Making your money work for you
If you’re a contractor, then having a strategy for personal finances is as important as having a strategy for business finances. Unlike a business, there are no regulatory requirements for managing your personal finances – so it is often overlooked and the benefits lost.
Whenever you take money out of your business it has a tax implication. As you no doubt know, there have been recent changes to dividend tax allowances – with more on the way. For this reason and more, it’s vitally important you understand how to plan and manage your money, and make sure it’s working for you.
Not sure where to start? Here’s my four-step foolproof plan for managing your personal finances.
First up, you need two personal bank accounts. I’m assuming you already have one account, either just in your name or in joint names. Open another, again in joint names, if that’s appropriate.
Your first account is your personal spending account; this is the account you’ll pay your income into. Call the second one ‘Household’ or ‘Bills’ or something else that will resonate with you. This is the account all of your direct debits and standing orders will go out of. (If you’ve got all your DDs coming out of your existing account already, you might just want to rename that one and use the new one for your income.)
Next, set up a spreadsheet and put your income at the top. Now list all your fixed monthly costs – the mortgage, council tax, water rates, phone, TV, Internet … absolutely everything.
The reason you’re using a spreadsheet for this is that the amounts will change over time, and when you update the spreadsheet with the new bill amount, it will automatically give you your new monthly total.
Your third step is to set up a standing order from your personal spending account to your bills account, for the amount the spreadsheet tells you that your monthly bills come to. Transfer the money over on the first of the month, and that way you know your bills are covered. Whatever you have left in your personal account once that’s gone out is yours to spend as you wish. When you go to the hole in the wall, you don’t have to look at the balance and wonder if the council tax has gone out yet or not – you know for certain how much you have to spend.
Managing your finances monthly isn’t ideal for many people. If you’ve ever found yourself with a ‘£0.00’ balance on your bank statement mid-month – this step is for you.
Take the balance of your personal account after you’ve transferred the necessary funds to your bills account, and divide by five. The number you reach is your weekly budget. Why five? Most months have four weekends in them, but you divide by five so that you don’t get caught short on the months that have five weekends. You’ll also have a nice little surplus on the months with four weekends. When you know this number, don’t spend more than that amount each week. Simple.
Fine tuning the system to suit you
Here are some other considerations.
You might want to pay a little extra on your mortgage each month, so you pay it off quicker.
You might want to regularly put some money into a savings account, so you have a rainy-day fund.
You might want to use the bills account to pay for some variable costs, too, such as fuel, food and clothing; if that’s the case, put an allowance on the spreadsheet to cover these items. Just remember to check that the allowance is sufficient – having a ‘float’ in the account, at least to start with, will help you overcome any low estimates.
You could use it to set aside the money you’ll need to pay your tax bill, so there are no nasty surprises when the time comes to pay HMRC.
You might have bills that aren’t paid monthly that you want to pay out of the bills account; if so, divide the annual amount by 12 and add that to your monthly bills payment. (A word to the wise: make sure you do this just after the bill has been paid, or else add a ‘float’ so that the account doesn’t go overdrawn because only two instalments of a quarterly bill have gone in before the payment comes out.)
A further consideration is that if you’re still under the higher rate tax threshold, you could actually pay yourself a little more, then put that money into a savings account. Sure you’ll pay 7.5% dividend tax on it, but if having a reserve fund gives you peace of mind, it’s worth doing.
However you fine tune the system to suit you – and you may tweak it a time or two before you’re finally happy with it, as you get into the new way of managing your money – you soon get used to only spending the amount available in your personal account, and you have the peace of mind of knowing that there’s no chance your bills will be overlooked.
Don’t just think about it …
Honestly, do it now! This system helps you to manage your personal finances better than any other method I know.
You know how much you need to pay yourself, as a salary and as a dividend, and you can keep the amount as low as possible in order to minimise your tax liability.
It takes a little effort to set up, but in return you gain clarity with regard to your finances – and money that’s working for you.
If you have any questions please get in touch.