What Percentage Of Your Pay Should You Be Taking Home?

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November 01, 2016

When knee-deep in the quest to jumpstart a freelancing or contracting career, it’s easy to forget one important thing: how much are you going to pay yourself? Tempting though it may be to allocate a generous level of ‘take home pay’, you must stick within the limitations of other payments on the horizon.

Being self-employed, therefore, demands a genuine assessment of what you have left after tax, NI contributions, expenses and pension payments. If you don’t want to be left in the lurch when these costs arise, you should look at how much take home pay is feasible for you.

Calculating your worth

Before you decide on a wage, you have to get an idea of what you’re actually bringing in. Calculating your average earnings, even if it’s over the course of a few months, will allow you to predict your overall earnings for the financial year.

This is important because the first £11,000 of your income is tax-free. Gross income above this is taxed at 20% up to £43,000, or 40% thereafter. Your taxable income – and what can be classed as viable expenses, with tax breaks to accompany them – can be down to your business model.

This is where being financially savvy can pay dividends… literally!

Setting your salary

Typically, a contractor or freelancer should look to take home around 70-80% of what they earn. Such a figure can be achieved by deciding on your status: will you work for an umbrella organisation, or establish yourself as a limited company?

Umbrella companies take away the trouble of managing your invoices, tax submissions, and NI payments, but they come at a price: usually around 10% of your earnings. This is before expenses and tax are taken into account, and income tax will be charged on your earnings as a whole. For example, a contractor who earns £45,000 will have to fork out 40% to the government.

Limited company directors, by contrast, can split their take home pay into two categories: salary and dividends, the latter of which benefits from a £5,000 allowance. As dividends face lower taxation – 7.5% or 32.5% depending on your tax band – it’s a far more cost-efficient way to withdraw your income.

Freelancers earning that same £45,000 over the course of a tax year, then, might withdraw half of their income as a salary, and the rest as dividends. That means their income stands at £22,500, falling into the 20% tax bracket, with significant savings on the other half classed as dividends.

Establishing your take home pay can seem overwhelming at first, but it’s essential to ensure you have enough money set aside to cover your tax bill at the end of each year. Once you’ve gained an idea of your earnings and the best business model for you, the percentage you can afford to take home will soon fall into place.

We can help with this – Bright Ideas Accountancy has limitless expertise in the freelancer and contractor field; our accountants can advise on how much you should set aside. Call us on 0161 669 4221 or email Info@biaccountancy.com to discuss your take home pay today.

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