Pension planning for the self-employed
It can be harder to think about saving for retirement if you’re self-employed and don’t have access to a company pension scheme, but pensions shouldn't be ignored and offer valuable tax benefits. We look at the importance of saving for the future, and explain the different pension options which are available to those who work for themselves.
Britain's self-employed army is booming, with latest figures from the Office for National Statistics (ONS) showing that there are currently 4.8m people in the UK who work for themselves, equivalent to 15.1% of all people in work.1 The number of self-employed people in the UK increased by 148,000 in the three months to January 2017 alone.2
If you work for yourself, it can be all too easy to push pensions to the bottom of your priority list, especially as you’ll need to keep some flexibility in your finances in case of a downturn in earnings, and you won’t be able to join a company scheme.
Under the Government’s auto-enrolment scheme introduced in 2012, those who are employed, aged at least 22 years-old and earning more than £10,000 must be automatically enrolled in a pension scheme by their employers. Both employers and employees must contribution to the scheme. If you are self-employed, however, you must make your own pension provision.
This mustn’t put you off saving for the future, as you can’t rely on the state pension alone to provide you with a comfortable retirement, and you may not be eligible to claim this for several years after you plan to stop work. Last month a report into the state pension commissioned by the Government was published which suggested that state pension age increases should accelerate and reach 68 between 2037 and 2039, seven years earlier than is currently planned.3
Why pensions matter
The earlier you start contributing to a pension, the bigger your retirement pot should eventually be as your money will have longer to grow and you will have paid in over a longer period. The more you can save, the greater the chance you will enjoy a financially comfortable retirement when you stop work. Although, the value of investments can fall as well as rise, so you may get back less than you invested.
One of the biggest advantages of saving into a pension is the tax relief your contributions benefit from. Remember, however, that tax rules can and do change, and their effect on you will depend on your individual circumstances, which can also change.
Under current rules, you'll get tax relief at the basic rate of 20% on contributions made to personal and workplace pensions, whether you are employed or self-employed, which means for every £80 you pay in, HMRC will top it up to £100. If you're a higher or additional rate taxpayer you can claim back up to an additional 20% or 25% through your self-assessment tax return. You can only receive tax relief on up to £40,000 of pension contributions each year, or 100% of your earnings, whichever is lower. Although some people may have a lower limit, so check your personal limit.
You can make use of any Annual Allowance that you may not have used during the three previous tax years, as long as you have enough income in the current year to do this. You must have belonged to a registered pension scheme during this period to carry forward unused allowances.
Even though you won’t benefit from any employer contributions if you’re running your own business, tax relief can still provide a substantial boost to your pension.
Different pension options
There are several different types of pension self-employed workers can choose from.
A personal pension is a type of defined contribution, or money purchase, pension scheme. This means the amount of income your pension will pay you when you retire will depend on how much you save into it and the performance of your chosen funds over time, after taking charges into account.
Once you, or your financial adviser, have chosen which pension provider you would like to administer your pension, you then decide where you want your contributions to be invested, from a range of funds offered by the provider. Personal pensions are often provided by insurance companies, or through banks and building societies.
Stakeholder pensions are usually cheaper than other personal pensions and tend to allow low and flexible minimum contributions. However, compared to other plans they often provide a narrow range of investment options. Like other types of personal pension, the success of your stakeholder pension will be down to how much you save and how markets perform.
Self-invested personal pension (SIPPs)
More experienced investors who are comfortable choosing and managing investments themselves may prefer to save into a SIPP, as these typically offer access to a wider choice of investments than other types of pension. You can usually invest in a broad range of investments, including shares, unit trusts, open-ended investment companies (OEICs), investment trusts, gilts and bonds and exchange-traded funds (ETFs). You need to have the necessary skills to invest your own pension fund, and must remember that the value of investments can fluctuate, so you could get back less than you invested.
The start of the new 2017/18 tax year on April 6 saw the launch of the new Lifetime ISA (LISA) designed to help those saving for retirement or who want to get on the property ladder, or both. If you’re aged under 40, you can save up to £4,000 a year into a LISA and can invest either in stocks and shares, cash, or a combination of both. Any contributions you make will be supplemented by a Government bonus of 25% of the money you put in. The maximum bonus that you can get is £1,000 each year.
You’ll get a bonus on any savings you make until you reach 50 years of age, at which point you won’t be able to make any more payments into your account. If using the account for retirement, after your 60th birthday you will be able to take out all your savings from your LISA tax-free. If you take money out earlier than this, and aren’t using your savings to buy a property, you’ll have to pay a withdrawal charge of 25% of the amount withdrawn.
Investing for the long term
Remember that any money you invest in a pension should be cash that you can afford to tie up for the long-term You won’t be able to access your pension savings until you reach the age of 55, rising to 57 by the year 2028.
Bear in mind that pensions aren’t the only option if you’re saving for retirement, so if you want some funds to be accessible earlier than the age of 55, you may want to consider tax-efficient ISAs too. This tax year (2017/18) you can invest up to £20,000 into ISAs, either in cash, or investments, or Innovative Finance ISAs, which invest in peer-to-peer lending. You can invest in a combination of these, but you can only pay into one cash ISA, one investment ISA and one Innovative Finance ISA each tax year, or you can put up to £4,000 of your allowance into the new Lifetime ISA (LISA) as part of your overall £20,000 allowance.
Please bear in mind that this article is for general information purposes only. If you’re unsure, seek professional financial advice.
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Investments can fall in value; you may get back less than you invest.