Before you start contracting, consider the potential benefits and drawbacks. While contracting can offer higher pay and greater flexibility than a salaried job, there are also hidden costs to be aware of. This guide provides tips, information, and highlights common mistakes to help you determine if contracting is the right choice for you.
Being a contractor entails:
- Being self-employed
- Having the freedom to select your work
- Deciding how and, at times, where to perform your tasks
- Being accountable for your tax obligations.
While there may be some similarities to being in a salaried job, such as performing similar duties, being a contractor means you are essentially running your own business. These distinctions, such as uncontrollable gaps between contracts, may indicate that contracting might not be suitable for everyone. Prior to making a decision, ask yourself the following questions:
Why become a contractor?
Some individuals opt for contracting as a career path. They aim to utilise their expertise and earn more than they would in a salaried position. Others may turn to contracting after losing their permanent salaried employment, such as after being made redundant.
Will it suit my personality?
Contracts can last from a few weeks to several years, so you’ll need to be prepared for any gaps between contracts, whether they are short or long and expected or unexpected.
Adjusting to new work cultures and ways of working can take time, so contracting may be a better fit for those who can quickly and easily adapt to new situations.
Consider the costs
Depending on your industry, there may be significant initial costs associated with starting a contracting business.
For instance, as a cleaner, you might need to invest a substantial amount in equipment and cleaning supplies, while as a courier or truck driver, you may need to purchase a vehicle.
Before making any major financial commitments, it’s important to consider how long it will take to repay any loans you may need to take out. Additionally, think about what could happen if the company you’re contracting with experiences a loss of work. Would you lose your contract? Would you be able to quickly find other contracting work? Would you be able to continue making payments on your equipment loans?
Sole trader or company?
If you’re a contractor, you have the option to operate as a sole trader or establish a company. Each choice has its advantages and disadvantages, so it’s essential to understand what each would entail for you. The Choose Business Structure tool can assist you in making the best decision.
Contractor versus employee
When you work as a contractor, it’s important to have a “Contract for Services” with your client. If you have an employment agreement, even for a short-term arrangement, you will be considered an employee for the duration of the agreement. This means that tax and ACC contributions will be deducted from your pay, and you will be entitled to sick leave and annual leave as a permanent employee would.
Before signing any contracts, it’s advisable to seek professional advice to ensure you understand the terms and implications.
If you know someone who is also contracting in your field, it can be helpful to have a conversation with them about their experiences. Ask them about :
- the challenges they’ve faced
- if they earn what they anticipated
- if they find any financial aspects of contracting stressful
- if they would recommend contracting to others close to them.
Hidden costs
It’s a common misconception to determine your annual earnings solely based on your contract rate, such as calculating $75 per hour X 8 hours a day X 5 days a week X 52 weeks a year = an annual income of $156,000. However, there are several costs that need to be taken into account, such as covering your own sick leave and ACC expenses.
Fractured income
If you’re working as a contractor, it’s important to be prepared for unexpected gaps between the end of one contract and the start of another. While these gaps can be an opportunity to take a break if your skills are in demand, it’s natural to feel stressed when there’s no continuous work available.
Stay vigilant and pay attention to any indications regarding the future of your contract. It’s advisable to start searching for new opportunities at least a month before your current contract is scheduled to end.
Tip
To ensure you have peace of mind, consider saving up to three months’ worth of income as a buffer in case you experience any unplanned breaks between contracts.
Sick leave
As a contractor, it’s important to note that you won’t receive paid sick leave. It’s wise to budget for at least five days per year when you may be unable to work due to illness, without receiving payment. Make sure to factor this into your budget when calculating your hourly rates.
Public holidays
As a contractor, it’s important to note that you won’t be paid for public holidays that you don’t work. Be sure to include this in your budget and when calculating your hourly rates.
In New Zealand, there are 10 national public holidays, along with one anniversary day for each province, such as Auckland Anniversary Day. If you have agreed upon set hours with a client, like 40 hours per week, you may have the option to work on these public holidays, especially if you work from home. However, it’s essential to remember that you won’t receive additional payment beyond your regular hourly rate.
If you work at your client’s workplace, it’s a good idea to check if they operate during public holidays, such as the period between Christmas and New Year.
KiwiSaver
As a contractor, it’s important to note that you won’t be automatically enrolled in a KiwiSaver retirement savings scheme. It is your responsibility to set up and contribute to the scheme yourself.
It’s advisable to consider your retirement plans, such as how much you intend to save for your retirement, in order to determine the appropriate amount to contribute to your KiwiSaver scheme.
