What a 2p tax rise in the Budget could mean for the self-employed

The self-employed look set to be left worse off after the Budget if chancellor Rachel Reeves goes ahead with plans to increase income tax and reduce employees’ National Insurance by the same amount – because they will suffer from the hike and won’t benefit from the cut.

Ideas in a Resolution Foundation report, which suggested taking 2p off National Insurance and adding it to income tax, are currently under consideration in the Treasury ahead of the Budget, according to several papers.

The move could raise £6 billion, the think tank said, without affecting people receiving income from employment under state pension age – and therefore technically avoiding hitting ‘working people’, in line with Labour’s manifesto pledge.

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However, it would hit self-employed people, who pay income tax, but not standard employee National Insurance.

A self-employed person earning £20,000 annually would be £149 worse off a year, those earning £30,000 would take home £349 less and a self-employed person earning £50,000 would be £749 down, according to calculations for MoneyWeek by Hargreaves Lansdown.

Self-employed people do pay National Insurance, but a different class at a different rate. They pay 6% on profits over £12,570 up to £50,270 and 2% on profits over £50,270. By only cutting National Insurance for employed people – while hiking income tax for everyone – the tax system would put more of a burden on the self-employed.

Sarah Coles, head of personal finance at Hargreaves Lansdown, said: “Speculation is mounting over tax changes in the Budget that would hit self-employed people.

“Given they’re already wrestling with insecurity, lumpy incomes, lack of a safety net from their employer, and less help with life’s milestones – like retirement saving – rumours about potential Budget blows will be one more thing to worry about.”

Other types of income that could be hit by the move include pension income, earned income from people over the state pension age, savings interest outside cash ISAs, and income for landlords.

Someone on a total pension income of £35,000, for example, currently pays £4,486 in income tax at 20%. A rise to 22% would mean they pay £449 extra a year, Hargreaves Lansdown calculated.

Dividend tax increase?

Changes to dividend taxation could also feature in the Budget tax rises – another blow for self-employed people who own their own business and take some of their income in dividends.

The higher and additional rates of dividend tax aren’t very different to the tax on wages – at 33.75% and 39.35% respectively – but given the basic rate of dividend tax is 8.75%, the Resolution Foundation has argued for a rise.

“This would be a headache for self-employed people, and would also hit investors with portfolios outside ISAs and pensions who make more than the annual allowance of £500 a year,” said Coles.

Self-employed people are already struggling versus their employed counterparts, with lower average incomes and less money to spare, according to research by Hargreaves Lansdown.

Households headed by a self-employed person have an average of £89 left over at the end of the month, compared to employed households with £244, it found.

Their income can be lumpier too, with good months and bad months, making it harder to save. Self-employed people save an average of 2.3% of their income, compared to employees who save 5.6%.

How can self-employed people beat tax rises?

1. Bring forward dividend payments

If you pay yourself at least in part through dividends, it could be a good idea to consider the timing of your dividend payments, potentially taking them now rather than later when the rules may change.

2. Pay into a pension

One way to cut your income tax bill is by making payments into a pension or Sipp, which will offer income tax relief at your highest marginal rate. This could be even more rewarding if the tax rate rises.

We look at how to set up a pension for the self-employed in a separate article.

3. Use ISAs

A cash ISA will protect you from tax on your savings interest. For broader tax savings, if you have investments outside an ISA or pension, and you have the allowance available, you could move them into an ISA through the Bed & ISA process or into a Sipp through Bed & SIPP.

It also makes sense for any new investments to be made within pensions and ISAs to protect them from dividend tax and capital gains tax in future.

4. Consider a Lifetime ISA

There is another option that could be of real use to groups such as the self-employed – the Lifetime ISA (LISA). The 25% government bonus on contributions up to £4,000 acts like basic rate tax relief on a pension. Though higher-rate taxpayers are better off with a pension due to the higher tax relief on offer. There’s also tax-free income when you come to draw down from this pot after the age of 60.

You can also access the money early if needed, though this is subject to a 25% exit penalty. This, unfortunately, has the effect of taking a chunk of your hard-earned savings, along with the bonus that you’ve built up.

Hargreaves Lansdown is calling on the government to enable people to open and contribute to a LISA up until the age of 55. At the moment, the age limit to opening a LISA is 40. The platform’s research suggested this could help 1.2 million self-employed households build a better retirement.