How do I pay National Insurance as a Sole Trader?

It’s not often I see fear in a client’s eyes. This happened recently, though, when I casually mentioned National Insurance. The chap concerned had just gone freelance, after carefully planning his transition from employee to free spirit. Somehow, in all the excitement, a crucial element had escaped his notice. Understandably so, I think. After all, nobody who creates a business has a burning desire to understand the National Insurance (NI) system. However, a basic knowledge of how NI works, and what you need to pay and when, will help you now and when you reach state retirement age.

In this post, I’ll explain this unnecessarily complicated tax and also share some tips on paying it if you’re self-employed.

What is National Insurance?

When it was first introduced in 1911, National Insurance was indeed an insurance scheme. Contributors were rewarded with payouts if unable to work or once they’d reached the state retirement age (70, at the time). The method of recording contributions was through stamps affixed to a card, which is why you’ll sometimes hear people refer to paying your stamp.

It’s since become far more sophisticated and there are now six types of National Insurance contribution. Thankfully, as a sole trader, you need only concern yourself with two of them:

Class 2 National Insurance

This is a fixed weekly amount of £3, regardless of your income. You’re not obliged to make Class 2 contributions unless your profits1 exceed £6,365. Nevertheless, it could be worth making voluntary Class 2 contributions. Why on earth would you pay more tax than necessary? Well, because this affects your state pension entitlement. To qualify for the full state pension, you need to have made 35 years’ NI contributions. Any gaps reduce the amount you’ll receive. So, paying £156 per year now could boost your income significantly in the future. Additionally, you need to have made Class 2 contributions to be eligible for other benefits, such as Employment and Support Allowance (the only sick pay you’re entitled to as a sole trader).

Class 4 National Insurance

These contributions behave more like a tax. Class 4 contributions are paid as a portion of your profits, so what’s left over once you’ve deducted any allowable expenses from your turnover. You’re liable for Class 4 NI payments if your profits exceed £8,632. You’ll pay 9% on profits from £8,632-£50,000, and 2% on profits above that amount. These contributions aren’t linked with state benefits.

To recap:

  • Class 2 if your profits are £6,365 or more a year and
  • Class 4 if your profits are £8,632 or more a year
  • You pay £3 per week (£156 per year) for Class 2 and
  • 9% on profits from £8,632 – £50,000 for Class 4. It drops to 2% on profits above £50,000.

How do I pay National Insurance?

Fortunately, this part is straightforward – and you no longer have to collect stamps on a card. Both Class 2 and Class 4 contributions are paid along with income tax through your self-assessment tax return. As you probably know, this is due by 31st January – both the return itself, and your payment.

You stop paying any NI contributions once you reach state retirement age, although you’re still liable for income tax.

How can I calculate my National Insurance liability?

The best way to deal with tax returns is to prepare well in advance. The tax year ends on 5th April, so you have almost 10 months to do some calculations and start saving, if you haven’t already put some money aside. StepChange has created a useful online calculator to give you clarity on what you’ll need to pay. For example, if your turnover is £30,000 and your business costs are £2,000, you’d pay:

  • Class 2 – £156
  • Class 4 – £1743.12
  • Income tax – £3099.96

That’s a total of £4999.08.

Screenshot of sole trader income calculator

As a sole trader, your income probably fluctuates. It’s worth using this calculator each month to ensure that you’re not taking too much money out of the business. Nobody enjoys saving for tax, but a monthly sacrifice is better than a big bill just after Christmas. Remember, Class 2 contributions are fixed at £3 per week, so it’s easy-peasy to budget for this amount. Think of it as an annual subscription of £156 that you pay every January.

Conclusion

The Government has promised to overhaul National Insurance and a review is currently in progress. Given everything else that’s going on, this is unlikely to be a priority.  In the meantime, using the calculator and setting aside your £156 should keep you on track. And you might even get a state pension when you’re 95.

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Key Points

  • check
    You pay Class 2 and Class 4 NI contributions through your self-assessment tax return.
  • check
    Class 2 NI contributions help you qualify for the state pension and other benefits, such as Employment & Support Allowance. It could be worth paying these contributions voluntarily, even if you haven’t reached the profits threshold of £6,365. The annual amount is £156.
  • Calculating your NI and tax liability each month can help manage your cash flow and avoid surprise bills in January.
  1. turnover minus allowable expenses []

Financial Minimalism

This post is based on a talk I gave to the Brighton Minimalist Group in July 2019.

You probably don’t associate minimalism with the finance profession. Financial advisors, for instance, are keen to boost clients’ assets. After all, they often only get paid when you become wealthier.

