When you’re self-employed, it’s important to save and invest in ways that provide you with a safety net for you and your business, as well as getting you closer to achieving your life goals for the future.

Being self-employed can bring flexibility and freedom to your life. But it can also make it harder to put your finances in order. One area that can be particularly difficult to manage is setting aside money for savings and investments.

Set aside at least six months’ worth of expenses, to cover any periods where you may not be able to work

What’s the difference between saving and investing?

That’s a good question. Savings and investments are terms that are often used interchangeably but mean different things. In an ideal world, you should think of them as different approaches to growing your money and, being self-employed, you should try to build a combination of the two.

Savings is a term usually applied to the money you’ve set aside for a ‘rainy day’, and that you can access easily whenever you need it.

Investments, on the other hand, are intended to grow over time, and should be considered as longer-term. In fact, you should probably think of investments as money that shouldn’t be touched for at least five years. It’s important to understand that investing comes with the risk that you may lose some or all of your investment, which is why it’s important to get advice from an independent financial planner before making any investment decisions.

Setting a savings goal

As a general rule, it’s a good idea to set aside somewhere between three and six months’ worth of expenses as an ‘emergency cash fund’. However, if you’re self-employed, you might want to consider setting aside at least six months’ worth of expenses, to cover any periods where you may not be able to work, or where your income has been significantly reduced.

Any growth or interest earned within an ISA is tax-free

Saving and investing through an ISA

After you’ve built up your emergency cash fund, you can then consider moving more money into investments. Individual Savings Accounts (ISAs) are a great place to start – they’re flexible, you don’t need loads of money to invest in one and they are transferable. What’s more, any growth or interest earned within an ISA is tax-free.

ISAs were introduced by the UK government back in 1999, and today there are four different types of ISA available: Cash ISAs, Stocks & Shares ISAs, the Innovative Finance ISA, and the Lifetime ISA (LISA).

– Cash ISAs

Cash ISAs remain popular with UK savers. For starters, they’re easy to set up – you can even take out a Junior ISA on behalf of children under 18. Plus, there’s no lock-in period, meaning you can access your cash almost instantly when you need to.

Another important feature is that Cash ISAs worth up to £85,000 are protected by the Financial Services Compensation Scheme (FSCS), meaning your money is protected in the unlikely event your bank goes out of business.

You don’t need to pay tax on the interest you earn via a Cash ISA. However, the rates of interest available on Cash ISAs have been stuck at low levels for a long time, meaning there’s very little chance of ‘growing’ your savings.

In fact, over time, the value of your Cash ISA can actually fall, as inflation erodes how much your savings are worth. Therefore, once you’ve started setting aside regular amounts, you might want to think about alternative ways to make that money grow.

– Stocks & Shares ISA

When you’re ready to start investing for the longer term, you should consider a Stocks & Shares ISA. These allow you to invest either directly in company stocks (if you’re able and happy to take a more active role in investing) or via a portfolio of funds managed on your behalf.

These are considered long-term investments that you should be prepared to hold onto for several years, and they tend to yield inflation-beating returns over the long-term. That’s because investing in the shares of companies means the value of your investment is tied to the fortunes of those companies, rather than the fixed rate of interest usually available through a Cash ISA.

So, provided those companies do well, your investment should grow in value over time at a rate higher than inflation. However, if the reverse is true and you should also be prepared for periods when your investment falls in value.

There’s no income tax or capital gains tax to pay on any investment gains made through Stocks & Shares ISAs. However, this type of ISA is not guaranteed by the FSCS, and you may lose some or all of your investment.

– Innovative Finance ISA

The Innovative Finance ISA was established in 2016. It was introduced in response to the increasing popularity of ‘innovative’ investments in the UK investment marketplace, like peer-to-peer loans, crowdfunding and other property and green energy projects.

By placing these investments within a tax-efficient ISA ‘wrapper’, the Innovative ISA ensures investors benefit from the same tax benefits as other ISAs. However, as with Stocks & Shares ISAs, your Innovative Finance ISA investment is not guaranteed, and you may lose some or all of your investment.

– Lifetime ISA

The most recent member of the ISA family is the Lifetime ISA or LISA. The LISA was introduced by the government in 2017, primarily to encourage younger investors to buy their first home or set money aside for later life.

You must be under 40 to open a LISA and it can hold cash, stocks and shares, or a combination of both. You can only pay £4,000 into a Lifetime ISA in a tax year, but the government will add an additional 25% bonus to whatever you pay in.

After you’ve used up your annual ISA allowance, you might want to consider other tax-efficient investments

How much can be invested in an ISA?

Every tax year (from 6 April to 5 April) individuals benefit from an annual ISA allowance, which is currently £20,000 (or £4,000 for a LISA). ISA owners can save or invest the full amount in one ISA or split their annual allowance across different types of ISA.

It’s worth remembering that ISA allowances operate on a ‘use it or lose it’ basis. In other words, if you don’t make an ISA investment during a particular tax year, you can’t ‘roll-over’ the allowance to the next one.

Tax-efficient investments for the self-employed

After you’ve used up your annual ISA allowance, you might want to consider other tax-efficient investments aimed at investors with a higher risk appetite.

For example, Venture Capital Trusts (VCTs) and the Enterprise Investment Scheme (EIS) are investment vehicles that let you own the shares of young and innovative smaller companies that are not listed on the main UK stock markets such as the FTSE. Not only do these types of investments have higher growth potential, but they also offer tax incentives that can be used to lower your tax bill.

With a VCT, you can invest up to £200,000 in a single tax year, and can claim up to 30% income tax relief against the amount you invest, provided they hold onto the investment for at least five years. So, if you invested £120,000 into VCT, you can reduce your income tax bill by £36,000. Also, any growth in the value of your investment is tax-free, including any dividends the VCT pays out.

An EIS investment is similar, in that investors can claim up to 30% income tax relief against the amount they invest (up to a maximum of £2 million), provided you hold onto the investment for at least three years. There’s also no capital gains tax to pay on the growth of your investment – and you can also claim ‘loss relief’ on those investments that fail.

However, it’s important to realise that VCTs and the EIS are high risk investments. Because the shares are not publicly traded, they can be difficult to sell. Investors must also hold onto the shares for the minimum holding period to qualify for the tax reliefs, otherwise any tax reliefs claimed will need to be repaid to HMRC.

Although these type of investments are clearly not suitable for every investor, they are becoming increasingly popular with self-employed investors who have used up their ISA allowances, are interested in reducing their annual income tax bill, and are willing to invest in higher risk smaller companies.

Amber River – helping to build your savings and investment plan

Being self-employed means taking ownership and responsibility – both for your business, and your financial future. But that doesn’t mean you have to make all the decisions by yourself. An Amber River independent financial planner can help you create a savings and investments plan that lets you build up a safety net for the short term, while also ensuring you make the most of your money – in the most tax-efficient ways possible – over the longer term.

Remember that the value of your investments, and any income you take from them, can fall as well as rise, and you may get back less than you invested. Please don’t consider the contents of this article as financial advice.

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Investments Money Savings and investments Self employed