Managing Your Freelancer Salary and Tax Money
Managing irregular freelance income can feel overwhelming, but there's a straightforward system that works. The key is creating predictability from unpredictable earnings.
TL;DR:
- Calculate your average monthly earnings from the past 6-12 months and set this as your fixed salary
- Transfer this set amount to your personal account each month, regardless of what you actually earned
- Keep tax money in a completely separate account
- Save a percentage of every payment you receive for tax obligations
- Review and adjust your salary amount every few months based on actual performance
- Always consult a tax professional to determine your correct tax saving percentage
When you're freelancing, your income bounces around from month to month. One month you might earn £5,000, the next only £1,500. This makes it nearly impossible to budget or plan ahead.
The solution is paying yourself like a traditional employee – with a fixed monthly salary that smooths out these peaks and valleys.
Setting Your Fixed Salary
Calculate Your Baseline
Look at your earnings from the past 6-12 months and work out the monthly average. This becomes your baseline salary. If you earned £36,000 over the past year, your monthly salary would be £3,000.
Start slightly below this average rather than above it. If your average is £3,000, consider setting your salary at £2,700. This buffer protects you during slower months and builds up reserves for business expenses.
Making Monthly Transfers
Each month, transfer your set salary amount from your business account to your personal account. Do this regardless of whether you had a £5,000 month or a £1,500 month. Your personal finances stay stable while your business account absorbs the income fluctuations.
During high-earning months, the excess stays in your business account. During low-earning months, you draw from these accumulated reserves.
Regular Reviews
Check your salary amount every three months. If your income has consistently increased or decreased, adjust accordingly. The goal is keeping your business account healthy while maintaining steady personal income.
Managing Tax Money
Tax obligations are the biggest financial surprise most freelancers face. The solution is treating tax money as if it never belonged to you in the first place.
Determine Your Tax Rate
Speak with a tax professional to understand your specific situation. They'll help you calculate the percentage of each payment you should immediately set aside for taxes. This typically ranges from 20-40% depending on your income level and business structure.
Create a Tax-Only Account
Open a separate savings account exclusively for tax money. This account serves one purpose – holding money that belongs to the tax office.
Every time you receive payment, immediately transfer the calculated percentage into this tax account. If you receive a £2,000 payment and your tax rate is 30%, transfer £600 straight into tax savings.
Automate Where Possible
Set up automatic transfers if your banking allows it. The less you have to think about moving tax money, the less likely you are to accidentally spend it.
Common Mistakes to Avoid
Most freelancers treat their business account like a personal piggy bank, withdrawing money whenever they need it. This creates chaos during tax season and makes financial planning impossible.
Another mistake is trying to time tax payments. Some freelancers think they can use tax money for "temporary" expenses and replace it later. This rarely works out well.
FAQs
How do I handle months when my business account runs low?
If your business account can't cover your salary, you have two options: reduce your salary for that month or temporarily loan money from your tax account (replacing it immediately when new payments arrive). The first option is usually safer.
Should I pay myself a percentage of income instead of a fixed amount?
A fixed amount provides better personal budgeting stability. However, some freelancers prefer a percentage system where they pay themselves 60-70% of each payment. Choose based on whether you prioritise personal budget stability or business cash flow flexibility.
How often should I review my tax saving percentage?
Annually, or whenever your income changes significantly. Tax obligations change as you move into different brackets, so what worked at £30,000 annual income won't work at £60,000.
What happens if I save too much for taxes?
You'll get a refund, which isn't the worst problem to have. It's better to oversave slightly than face a large tax bill you can't afford.
Jargon Buster
- Tax bracket: Income ranges that determine your tax rate – earn more and you might move into a higher bracket with increased tax obligations
- Business reserves: Money kept in your business account to cover expenses and smooth out income fluctuations
- Self-employment tax: Additional tax obligations that freelancers face beyond regular income tax
- Quarterly payments: Tax payments made four times per year instead of one annual payment – often required for freelancers
Wrap-up
The freelance salary system works because it separates your business finances from your personal finances. Your business absorbs income volatility while your personal budget stays predictable.
Start conservative with your salary amount and tax savings percentage. It's easier to increase your salary later than to deal with cash flow problems or unexpected tax bills.
Remember that this system only works if you stick to it consistently. Set up the accounts, calculate your numbers, and then trust the process even when it feels strange paying yourself a steady salary from irregular income.