Self-employment brings with it tremendous freedom. No longer are you beholden to an employer who dictates when you can take your holiday, how much you can earn, what your conditions of employment are. Independent contracting is just that…independent. You may be based with one particular employer for a period of time – but when your contract ends you can move on to a new opportunity. You are hired for your skills and your expertise and you manage your product – you!
But being your own boss also means no regular salary cheque. It means no paid holiday, no paid sick leave. So how can you get the best of both worlds – the freedom of independent contracting and the financial security of permanent employment? The answer is you can’t – not completely. Self-employment can be more lucrative than employment but it will never be as secure. However, there are ways to manage your finances to create as much stability as possible. Let’s look at some techniques that may help you to achieve financial control.
In the short term
Day to day and month to month you need to manage your income and your expenditure. This is not unique to self-employment but becomes much more critical when income is not predictable or guaranteed. Unless you are lucky enough to secure a long-term contract, and then another long-term contract, your income will be sporadic. If you have been contracting for some time, it should be easy to work out your average income. If you are just starting out, you will need to estimate it. Be conservative! Then, in the months when your earnings exceed your estimated (or actual) average, put the surplus into a savings account. Make sure this savings account is dedicated to this purpose – give it a name. Some accountants like to call it an “overhead account”. As you build up reserves in your overhead account, you’ll have funds to pay your monthly “salary” should you experience a period of reduced or (heaven forbid) zero earnings.
Because your income will fluctuate, when you budget for tax, retirement and other saving, it’s best to think in terms of percentages rather than fixed amounts. After all, tax is calculated as a percentage of income. So each month take a proportion of your income and allot it to three pots: tax, retirement and emergency savings. The tax proportion will generally be accurate for the reason stated, and while you may prefer to put, for example, R10,000 aside each month for retirement, it may not always be achievable. Working out a percentage you can manage means you will always be saving something for the future and still have enough to live on today. The same goes for emergency savings, which can be put in your overhead account. You want to avoid at all costs being lumbered with a tax bill you cannot afford, so get in the habit of filling these pots now. And in good months, if you work on a percentage basis, you’ll be putting away extra and building up reserves, both for the short term and the long term.
Don’t underestimate them! Many small businesses fail because of inadequate cash flow. As a contractor you shouldn’t have high expenses; after all, your commodity is your talent and experience. But when you build your spending plan, don’t forget expenses such as childcare, insurance, transport to and from sites, any equipment you provide (such as software specific to your area of expertise), etc. It is always the unexpected outgoings that catch us out, so try to anticipate everything. Then, if you don’t spend as much as you budgeted, you’ll be ahead.
In the long term
If you’re starting out, or if you’ve been contracting for a while but not yet done so, take a look at the employee benefits you previously enjoyed courtesy of your employer and consider how you will replace them. You will need to think about income protection, medical aid, life cover, disability and critical illness insurance, etc. There are many products on the market and it can be difficult to work out the most suitable policies for your circumstances. A few hours with a good financial adviser can be time and money well spent.
Then there is your pension. Perhaps you belonged to a company pension or provident scheme where your employer made contributions on your behalf, or you contributed directly from your pre-tax salary so you didn’t have to give it any thought. Retirement planning is now your responsibility and yours alone. Ironically, though we don’t all suffer injury or disability but we all get old, self-employed people often place a higher priority on income protection than on saving for retirement. This may be because retirement seems a long way off, but injury can happen at any time. While it may be tempting to prioritise today’s lifestyle over tomorrow’s, delaying or avoiding saving for retirement will have very real and unfortunate consequences in years to come.
A financial adviser will look at all your financial planning needs – protection and savings – and help you work out a plan that balances these needs with what’s affordable for you.
The good news
There are some advantages to being self-employed. You pay provisional tax twice a year. Hopefully you are putting money aside for it each month. There is nothing wrong with putting that money to work for you while you wait to pay SARS. Many banks have 32-day notice accounts paying a reasonable interest rate. Since you know in advance the dates on which you will pay your provisional tax, a 32-day notice account is a practical vehicle in which to store your tax money and put it to work for you at the same time. You won’t get rich, but every little bit helps. You can use the interest to either reduce your own liability or pay yourself a little bonus.
Highveld can help
Contracting holds many rewards for the entrepreneurial spirit, but it can be lonely. A professional contractor management service like Highveld provides a supportive network for contractors and can help you maximise your earning potential. Contracting through Highveld also gives you access to a range of benefits that may not otherwise be available to you, such as travel, insurance and training courses.
To get the most from your lifestyle choice as an independent contractor, contact Highveld on 012 367 5600 or firstname.lastname@example.org.