Inflation v contractors: how umbrella and limited company workers can mitigate rising costs
The prospect of IR35 reform repeal wasn’t the only reason for contractors to cheer ill-fated Mini-Budget 2022. For a moment, it looked like a series of favourable tax cuts might cushion the blow of the fastest inflation rise we’ve seen since the 1990s.
We’re now left with a 10.1% rate of inflation, and the only new tax relief coming down the pipe is from the (currently) cancelled National Insurance Contributions increase. So, asks Jo Elwell of Brookson Financial, a People 2.0 Company, what does scant tax relief but high inflation mean for contractors, and what can be done to mitigate it?
A particular challenge for PSCs
High inflation will impact everyone’s finances and savings over the coming months, but contractors with personal service companies are particularly vulnerable due to their personal finances being so closely intertwined with their business.
In addition, there is also a risk that accountants and financial service advisers who don’t understand the intricate ways in which the legal framework and tax rules govern the finances of the self-employed might be providing unsuitable advice. Those who are new to contracting are particularly vulnerable to this.
What, then are the main personal finance beartraps and how can they be avoided?
Expenses and energy
Before we turn to income and savings, it’s worth a quick note on expenses. With the hike of corporation tax kicking in on any company profits over £50,000, it is worth off-setting any relevant rises caused by the current cost of living crisis through expenses. Business travel will, of course, always come under this, but some contractors are as still not aware of other opportunities to reduce profits e.g. by claiming on energy bills for a home office. This might be worked out as a portion of the household bill, or if you happen to have an outhouse it could even be worth installing a separate supply.
Dividends and salary
As many readers of ContractorUK will be aware, one of the most tax-efficient means of taking income from the profits retained by limited company 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.
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 form of personal pension. This is sensible enough in a time of low inflation, but the current situation 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 pensions contributions and limited company buy-to-lets.
How to approach pensions, including salary sacrifice options
Pensions still offer the biggest tax break for contractors in the battle against erosion. If 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 provider it’s a very good question to ask up front. 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.
There are a lot of myths around contractor mortgages. This is 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 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
With low interest on savings, the buy-to-let market has been a popular choice for contractors seeking to invest in recent years. Similar to the tax breaks from a company pension, this investment can be made through a special purpose vehicle (SPV). The advantage of this is that you get tax relief on rent through your limited company.
But spiking rates for mortgage renewals have left many buy-to-let landlords trapped between hiking rentals and selling up. This has a particular challenge for contractors with SPVs. If the property value grows, you may find the profit is stuck in your company, with a heavy tax penalty to take it out.
This is another good example of the need to work with a specialist mortgage adviser. You will need to ensure that the tax advice you receive from your accountant aligns with the mortgage advice you receive from your broker in order to ensure that you remain tax compliant and are offered the most suitable and competitive rates. The challenge is getting these two parties to talk to each other and work together, so you can be sure that this is the best route for you.
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.
Editor’s Note: Brookson Financial (179752) is authorised and regulated by the Financial Conduct Authority.
The value of investments, and the income or capital entitlement which may derive from them, if any, may go down as well as up and is not guaranteed; therefore investors may not get back the amount originally invested. A mortgage is a loan secured against your home. Your home may be repossessed if you do not keep up repayments on your mortgage.