DEBT difficulties are mounting among the growing army of Scots that have taken the self- employment route in the wake of the financial crisis.
The self-employed are more likely than other workers to be burdened with heavy debts, new research shows, and experts warn of the considerable financial planning demands facing those working for themselves for the first time.
The number of self-employed workers in Scotland has been edging up since the downturn began; they now account for more than 12 per cent of Scotland’s workforce, up from 10.5 per cent in 2008, according to the Office for National Statistics. The rise has been driven largely by need, with many having little option but to strike out on their own in the wake of redundancy.
While self-employment has been the answer for many people – and the realisation of long-term ambitions for some – it comes with its own financial challenges. From mortgages and pensions to protection insurance and tax, those working for themselves have plenty to think about.
Debts are a problem too, an all-too inevitable result in some cases of relying on an inconsistent income. Dependency on credit is higher among the self-employed than other working groups, according to research published this week by the StepChange Debt Charity (previously the Consumer Credit Counselling Service).
The study, carried out for StepChange by the personal finance research centre at the University of Bristol, found that of the three main types of credit used by debtors – credit cards, overdrafts and personal loans – the levels of debt were highest among the self-employed. (See the accompanying story for more on this).
The trend reflects the greater earnings vulnerability of the self-employed, who saw a sharper fall in monthly income levels last year than other working households.
Debt isn’t the only potential problem facing self-employed workers, however. The shift from employment to self-employment can be hard enough just in terms of setting up. But there are also financial pitfalls to be mindful of.
Michael Jackson, director at Kelvin Financial Planning in Glasgow, said: “Self- employed workers are unique in that they have irregular income and they may also have irregular outgoings for taxation.”
The priority for those new to self- employed or freelance status is to establish a rainy day fund that can help them stave off any cash flow problems. “The exact amount will depend upon the outgoings and situation of the individual, however, three month’s outgoings are preferable, with a minimum of one month,” he said.
“The constant reminder of pay-day loan companies and the rates of interest charge-able should be enough of an incentive to hold some form of emergency funds.”
Cash savings are the first port of call, starting with tax-free individual savings accounts (Isas). But few cash accounts are paying interest above inflation and of those that do, the majority involve locking your money away for a fixed period of three to five years. If you’re willing to take more risk and have a decent rainy day fund you could look at collective investments such as funds and investment trusts. Financial advice is recommended when taking this approach, however.
Then you have to think about replacing benefits you enjoyed as a full-time employee.
Kevin Garfagnini, director of financial planning services at Mazars, said: “Your company will have probably laid on a range of employee benefits, such as life insurance and private medical insurance. Anyone who is self employed will now need to work out what benefits are really important to them.”
Take pensions, for example. If you were part of a company scheme, you’ll have paid your own contributions and probably benefited from your employer’s contributions, too. If you want to continue making the same provision for your retirement, you’ll need to look at how to maintain or boost your pension savings in other ways, such as a personal pension. It might not be top of your list, given other demands on your time and money as you forge your new path, but don’t let it slide too long.
If you don’t already have a personal pension or some form of retirement fund, then it’s worth getting independent financial advice on setting something up.
And there’s an added benefit to making pension contributions, Jackson pointed out. “The self-employed can use pension products as a tool, not only to provide for retirement, but also to assist with reducing tax liabilities,” he explained.
“For those with pension assets already accrued, the option exists to control income withdrawal to dovetail with any self- employed income in a tax efficient manner.”
Also remember that self-employed status means having to pay class 2 national insurance contributions – and possibly class 4 as well – to ensure you remain entitled to state benefits.
Then there’s the insurance benefits you may have enjoyed as a company employee, some of which will be more important now than ever.
Income protection, which pays out a monthly income in the event of being unable to work, should be a priority, said Jackson.
“A range of different contract options are available. For those on a limited budget, lower-cost policies offer shorter periods of protection,” he said.
“However, the contract should be established taking into consideration factors such as how much emergency fund you hold and how much money you will need to meet your outgoings,”
Being self-employed may prove more problematic when it comes to your mortgage. The disappearance of self-certification mortgages, dubbed “liars’ loans”, has hit self-employed borrowers hard.
Now the self-employed must be able to produce accounts for two, or even three, years to satisfy lenders, making it difficult to secure mortgage finance where that paperwork isn’t available.
“The self-employed should take care to ensure they hold sufficient cash on deposit to meet lender deposit requirements,” said Jackson. “Borrowers should also take care to ensure they have adequate taxable income, so that affordability can be justified in the eyes of the lender.”