As a financial coach, my priority is a client’s wellbeing. Sometimes we’re working to reduce their income so they can spend more time enjoying life. Typically, this involves helping them to spend less so they don’t need to earn as much or can retire earlier.

So, financial minimalism, I think, is about minimising your efforts and stress when it comes to money and adjusting to living on less. The more money you can save for the future, the more choices and control you have over your life.

I have devised five principles of financial minimalism to share with you:

1  Stick to a budget

Think about what you spend each month. Does every pound either support your life goals or make you happy? Money should be working for you.

First, cancel any unnecessary expenses. Many of my clients are paying for insurance policies that benefit ex-partners, or extended warranties on contraptions that have long since perished. Do you have subscriptions to Spotify, Kindle Unlimited, or Audible? Are you getting enough use? I’ve paid £60 to Spotify over the last six months. When I looked at my history, I’d repeatedly listened to the same three albums – two of which I already own. This is not very bright.

There are lots of tools that you can use for managing a budget. If you’re not a spreadsheet type of person, there are apps such as You Need a Budget. Or Money Dashboard works with most bank accounts.

2  Invest in assets rather than renting stuff

There has been a significant shift in business models over the last decade. Whereas once we would purchase expensive items outright, now we are encouraged to rent or lease them. One example is the mobile phone. Many of us pay a monthly subscription that covers the handset, calls, and data use. While this looks cheaper than buying the handset outright, it isn’t always a better deal for us.

I bought my high spec Android phone just over 3 years ago. It cost me £150 and then I got a SIM-only monthly subscription for £7.99. If I add up the total amount and divide by 39 (which is the number of months I’ve had my phone) the monthly cost works out at £12. This has saved me around £400. The longer it lives, the more I’ll save.

If there is a choice, consider whether renting is definitely better than purchasing outright. If a subscription looks more appealing, that’s probably because it benefits the company behind it. Of course, there are also situations where renting is better – for example, things you use only once or occasionally.

3  Get rid of debt

There’s a lot of talk in the media about the difference between good debt and bad debt. Generally, good debt refers to borrowing that services an underlying asset – for example, if you borrow money to buy a car that could help you travel further for a well-paid job, or if you use that car for your business. Mortgages are also typically referred to as good debt because the value of a house generally increases. But is it really a good debt?

Let’s look at a simple example. Suppose you borrowed £300,000 at an interest rate of 3.5% over 25 years. The total interest you would pay would be £150,715. According to the Land Registry last year, average house price inflation was 1.4%. This means by the end of your 25-year mortgage term, your house would be worth £425,633. So, you’ve actually lost around £25,000. Nobody knows what will happen to house prices or interest rates in the future – this is just a very simplistic illustration. Nevertheless, I think it shows that while mortgages might be good debt, they’re not necessarily beneficial over the longer term.

Naturally, house ownership is a complicated area. We want to buy our own home for various reasons, including security, inheritance and freedom. However, it’s worth thinking about your motives. If you see home ownership as an investment, do the sums to see whether it really is appreciating or if you are effectively just renting an asset that ties you to one place.

4  Simplify your finances

It’s easy to end up complicating finances, for example by juggling credit cards or trying to be clever with when we pay bills. This can result in overdraft charges and quite a lot of stress. Wherever possible, it’s a good idea to automate finances through direct debits or budgeting. This reduces the number of decisions and also the possibility of something going wrong.

It’s also tempting to pursue rewards for our spending. I did this with an Amazon credit card a couple of years ago. I started to buy larger, more expensive items to boost the likelihood of receiving a gift certificate. I was so seduced by the idea of points, my brain wasn’t noticing the unnecessary expenditure.

As a financial coach, I really don’t like the idea of rewards for spending more money – it sends the wrong message. The reason they exist, of course, is that they are highly profitable for the credit card providers. They know exactly how our minds work. When you’re buying something, consider your motivation. Is it something you really wanted, or is there an external force compelling you to buy it?

5  Find cheaper alternatives

Something I’ve noticed from financial coaching is that many clients feel pressured into spending more money than they can afford, especially in social situations. We don’t like having to say we don’t have enough money. Often, I encourage clients to have the “money conversation” with their friends. This involves saying, “actually I have less cash to spend this month – could we go somewhere cheaper?” In all cases so far, the friends have been hugely relieved at this suggestion. They also felt pressured into overspending. Some friends will be happy to stay in with a pizza rather than going out to a fancy restaurant.

