Self-Employed Pensions
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Self-Employed Pensions
Why is it important that self-employed people set up a pension?
It’s important that everyone plans for retirement. But self-employed people don’t benefit from auto-enrollment, where an employer will pay into an employee’s pension plan as part of a workplace scheme.
That’s a government initiative where, subject to meeting certain requirements, all employers must offer it for their workforce. The self-employed don’t benefit from that.
So it’s more important for self-employed people to take control of their financial planning. Pensions are about financial security and stability in retirement, and they are currently one of the most tax efficient savings plans available to us in the UK.
What is the most suitable pension for the self-employed?
That’s quite a difficult one to answer. It very much does depend on individual circumstances. The self-employed could be a sole trader, for example, or a director of a limited company – who may have employees or other staff to consider.
So the type of self-employment is relevant. Typically, a sole trader might simply have a personal pension plan or stakeholder pension plan, whereas a limited company director might want a group scheme to accommodate themselves as well as any employees.
The most important thing is for the scheme to accept contributions from the source they are considering. A director of a limited company might want to make employer contributions. So it’s important the scheme doesn’t restrict that.
For a sole trader, that’s treated as a personal pension contribution. So the structure of the scheme is more important than necessarily the type of scheme.
What is the process for setting up a pension? Does it differ if you are self-employed?
It doesn’t necessarily differ if we assume that the self-employed individual doesn’t run a business with auto-enrollment requirements for their employees. If they did, the process would be very different.
For a sole trader, believe it or not, you can find online app-based pension plans and set one up within a matter of minutes. My advice, of course, would be to engage a financial advisor – someone who can understand what you’re trying to achieve by setting up a pension.
That sounds really obvious, because a pension is about income in retirement, but there are also tax efficiencies and tax benefits involved. An advisor will assess your needs, discuss the key considerations such as the source of the contributions, as I mentioned, and then make a recommendation for the foreseeable future.
Does it matter if you are a sole trader, a partner or a limited company director when it comes to setting up pensions?
Structurally, it does matter. Fundamentally, we’re saving for retirement, but the type of scheme and its structure is very important. It could just be a stakeholder or personal pension plan that’s specific to an individual, who might be a sole trader. Or, it could go all the way up the scale to SIPPs and SSAS pensions and possibly group schemes.
The structure of the scheme matters in how it can accept contributions and how it allows benefits to be taken. Different schemes facilitate different methods of drawdown – or what we might call crystallisation. That’s the point at which we want the money back out of the scheme, having contributed to it for many years.
How you access the funds may differ depending on the scheme. So it varies according to the type of self-employed status – getting it right at the start is key to that.
How does a SIPP work – a self-invested personal pension?
This is moving into realms that are more technically complicated. A self-invested personal pension plan, or SIPP, is a scheme that allows slightly different investments within it compared to a personal pension plan.
Two plans fall into a similar category. One is a SIPP and the other is a SSAS, a small self-administered scheme. They are designed for individuals or small collectives of people. You could, for example, have a group SIPP for shareholders or directors of a limited company.
SIPPs differ in how you can invest. Any pension plan holds assets that are designed to drive growth or income. The most typical assets in a pension plan are shares, stocks and shares or bonds.
But SIPP can hold different classes of shares – it can crucially hold commercial property, so they’re often used by business owners who wish to purchase business premises, for example.
They allow the SIPP to buy the commercial premises and the business in effect leases or rents the business from the pension plan. That’s quite technical, but they definitely have advantages and are very popular.
In certain circumstances, they can be better than the equivalent personal pension plan or group scheme.
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Do self-employed people get tax relief on pension contributions?
Yes, tax relief is available on pensions. For most of us, and certainly for most of the clients I see, the state pension isn’t sufficient to support the sort of lifestyle that most people would want. The government incentivises people to make provisions for their own pension, by way of tax relief.
It does depend on the source of the contribution. If a sole trader is making personal pension contributions, the government grosses that up. A credit goes into the pension scheme where every £8,000 contributed is actually worth £10,000 – the scheme is topped up by 20%.
