How to set aside money for your tax and National Insurance

The most important financial habit to build as a sole trader is to set aside a portion of every payment you receive for your future tax bill. A good rule of thumb is to move 25-30% of your income into a separate savings account the moment you get paid. This simple discipline is the key to making sure you have the funds ready when your Self Assessment tax and National Insurance bill arrives.

Why is this so important?

When you're an employee, your tax is usually taken care of for you through the Pay As You Earn (PAYE) system. But as a sole trader, you receive your gross income directly from clients. It's your legal responsibility to calculate and pay your own Income Tax and National Insurance contributions to HMRC. This is done through an annual Self Assessment tax return. By putting money aside from day one, you avoid the stress of finding a large lump sum when the payment deadline looms.

How much should I set aside?

The 25-30% figure is a widely used estimate that provides a safe buffer for most new businesses. This percentage is designed to cover:

• Income Tax: The basic rate is 20% on profits over your personal allowance.
• Class 4 National Insurance: A percentage of your profits over a certain threshold.
• Class 2 National Insurance: A small, fixed weekly amount once your profits reach a set level.

Think of it this way: for every £100 you earn, immediately move £25 into your tax savings account. If you do this consistently, you'll be in a great position when it's time to pay HMRC.

If you start earning significantly more and move into the higher rate tax bracket (40%), you should increase this percentage accordingly.

A simple 3-step process

1. Open a separate savings account: This doesn't have to be a formal business account, just any separate, easy-access savings account. The goal is to ring-fence the money so you aren't tempted to spend it.
2. Do the maths on every payment: The moment a client pays you, calculate your chosen percentage (e.g., 25%) of that income.
3. Transfer it immediately: Move that calculated amount straight into your dedicated tax account. Don't wait until the end of the week or month. Make it a habit.

Top Tips for Success

• Name your account: In your banking app, nickname the savings account "Tax Pot" or "HMRC Fund". This acts as a constant reminder of the money's purpose.
• Use accounting software: Tools like Xero, QuickBooks, or FreeAgent can connect to your bank account and often provide a real-time estimate of your tax liability, giving you more accuracy.
• Review and adjust: Check your total income every quarter. If your business is growing faster than expected, you might want to increase your savings percentage to 30% or more to be safe.
• Pretend it doesn't exist: Once the money is in your tax pot, consider it gone. It's not your money to dip into for business expenses or personal treats – it belongs to the tax office.