No holiday pay, no pension, no sick pay. That's freedom
New workforce: people who think there's more money in freelancing should look at all the angles
Sunday 05 May 1996
It is quite common for people who turn to self-employment to see a significant rise in their earnings. Indeed, the possibility of making lots of dosh is often part of the motive to go it alone.
But the self-employed should be looking for an increase in earnings simply to maintain the same standard of living and financial benefits as those available from a salaried position. They should also be looking at compensating for the extra risk they take; the risk that things could go wrong.
Business expenditure is one aspect worth reviewing. It is often said that the self-employed have tax advantages over employees taxed under PAYE because of their ability to claim tax-deductible expenses. But the self-employed also have to spend money on things with which an employee is provided by the employer. It is a misapprehension to assume being self- employed allows you to go on a tax-avoiding spending spree. Tax-allowable expenses still cost something. A pounds 100 of expenses simply means pounds 100 of income that can be exempted from tax. A higher-rate taxpayer can escape pounds 40 of tax otherwise payable. But the item still costs pounds 60 (ignoring any additional ability to reclaim VAT).
Depending on the nature of work, the self-employed person grossing pounds 50,000 might spend pounds 5,000 (before tax relief) on business costs and on capital expenditure - items such as computers, for which tax relief has to be phased over several years. Capital expenditure is rarely a once-and-for all cost. The chances are that changing needs and technology will fairly soon require further outlay.
An employer's pension scheme can be valuable. Salaried people might typically pay 5 per cent of pay into a pension scheme. But the lion's share is usually borne by the employer. It is difficult to put a figure on how much a self-employed person would have to pay into a personal pension plan to get an equivalent pension. But 15 to 20 per cent of gross earnings may not be wide of the mark.
National Insurance paid by the self-employed, unlike that paid by the employed, does not build up entitlement to the earnings-related part of the state pension, called Serps, nor to unemployment benefit, should work ever dry up. A self-employed person has to fund his or her own redundancy. If you are a professional person in your 30s or 40s you may know several people who have received tax-free lump sum payments as a result of redundancy, it is common in the job-insecure 1990s. The self-employed person will never benefit from such a windfall. It is hard to quantify the worth of an entitlement to redundancy, but it is an extra to consider.
You may be in rude health and never have to take a day off sick. But there is always the chance of a serious illness that could put you out of action for weeks or months. Many employers still have generous sick- pay schemes. By contrast, the self-employed have to fund their own days off through what is called income protection or permanent health insurance. A quote from Norwich Union for a non-smoking professional male aged 35, who drives 20,000 business miles a year and grosses pounds 45,000 a year after business expenses, puts the annual cost at pounds 732, and that is for a policy that pays out a sum equivalent to the lost income but only after three months of illness. A higher-rate taxpayer would need to gross pounds 1,220 to pay this pounds 810 premium.
There are other benefits an employee may get that the self-employed person may want to replace. If, as an employee, you have a company car, how much would it cost to run your own? Does your employer provide free life insurance, cheap meals, or a share option scheme?
Finally, if you are self-employed, have you ever been delighted at how you can earn a big fee for just a few hours' work? In fact the fee may not appear so good once you take account of any time you spend on work- related matters for which you do not get paid - general administration, travelling and so on. You might be earning good money only by putting in a lot of hours. A typical employee works seven hours a day for 225 days a year, once annual leave and bank holidays are taken into account. Anyone considering self-employment should also ask if they could earn, say, pounds 50,000 by putting in just those hours.
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