How Can Freelancers Best Manage Their Money?

When you’re a freelancer, you’re not just responsible for your deliverables and sales, you’re also responsible for your payroll.

People usually react to these things in two ways:

1. They either think this is great because they get all the money and spend little on outgoings.

2. They fear messing up because numbers are alien to them.

I also hear horror stories (to me at least) about people spending entire days working on payroll and accounts. The notion that someone is doing this fries my mind. I estimate I spend ten minutes per week on my finances.

I split my finance tasks into two segments: when I get paid and when I spend money.

Here’s my exact process when I receive payment from a client:

This way, I know that my balance is my genuine spendable business income. The tax pot is exactly that. In reality, I don’t pay 43%. That is, however, the amount I was paying when I was employed. So, as a backstop and a nice bonus, I move 43% to the tax pot so I’m covered for all eventualities. When tax-paying season comes around, I make a single payment safe in the knowledge that it’s all available. Whatever’s left in the tax pot after I’ve paid tax can either stay there as a buffer or be moved to the main balance.

That’s it. I’ll match up money with relevant invoices by clicking “approve” when I log into my accounting software every few weeks or so. That keeps my accountant happy.

There are some circumstances when I move money back from the tax pot:

Each month, pay your own salary. Make it the bare minimum for tax efficiency. In the UK, this is £758.33 (as of January 2023). By doing this, your company is paying you a salary small enough not to be taxed in your personal self-assessment. On paper, this doesn’t sound liveable. And it’s not. So let’s become tax-efficient…

Being savvy with your expenses and knowing what you can claim as a legitimate business expense pays for itself here.

These include:

These are all pretty standard guidelines. But, until you learn exactly what you can spend (and claim as a tax-deductible expense), it’s just words on a page.

Here’s what you can (and should) claim as a business expense. Note, these are applicable in the UK for limited companies. Always check with your/an accountant first.

Accounting : you can claim for your own time spent on accounting if you don’t have an accountant. If you do have an accountant, you can claim for their fee.

Advertising & marketing : if you run a campaign to generate new leads, you can claim for the cost of the platform and resources you use.

Business account payments: if you have to pay a fee for your business bank account, or need to pay interest, you can claim for this.

Broadband/internet : claim back the percentage of your home broadband bill you use for business. E.g. if you work 8 hours a day, claim for 33% of your broadband bills.

Business use of home: as above, claim the 33% of your heating, electricity, gas, logs if you work 8 hours per day.

Charity donations: any donation using Gift Aid is applicable for tax relief.

Computer equipment : this covers a wide variety of things you will likely use in your business and personal life. Laptops, printers, cables, chargers, etc. are all covered in this category. The same applies to software and subscriptions used for business.

Equipment your company buys from you as a person: (taken from Freeagent’s “Business Costs Expenses for Limited Companies Guide”): If you already own a computer, office chair etc and want to bring it into your business, you can claim tax relief for its market value at the point you brought it into the business. Check eBay for similar items and then include that cost in the company’s accounts. Don’t forget that if you are going to carry on using the equipment privately too, HMRC would consider this to be a taxable benefit.

Travel: if you need to fly, drive, cab, train, or something more inventive to see a client or attend a business function, you can claim the full amount of this. The same applies to where you are staying. Check your local rules on claiming fuel for mileage if you drive. If you have a company car, even as the sole employee, all mileage is included as the vehicle is a company asset.

Company car: if you have a company car, everything associated with this vehicle is a business expense, with the exception of parking and speeding fines.

Food while traveling: in the above situations when you’re traveling, you can claim for food away from your office. These will match up with your dates for other travel expenses.

Swag: if you create merchandise with your name on it to send to prospects and customers, you can claim for this.

Mobile phone: switch your mobile phone contract to a business account in your business name and you can claim the full amount as a business expense.

Pension contributions: you can claim the full amount of every pension contribution. More on pensions in the next section.

Stationery: any pens, notepads, etc. can be claimed as a business expense.

Training: if you sign up for courses or resources to be used exclusively for business purposes, you can claim the full amount of these.

