Since the financial crisis, more people have become self-employed – and potentially in need of financial advice.
There are 4.3 million people classed as self-employed in the UK, according to the most recent figures from the Office of National Statistics, around 14 per cent of the workforce. This has increased sharply in recent years, with 367,000 more people becoming self-employed in the last five years.
The self-employed have many of the same financial planning problems as employees but being your own boss does make a difference in limiting access to some financial products and creating an urgent need for others. Unlike employees, the self-employed do not have access to benefits such as sick pay and company pensions.
Many industry commentators point out that self-employed workers fall outside the scope of auto-enrolment.
Aegon regulatory strategy director Steven Cameron says: “Auto-enrolment does not extend to the self-employed so for them, inertia means no pension. With no boost from a separate employer contribution, they need to be very realistic about the pension contributions they need to make to meet their retirement goals.
“The self-employed who do not take additional measures may find they struggle and are unable to achieve their expected retirement income.”
Self-employed workers also need to ensure they qualify for the state pension. But the Association of Chartered Certified Accountants is concerned that many self-employed workers will not qualify for a full state pension because they have not made enough national insurance contributions.
“I think there is a lack of understanding that people currently need 30 qualifying years to get a full state pension. That may go up to 35 years but that will not happen until at least 2016,” says ACCA head of taxation Chas Roy-Chowdhury.
Roy-Chowdhury recommends that self-employed workers request a statement of their national insurance contributions from HMRC to identify any gaps. “They may still have time to catch up before retirement and if they haven’t they can make up the shortfall – but that costs money and they may not be able to afford it at that point,” he says.
As the state second pension is being scrapped, those with full entitlement will get no more than the basic state pension. But those due to retire after 6 April 2016 will qualify for the new higher single-tier state pension.
“This new state pension provides a starting point, but few would view is as sufficient. For the self-employed, as for everyone, additional savings – including private pensions and other investments – are the only way to make sure that you are ready to retire.” he says.
Prudential head of business development Vince Smith-Hughes highlights the importance of tax planning for the self-employed. He says pension contributions can enable people to retrieve allowances or benefits that they do not currently receive because their earnings are above a certain level. For example, those who pay the high income charge on child benefit because they earn over £50,000 a year could pay into a pension to reduce their income below that earnings threshold.
“Another example is where people earn more than £100,000 a year, their personal allowance is taken away,” says Smith-Hughes. “If someone earns £110,000 a year and pays £10,000 into a pension they would get higher-rate tax relief of 40 per cent and their personal allowance, so their overall tax allowance would be 60 per cent. It is well worth people thinking about it.”
Mortgage lenders typically require two or three years of accounts in support of mortgage applications from the self-employed, which means some people may have to wait to buy property. Another difficulty is that lending decisions are based on a self-employed applicant’s accounts and net profits.
“What someone’s income really is and their net profit can be two different things,” says IPFM director Luke Gibbon, an IFA.
Gibbon points out that the self-employed can legitimately reduce their net profits so they pay less tax. They can, for example, write off business costs and expenses against tax. But the drawback is that their net profits will appear lower in their accounts, which will limit the amount they can borrow.
“You could say they can’t have it both ways,” says Gibbon. “But for good cases mortgages are not difficult. If somebody has good accounts, doesn’t want to borrow too much and hasn’t got a black mark on their record it shouldn’t be a problem.”
Before the credit crunch, the self-employed could choose self-certification mortgages, which did not require proof of income. These were later dubbed ‘liar loans’ because some people were exaggerating their income and taking out mortgages they could not afford. After the financial crisis, lenders had to tighten their lending criteria and proof of income was made mandatory in 2011. This effectively banned self-cert mortgages – but some people still remain on self-cert mortgages that were taken out before 2011 and may have problems if they want to move or remortgage.
Lenders have responded by providing transfer products to their existing self-cert borrowers and offering to review the current status of those borrowers, with a view to helping them into cheaper mainstream deals. But Gibbon has concerns about some people being trapped with their current lender.
“I have a client on a fixed-rate self-cert mortgage that is due to run out in the next couple of years and I know that is going to be a problem. We will most likely carry on with the current lender but that could be expensive,” he says.
With no employer to fall back on for sick pay, death in service benefit or group protection benefits, the self-employed have to make their own arrangements to cover lost earnings if they become too ill to work – or try to scrape by on low state benefits.
But the protection message is largely falling on deaf ears because people think the state will provide; they do not think it they are likely to become so ill they cannoy work; or they have other priorities.
“The need for protection is arguably more urgent for the self-employed,” says LV= protection manager,Chris McNab. “People might want to work through their illness but there will be a financial impact if they physically can’t work.”
McNab highlights income protection and critical illness cover as products that could be most suitable for the self-employed.
Plan Money director Peter Chadborn says:“I find a good way to position the need for protection for the self-employed is to relate it to benefits they would have got if they were employed. That puts it into context.
“If you can’t work due to sickness you are either relying on work in progress – invoices not yet paid; the capital within the business or your own savings. Income protection is arguably the most important, followed by life cover.”