Higher rate taxpayers can claim additional relief via self-assessment. They will benefit from 20% pension credit within the scheme, and then can claim additional tax relief via self-assessment. It’s fantastic from a tax perspective, frankly, the way pensions work.
That’s personal pension contributions. If someone is self-employed as a limited company director or owner, and they decided that the business would be the source of the contribution, there is no credit added within the scheme. But the contribution itself will attract corporation tax relief and is not subject to national insurance.
So there is still a tax benefit for employers or limited company directors making pension contributions. Up to a £60,000 limit, we can contribute what we earn into a pension plan. The bigger the contribution, the bigger the tax relief, and clearly the more appealing it is.
Both self-employed and employed people benefit from tax relief either within the pension plan or by way of their employer or payroll arrangement. It’s a fantastic tax-efficient savings plan.
If someone really wanted to delve deeper, save some tax and really understand that overall position, having a chat with an advisor would be very helpful.
How much should the self-employed save for a pension? How much should I pay into my pension if I’m self-employed?
These are very popular questions – I get them a lot. They’re also the two questions that are probably hardest to answer.
I recently had a conversation with my father-in-law where we concluded that everything depends on how expensive the wine is that you want to drink in retirement. It’s a bit flippant, but I think there’s some truth in that.
It depends on your expectations of lifestyle, your age, when you start the pension plan and your goals. Whilst I appreciate we’re focusing on pensions, other savings or investments are relevant too, because they can also be brought into the conversation.
An advisor has sophisticated tools for cash flow modeling and forecasting, to delve into the details. There are probably some online equivalents as a self-serve strategy too.
There are a couple of rules of thumb that are decades old and may not be particularly factual, but they could give you an idea. One is that your contribution should be half your age as a percentage of your salary, when you start. So if you start a pension plan at age 30, your contribution should be 15% of your salary.
Another crude guideline is to aim for a pot of five times your post-retirement income. So if you want an income of £30,000 post retirement, you should try and aim to have a pension pot that’s worth £600,000, which obviously is a very big number.
But circumstances are so different. I’ve read articles that suggest for an average lifestyle you need a pot worth £300,000 to £500,000. For a more glamorous lifestyle, it needs to be £600,000 plus. If you look it up, you would probably get 10 different answers, all coming from a different angle.
This is the benefit of engaging with an advisor: sitting down and doing more detailed planning, because it is individual. A lot of people when they retire might downsize and free up some additional cash for their pension planning that way. It’s not just about the size of your pension – it’s your overall position and whether other funds may be available.
How much state pension will I get if I’m self-employed?
The state pension doesn’t differentiate between employed or self-employed. It’s based on national insurance contributions. Typically, self-employed people might pay a different class of national insurance. Sole traders, for example, might pay class two or class four contributions, but ultimately, it’s about the total contributions you’ve made over your working life.
To benefit from any state pension, you need to have 10 years worth of national insurance. For a full state pension, you need 35 years.
But you can actually fill any gap. There’s an amazing thing online via HMRC’s website called the state pension forecast. In the space of about three clicks, it gives people an understanding of what their state pension entitlement might be.
A full state pension is currently £221.20 a week. If you look to be falling short, you can actually make further contributions. They’re known as class three contributions, to help you benefit from a full state pension.
What are the benefits of setting up a pension if you are self-employed?
First and foremost, it’s the difference between a nice Rioja and a house red. It’s about making provision for your financial security in retirement. It’s taking ownership of how you want your lifestyle to be when you retire.
There are lots of benefits as we touched on – especially the tax efficiencies that pensions offer as a savings plan.
Self-employed or employed, there are far more benefits to having a pension plan, and undertaking some long-term financial planning, than not.
Is there anything else we need to know about self-employed pensions?
These questions have probably been posed by lots of different people, and the important thing is that the answers are not the same for everyone. People’s own individual circumstances are important and relevant, as well as their future plans, wants, needs and desires.
That’s where an advisor comes into their own – to get to know each individual client and their circumstances, and make sure that pension recommendations are suitable to them, not just in the context of lots of other people’s questions.
The value of pensions & investments and any income from them can fall as well as rise. You may not get back the amount originally invested.
