How much to set aside for tax when you're self-employed

Every tradesperson who's been going a few years has either had the January phone call, or watched a mate have it. The tax bill lands, it's bigger than expected, and the money isn't there — because for twelve months everything that came in looked like income.

The fix is boring and it works: a second bank account and a percentage. Here's how to set the percentage so it's actually enough. Tax rates and thresholds change every year — the percentages below are planning rules, not tax advice. Confirm against gov.uk or your accountant.

The mistake: treating turnover as wages

Money lands in the account. It doesn't feel like anyone else's. So it gets spent — on the van, on the house, on a decent weekend.

But a chunk of it was never yours. Out of what a customer pays you comes:

• Income Tax on the profit
• National Insurance on the profit
• VAT, if you're registered — and this one was never yours for a second
• Sometimes payments on account towards next year, too

Set the percentage aside on the day the money arrives and none of that is ever a shock.

What percentage?

You're taxed on profit, not turnover — so the honest answer is "a percentage of profit." But nobody wants to calculate profit weekly, so most trades use a percentage of income that's deliberately generous.

Sensible planning rules, assuming you're not VAT registered:

Situation	Set aside
First year, low profit, still under or near the personal allowance	20% of income
Steady, profits comfortably inside the basic rate	25–30% of income
Good year, profits approaching or into the higher rate	30–40% of income
Any year where payments on account are coming	Add a further 10–15%

If you'd rather work from profit, the shape is: Income Tax at your marginal rate plus self-employed National Insurance on top. For most one-person trades sitting in the basic rate, setting aside around 30% of profit is a comfortable working assumption that usually leaves a bit spare. Over-saving is a nice problem; under-saving is a horrible one.

If you're VAT registered, it's two buckets

VAT is not your money at any point. You collect it for HMRC and you hand it over quarterly. Treat it as separate from tax saving entirely:

• Bucket 1 — VAT. The VAT element of every invoice, moved out on the day it's paid. If you're on the flat rate scheme the arithmetic differs slightly, but the principle doesn't.
• Bucket 2 — Income Tax and NI. Your percentage of the net (ex-VAT) figure.

The trades who get into trouble with VAT are almost always the ones who let it sit in the main account and mentally counted it as a good quarter. If you're not registered yet, do you need to register for VAT covers when you will.

The system: one extra account, one standing habit

1. Open a second account. A savings account, ideally paying interest, at a different bank so it's slightly awkward to raid. Call it "TAX".
2. Move the percentage the day a payment lands. Not weekly, not monthly — the day. If it sits in the current account it will be spent, because it looks like money.
3. Never take it back out. The tax account is not an overdraft. If you're tempted, the problem is your pricing, not your savings.
4. Check it against reality twice a year. After you file, you know the real bill. Adjust the percentage up or down for next year.
5. Let it earn something. It's sitting there for months. It may as well earn interest — just remember interest is itself taxable.

If you're limited rather than a sole trader, the same discipline applies to Corporation Tax, PAYE and VAT — with the added rule that money in the company account isn't yours to spend personally at all. Structure differences are in sole trader vs limited company.

The first-January problem

Read this bit even if you skip the rest.

In your first proper Self Assessment January, you may owe the full year's tax plus a payment on account towards the next year — often half the bill again. Then another half in July.

So the first January can be roughly 150% of a normal year's tax, in one payment.

If you saved 25% all year, you'll be short. Not because you did it wrong — because the changeover year is genuinely bigger. Two ways to handle it:

• Save extra in year one. Add 10–15% on top of your normal percentage for the first year.
• File early. File in the spring or summer and you'll know the exact January number six months out, with time to close a gap. There's no downside — filing early doesn't mean paying early. The mechanics are in Self Assessment basics.

What reduces the bill legitimately

You're taxed on profit, so anything that's a genuine business cost reduces it. Not by claiming things that aren't — by claiming everything you're actually entitled to:

• Materials and subcontractors
• Van running costs, or mileage
• Tools and equipment (often via capital allowances)
• Insurance, scheme and registration fees
• Phone, broadband, software, website
• Accountant
• Protective clothing and workwear
• Training that maintains your existing skills
• Use of home for the admin you do at the kitchen table

A pension contribution is worth a specific mention: it's one of the few things that reduces your tax bill and keeps the money yours. Annual limits and rules apply — worth an accountant's advice on the amount.

Detail on what's allowable and what isn't is in what you can claim as expenses.

Six warning signs you're not saving enough

1. You've no idea what your profit was last year.
2. Your business and personal money are in one account.
3. You paid last year's tax bill out of this year's work.
4. You've ever used a credit card or a director's loan to pay HMRC.
5. You've had a penalty for late payment.
6. January makes you feel sick.

Any two of those and the fix is the same: separate account, fixed percentage, moved the day the money lands.

The honest summary

Set aside 25–30% of everything that comes in as a starting point, more if you're having a good year, more again in your first Self Assessment year, and VAT in a separate bucket if you're registered. Move it the day it arrives. Check it twice a year against your actual bill.

It's not clever and it's not tax planning. It's just the difference between January being an admin task and January being a crisis — and unlike almost everything else about running a trade business, it takes about ten minutes to set up once and then looks after itself.

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