Retirement planner — Sorted
Upfront costs
If you provide your own tools and equipment when contracting, calculating your expenses can be tricky. You’ll need to consider factors such as depreciation and tax-deductible expenses. Seeking professional advice is recommended, particularly if you need to take out a loan or lease equipment, so you understand the implications and options for tax.
However, if you are not expected to use your own equipment, your set-up costs may be minimal.
If you’re planning to work from home and need to set up an office, you can claim these costs as tax expenses.
Getting loans
Securing loans from banks for purposes such as a mortgage or a car can be more challenging for contractors. To increase your chances of approval, you’ll likely need to demonstrate to your bank or lender:
- A track record of continuous work, typically spanning at least two years.
- A savings buffer that assures your ability to make mortgage payments even during periods when you’re in between contracts and not earning.
Case study
Minding the gaps
“When I started contracting I was surprised at the end of the year that I hadn’t earned more,” says long-time IT contractor Stephen. “I’d negotiated a pretty good rate and lined up a second contract to start three weeks after my first one ended, so I thought ‘Sweet, I’ll take a holiday’.”
But when the start of the second contract was delayed, what was meant to be a three-week gap turned into two months.
“It was quite stressful when I look back on it because I had to take a hard look at my finances.”
Now, he saves a portion of his monthly income as a buffer in case of future contract gaps. “I also put aside time towards the end of contracts for finding work — not just talking to agencies, but doing some networking, even if it’s talking to mates in the industry, it all helps.”
Hourly rates
Setting a realistic hourly rate for your contract work is crucial. It should cover all of your expenses and hidden costs, such as sick leave and public holidays. If your rate is too high, it could deter potential clients, but if it’s too low, you may end up losing money.
Tip
When you begin contracting, it might be wise to offer a reduced hourly rate initially to establish your reputation.
Additionally, for longer contracts like those spanning 12 months, you may need to agree to a slightly lower rate.
How to work out your hourly rate
Determining your rate becomes easier as you gain experience in contracting and develop a better understanding of the market. However, if you’re just starting out, a practical approach is to take the rate you would earn from a comparable salaried job and add a minimum of 20 per cent. For example:
- $50 per hour salaried rate
- + 20 per cent
- = $60 per hour contract rate
This additional percentage accounts for expenses that would typically be covered by an employer in a salaried position, such as:
- annual leave
- sick leave
- public holidays
- ACC
- Business-related costs like bank account fees, credit card charges, stationery, printer ink, data plans, and IT security expenses.
There are additional expenses that you should consider when calculating your contract rate. These include:
- Purchasing new equipment
- Regular payments or interest costs if you take out a loan to buy new equipment
- Budget for repairs and maintenance
- Fees and levies for annual licensing or registration
- Insurance costs for your assets and equipment
- Public liability and professional indemnity insurance expenses.
If you’re offered a contract rate, such as a daily rate or a rate for covering a specific route or territory, it’s important to ask questions to understand the details. Here are some examples:
- What assumptions are made about the hours worked in the rate?
- Is the rate guaranteed? If not, what factors could affect it, such as the specifics of a site or route, or your skill and speed?
- Is work always available at that rate, or could external factors like weather, customer demand, or the time of year affect your potential earnings?
- Can the other party change the site, route, or territory you’ll be working on, and if so, how will that affect your potential earnings?
Things to think about before you start
Once you have thought through the pros and cons and decided to become a contractor, it’s important to ensure you set yourself up correctly. Here are some questions to consider:
- Should I operate under my own name as a sole trader or as a company?
- What are the registration requirements for GST?
- How can I finance my equipment?
- How much should I set aside for income tax and GST?
- What is the best way to pay my tax?
- What records do I need to maintain?
- What expenses can I claim?
If you need assistance with these matters, it may be a good idea to seek advice from an accountant or financial adviser to ensure you receive professional guidance.
Common mistakes
- Failing to set aside enough money for tax and ACC – Remember to save a portion of every invoice payment for tax and ACC obligations.
- Delaying tax payments – Paying your GST or income tax late can result in penalties.
- Not seeking professional advice – Getting the right advice from experts early on is essential for contractors. They can guide you in setting up your finances properly and avoiding common mistakes, such as saving the correct amount for provisional tax.
- Not sending invoices promptly – Timely invoicing is crucial for ensuring timely payment. Send your invoices as soon as possible, such as at the end of each working week if you invoice weekly.
- Setting your hourly rate too low – Your rate should consider all your expenses, cost of living, and items typically covered by an employer in a salaried job.
- Ignoring record keeping and administration – Maintaining organised records is important to stay on top of key dates and to have the necessary documentation for Inland Revenue if required.
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