tax years and provide the opportunity to use up those unused allowances. That is on the condition that you were a member of a UK registered pension scheme in those tax years that you wish to use.
Keep in mind though, other eligibility criteria will apply.
ISAs; what is an Individual Savings Account and how can it benefit me?
These types of savings and investments are a very useful tool for achieving gross interest or returns on your savings as a contractor.
In particular, if you are close to or in the higher rate tax thresholds the income achieved on an ISA will not affect other allowances available, such as savings or dividend allowances.
ISAs can be cash-based, investment, or a combination of the two. They are also a very useful source of future income that can then be achieved tax-free.
Higher rate reality
The higher rate catches you when your annual income from all sources exceeds £50,000, including rental income, investment income and for those running their own company, this will include dividends too.
Other benefits such as Child Benefit can also be affected at this level of income, so be aware.
Fortunately, there are options available through some forms of investment to restore or reduce the levels of income to mitigate this threshold.
Capital Gains Tax (doesn’t have to be taxing – at present)
Any investments including shares and property that is not your main residence are subject to this tax – CGT - on disposal. This tax is often considered the ‘forgotten tax.’ That’s because you have an allowance of £12,300 each year that can be used on gains before the tax is payable.
However for gains above this amount the tax can be as high as 28%, which is fairly substantial.
In addition, you are also unable to carry forward any unused allowances from year-to-year. Planning the disposal of assets (taking into account your income in a given year) is vital to ensure you don’t pay more tax than you need to.
Run the ‘stand back and tot-up’ test
So where’s a good place to start – or what do contractors need to do? Always consider your finishing position for all income and gains in the current year with a forward view in mind of the coming year, looking at what your potential liabilities could be.
From there, work through all the allowances that are available to you, allowing enough time to take action if required. In our experience, leaving things to the last minute can often be at a cost to you and to the benefit of the taxman.
Still feel like you’re missing something? Financial planning can feel like a maze and getting lost is all too easy if there’s not a professional to help navigate you. Here is a simple checklist to run through to rid that feeling that you’ve forgotten a vital area.
- Personal Income Allowance
- Your Spouse or Partner’s Personal Income Allowance
- Dividend Allowance
- Pension Allowance (including the last three years)
- ISA Allowance
- Savings Allowance
- Capital Gains Allowance
- Inheritance & Gift Allowances
There are a few extra areas listed here to those considered in detail above. But such is the nature of financial planning; there’s often more to consider than first meets the eye! If you wish to discuss any aspect of the financial planning areas outlined, please complete the form below.
ContractorUK offers a FREE consultation via our financial planning and pensions partner.