I suggest you take a photo of the section above and stick it to your corkboard above your workstation ready for when you do your accounts. Every element here contributes to a much nicer tax bill at the end of the year and helps reduce the burden on your personal salary.

In the likely event that you are still lacking funds in your personal bank account, there are scenarios where you can make tax-free transfers from your business account to your personal account. These include things like taking dividends from your company. Here, check with local rules. In the UK in 2023, this is capped at £1,000. In 2024, it is being reduced to £500.

If you’re desperate for cash from your business account, consider taking a director’s loan. Here, you can take a tax-free loan from your business on the basis that you must pay it back.

Outside of these tax efficiencies, it’s time to start paying tax. However, running a company means you pay tax for the company and on your reduced “earnings” you withdraw from it. This is a far more efficient way to be a freelancer than working as a sole trader. There is a small caveat that this is only effective at a certain threshold. No accountant or financial advisor wants to commit to confirming what that threshold is. My personal experience says that it’s 100% before you start earning £100,000 per year. I paid a lot of tax in my first full year as a freelancer and learned the hard way.

In reality, the threshold is based on your profit and loss. I’ve searched far and wide for the magic number but the best guidance is this…

Okay, it’s not easy. I started writing this section out but ended up making it more complicated.

Here’s the guidance taken directly from Tuchbands article, How to become a limited company:

“Why a low income businesses should become a limited company

A sole trader with a profit below the personal allowance and the Class 4 National Insurance lower limit will not be liable to pay any tax, but if they earn above the small earnings exception (£6,025 for 2017/18 and £5,065 for 2016-17), then they will be liable to pay Class 2 NI contributions.

If that same person had operated through a limited company and withdrawn the same profit solely through a salary – and not via a dividend – they would not have to pay tax or NI contributions. At a salary level above the lower earnings limit, they would also retain any contribution record for state pension and benefit purposes.

Why a high income businesses should become a limited company

A sole trader who makes a profit of £50,000 would benefit from part of the profit being non-taxable, due to the specifications of their personal allowance. The remainder of the profit would be taxable at the basic rate of income tax and part at the higher rate of income tax. Class 2 and Class 4 National Insurance Contributions would also apply.

If an incorporated business made the same profit of £50,000, the business owner would receive a small salary of less than the current personal allowance and would still receive the remainder of the profit as dividends.

For the 2017/2018 tax year, corporation tax, income tax and employee NICs would amount to £10,076 on profits of £50,000, leaving the owner of the limited company £2,187 better off than a sole trader with the same level of profits.

If the same owner had taken a lower dividend below the basic rate limit and left some profit in the company then they could have paid less tax.”

If, at this point, you’re still stuck, I strongly advise seeking the advice of an accountant or financial advisor.

It’s through my financial advisor that I have, without any real financial knowledge, accrued a pension pot of £70,000 and an accessible ISA of £30,000 on top of my regular income by the time I am 30. And all without feeling like I’m missing out on disposable personal income. I live a very good life balanced somewhere between saving up for the long term and “I’m here for a good time not a long time”.

Some freelancers report they miss the employer benefits like pensions.

“As a freelancer for over 15 years, I certainly feel that freedom was oversold though. It has probably also cost me about “250k in employee benefits, especially pension controls too.”

These are the thoughts of a disgruntled freelancer who didn’t take any steps to protect or invest in their future finances. And I can only blame the individual.

When you become a freelancer, you are responsible for all aspects of your business. And that includes pensions and benefits.

I do, however, understand the hesitation to lose these things. What if I suddenly need access to something my employer did provide? I’d feel like an idiot. But that’s the bullet you bite. And after your likely rise in rate, you won’t even notice it anyway.

I haven’t ever come across anything I’ve ever needed or missed in the traditional benefits package. My pension works harder in an investment portfolio, I have my own life insurance, I should get around to making a will***, and I recently paid for my dental treatment upfront.

***I made one after writing this section. It took less than 30 minutes on farewill.com 

Sure, I could have got some of these if I stayed with a company long enough. But, when weighed up against my potential earnings and freedom as a freelancer, there is no doubt in my mind I am better off both financially and mentally.

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