What to think about before you start contracting
There are many benefits to working as a contractor — it can pay better than doing a similar salaried job and be more flexible. But there are hidden costs to think about, too. Here’s where you’ll find tips, information and common mistakes to help you decide if going contracting is for you.
What is a contractor?
Being a contractor means you:
- are self-employed
- choose what work you do
- choose how — and sometimes where — to do your work
- are responsible for paying your tax.
There are similarities with being in a salaried job, eg you may do the same job a salaried person does. But there are differences that may mean contracting is not for you, eg gaps between contracts that you can’t control. Ask yourself the following questions before you decide:
Why become a contractor?
Some people become contractors out of choice, eg to use their skills to earn more than they could in a salaried job. Others do it because they find themselves out of permanent salaried work, eg after being made redundant.
Will it suit my personality?
Contracts can be as short as a few weeks or be carried on, sometimes for years. You’ll need to handle the stress that may come with any gaps between contracts - short and long, expected and unexpected.
It can take time to get used to new work cultures and ways of working. Contracting suits people who can adapt quickly and easily to new situations.
If you find out that you prefer being an employee, remember you can always change once your contract ends.
Sole trader or company?
If you’re contracting, you can choose to be a sole trader or start a company. There are pros and cons to each option, so it pays to understand what each would mean for you.
Contractor versus employee
When you're contracting, you should have a "Contract for Services" with your client. If you have an employment agreement — even if you're only with the organisation short term — you're classed as an employee for the length of your agreement. You’ll have tax and ACC taken from your pay, and get paid sick leave and annual leave as a permanent employee would.
It’s a common mistake to assume what you’ll earn in a year simply by looking at your contract rate, eg $75 per hour X 8 hours a day X 5 days a week X 52 weeks a year = annual income of $156,000. There are several costs to include first, eg covering your own sick leave and ACC.
If you’re contracting, you may have to get used to unplanned gaps between the end of one contract and the start of another. If your skills are in demand, you can take advantage of these gaps by turning them into holidays. However, it’s normal to want to have continuous work - and get stressed when you don’t have it.
Keep alert when working for any clues to what will happen with your contract. You should start looking for more work at least a month before your contract is due to end.
TIP: To give yourself peace of mind, save a buffer of up to three months' income in case of unplanned breaks between contracts.
As a contractor, you don’t get paid sick leave. It’s a good idea to budget for at least five days a year when you’re too sick to work - and won’t get paid. Make sure you include this in your budget and when working out hourly rates.
As a contractor, you don’t get paid for public holidays that you don’t work. Make sure you include this in your budget and when working out hourly rates.
There are 10 national public holidays, plus one anniversary day per province, eg Auckland Anniversary Day. You may be able to work those days — especially if you work from home — to make up set hours you have agreed with a client, eg 40 hours a week. But you won’t be paid above your hourly rate.
If you work at your client’s workplace, check if it’s open on public holidays, eg between Christmas and New Year.
As a contractor, you are not automatically enrolled in a KiwiSaver retirement savings scheme. You must set that up and pay into it yourself.
It’s a good idea to think about your retirement plans, eg how much you plan to save for it, to work out how much to pay into your scheme.
Unless you’re contracting for clients who expect you to use your own equipment, eg tools, you may have few set-up costs.
If you are going to work from home and need to set up and equip an office, you can claim back these costs as tax expenses.
Borrowing money from a bank, eg for a mortgage or a car, can be harder if you’re a contractor. You’ll probably need:
• a history of continuous work, eg two years
• buffer savings, to show you can pay your mortgage even when out of contract work.
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 a delay starting the second contract turned a three-week gap into two months.
“It was quite stressful when I look back on it because I had to take a hard look at my finances.”
He now saves some of his monthly income for 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.”
It’s important you set a realistic hourly rate for your contract work. It needs to cover all your expenses and hidden costs, eg sick leave and public holidays. If you set your rate too high it could put off future clients. Setting it too low could leave you out of pocket.
TIP: When you start contracting, it can be a good idea to discount your hourly rate while you build your reputation.
You may also need to agree to a slightly lower rate for longer contracts, eg 12 months.
How to work out your hourly rate
It’s easier to settle on your rate when you have been contracting for a while and have a better feel for the market. If you’re starting out, a good method is to take the rate you would earn from a similar salaried job and add at least 20 per cent, eg:
- $50 per hour salaried rate
- + 20 per cent
- = $60 per hour contract rate
The increase covers things an employer would pay for if you had a salaried job, eg:
- annual leave
- sick leave
- public holidays
Things to ask an accountant before you start
You have thought through the pros and cons of becoming a contractor and want to get started. You’ll want to make sure you set yourself up correctly, so unless you’re a financial expert, it’s a good idea to talk to an accountant. Questions to ask them might include:
- Should I work under my own name — as a sole trader — or as a company?
- Is it worth me registering for GST?
- How much should I put aside for GST and income tax?
- How should I pay my tax?
- What records do I need to keep?
- What expenses can I claim?
- Not putting aside enough money for tax and ACC — you should save this from every invoice that’s paid to you.
- Leaving it too late to pay your tax — whether it’s GST or income tax, not paying on time could cost you more in penalties.
- Not getting advice up front — getting the right advice at the right time is crucial for contractors. Experts can help you to set yourself up so you don’t keep making the same mistakes, eg saving the right amount for provisional tax.
- Not sending invoices on time — if you don’t send an invoice, you won’t get paid. Send it as soon as you can, eg at the end of your working week if you’re invoicing weekly.
- Not having your hourly rate high enough — it should cover all your expenses, your cost of living and things paid for by an employer in a salaried job.
- Not making time for record keeping and administration — if your records are a mess it’s easy to miss key dates and lose documents Inland Revenue may need