Financial considerations for contractors

Most contractors generally earn more than they would as a permanent employee, this is one of the main reasons some professionals turn to contracting. However, it is important to understand the differences between full-time employee finances and a contractor’s finances before making the decision to switch.

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Salary

The obvious place to start when considering the financial implications of becoming a contractor is your salary, using an umbrella company calculator you can work out your hourly rate based on your current salary. Once you have this information you can compare what you would earn as contractor compared to what you earn as a full time employee. With this comparison you can calculate how much you need to earn as a contractor to support your lifestyle.

Determining your rate

As a contractor you must determine your rate of pay – this usually depends on how much your skills are worth in the current market. Quoting the correct market rate is important, you may miss out on a contract if you quote too high for your skills, alternatively if you quote too low the client may think this is a reflection on your skills and look elsewhere. Permanent employees do not have to negotiate a rate, they have a set salary and benefits package which they will be aware of when applying for a job.

A good way to determine your rate could be to ask other contractors in the same market what they charge.

Tax

Full-time employees do not have to worry about their tax, this is taken care of by their companies payroll department. Now that you are a contractor you have to consider certain tax legislation.

Working through an umbrella company can help be beneficial when contracting. Essentially the umbrella company will behave like a permanent employer and will deduct your tax and national insurance for you.

IR35

IR35 is a piece or tax legislation introduced by the HMRC in the early 2000s. The legislation enabled the HMRC to close a loophole that allowed freelancers the ability to avoid paying large amounts of tax and National Insurance contributions. As part of the IR35, a framework was also introduced in order to remove the ambiguity of employment status surrounding contractors. How this affects you comes down to whether you are seen as ‘inside’ or ‘outside’ IR35.

If you are seen to have a contract of service and are therefore employed by the client then IR35 will apply the same as a permanent employee. However, if your contract is seen as a contract for service you will be classed as a self-employed independent contractor and IR35 will not apply and you will be afforded specific tax advantages.

An umbrella company can be a good source of advice when considering IR35.

Holidays

Holidays for contractors are slightly different to that of permanent employees. As a contractor you are no longer entitled to the same rights as before – this is nothing to worry about as it is normal. You will not be paid for holidays or sick pay so you will have to account for these things financially. You can still take days off but you must first agree this with the client.

Potentially increasing earnings

By continually adding new skills to your CV you can get a higher rate and therefore maximise your earning. As you gain more experience you may also be able to set a higher rate. This is a feature unique to contracting as a permanent employee generally has to work for longer to earn a pay rise.