In summary, be intentional when spending your money. Cut what you spend on the boring stuff, then you’ll have more cash for priorities. And to make it even snappier: minimise your spending, maximise your wellbeing.

Image © ArchiVIZ – stock.adobe.com

Deciding What to Charge Clients – Part 3

Many freelancers fantasise about earning a six-figure income. We sense it’s possible, but the financial responsibility that comes with running a business often means we pay ourselves last, once all the expenses have been covered. Usually, the only way to earn significantly more is to charge a lot more.

In my last post, I talked you through how to decide what you want to earn from your business. Hopefully, you now have your Happy Rate. How did that feel? Is the Happy Rate a long way from what you’re currently charging clients? Do you need to increase your fees? If so, you should start communicating your value. Here’s how.

What will you pay for?

First, I’d like you to think about the last expensive professional you paid. Make sure it’s a situation in which you were obliged to part with an uncomfortably large sum of money, more than you would normally spend. What made you decide to spend this sum? What convinced you this was a worthwhile expenditure?

When I facilitated this exercise at a workshop recently, some of the examples cited included a hairdresser, a structural engineer, and a physical therapist. In the case of the hairdresser, the attendee had very precise requirements and she wanted to feel sure they would be carried out. Her hair was very important to her, so it was worth paying someone who would do it properly. The structural engineer was by far the most expensive professional. He convinced this attendee to pay a lot of money because his website clearly showed he had extensive experience. This reassured her that the house wouldn’t collapse. Indeed, this was a situation where low prices would have created distrust. The physical therapist was chosen because his personal warmth and genuine caring nature convinced the attendee to entrust him with her ailments.

Although these example businesses might be very different from your own, hopefully it gives you an idea of how we make these decisions. And if you also consider your own recent decisions, you’ll start to see what makes us say yes, and, of course, what makes us hesitate.

What are you worth?

How did you set your current fees? Perhaps you just looked around to see what everyone else was charging. Or maybe you plucked a figure out of the air – one that seemed a good number, but wasn’t too cheeky. This is what we tend to do when we feel uncomfortable or lack confidence. Instead, I’d like you to think about your business and what you are offering. Ask yourself these questions:

  1. What do you do?
  2. Who do you do it for?
  3. Who else does the same?
  4. How are you different from them?
  5. Are you selling time or results/solutions?
  6. What difference are you making?

It’s unlikely you’re simply selling time. If you’re a therapist, a client doesn’t book a session because he wants to spend an hour with you. He wants you to solve his problem and to make a difference. This is what you are charging for.

Your experience and approach won’t be exactly the same as anyone else’s, so don’t use their charging model. And in this type of business, you are not competing. Your business isn’t directly comparable with anyone else’s. Instead of competing on price, communicate your value and the difference you are making. You never want to compete on price as it’s a race to the bottom.

So, decide on a fee that allows you to cover your costs, pay yourself a decent income, and one that conveys the difference you’re making.

Here are some tips on communicating value:

  • Deliver good work, consistently
  • Gather feedback and testimonials and make them visible
  • Present yourself appropriately – if you charge £500 per day, you want a proper website, not a Tumblr page

Getting the price right

As I said a moment ago, you don’t want to compete on price. However, you still need to be realistic – it’s about achieving a balance. Remember, you can’t serve everyone (unless you have a truly scalable business), so pricing can be an effective way of restricting demand. You never know how much money potential clients have, or what type of spending they are prepared to prioritise. Consequently, it’s important not to set your prices too low out of fear.

One effective technique is to offer different price points in the form of packages:

  • Basic – a cheap package that’s affordable to most people and easy to deliver. Once they’re through the door, they might upgrade to a more expensive option.
  • Medium – this package is a bit more expensive and has many more features. This is likely to be the most popular choice.
  • Premium – this includes absolutely everything. Not many people buy the premium package, but when they do it’s a big chunk of income for you.

If you want to learn more about pricing strategies, I heartily recommend Sweetspot Pricing by Julia Chanteray. This short book includes tonnes of valuable information for small business owners.

Nobody likes having the ‘money’ conversation with clients. It feels grubby and graspy. Here are a few hints on how to handle it:

  • Have the conversation as early as possible! Don’t leave the fees to your client’s imagination (or, worse, let them think you’re working for free).
  • Never haggle. Use the exercises in this series to be clear on what’s a fair price.
  • Talk about price at the beginning, then focus on your value.

It’s not your responsibility to be affordable – it’s up to them to decide whether the problem you’re solving is a priority.

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Image: © pogonici – stock.adobe.com

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