Self-employed people represent around 15% of the total UK workforce*. If you are one of those 4.9 million workers, it is important to think about your future pension needs and start saving as early as possible. If not, you could find yourself unable to retire at the age you want to because you simply don’t have enough to live on.
Self-employment – a popular choice
Being self-employed certainly has its benefits. It allows you to be your own boss, build a portfolio career with multiple income streams and maybe work flexible hours. This way of working appeals to many, as it allows them to balance work and family life more effectively. In fact, in the second quarter of 2019, 213,000 workers changed status from employed to self-employed, although the net increase in total self-employed was about 15,000. While the freedom of being self-employed is definitely an advantage, you could be missing out on workplace benefits enjoyed by employees, such as a workplace pension scheme.
Neglecting the pension pot
A majority of self-employed people are aware of the importance of saving for retirement, according to recent research by consultancy ComRes on behalf of the Association of Independent Professionals and the Self-Employed. However, the research indicated that only about 31% of the self-employed are paying into a pension whilst 67% are concerned about their levels of saving for retirement**.
So, how much should you save?
’As much as you can reasonably afford in your personal situation’ is the short answer. A substantial six-figure pension pot would be required alongside someone’s state pension to fund a comfortable retirement income via pension drawdown. Projections of pension income under drawdown and whether a pot of given size would provide income for life depend on a range of personal circumstances and other factors that your adviser would take into account. Some of these apply also if you are taking out an annuity, but this product is structured to provide assured income for the rest of your life. Options for inflation linking or an ongoing (lower) pension income for a surviving spouse are also available but would cost more for a given initial annuity income level.
Among the factors to be considered when estimating how much someone can expect to receive when they retire, are:
- How much is paid into a scheme
- How well the investments perform
- The length of the investment term
- Associated charges
- Age at retirement
- How the benefits are taken
Whilst the investments in a drawdown pension pot may rise in market value and dividend income may increase before and after retirement, both value and income may also fall, with the pot’s post-retirement value also dependent on the size and duration of annual amounts drawn. The terms of an annuity, based on rates at the time, are agreed when it is purchased and for someone in poor health an enhanced annuity income may be available. Discussing your needs and circumstances with a qualified adviser will help to ensure that projected or quoted benefits are as realistic as possible, to enable an informed decision about the path to choose when you start taking your well-earned pension.
Take advantage of tax breaks
The government initiative of auto-enrolling all eligible employed workers into a workplace pension scheme has helped this group to fund their retirement, but auto-enrolment is closed to self-employed people, who can find it harder to adopt a regular saving habit. There are certain tax breaks that self-employed can benefit from, including tax relief on their personal pension contributions. Tax relief is paid on contributions at up to the highest rate of tax you pay, so for 20% basic rate taxpayers paying a contribution of £80, the government will add an extra £20 in tax relief.
Higher rate taxpayers can claim further relief at 20% (21% in Scotland) through their Self Assessment tax return, to the extent that earnings taxed at the higher rate are sufficient to permit this. Although you can save as much of your annual income as you like into your personal pension, the amount on which tax relief can be claimed is limited, the annual allowance for 2019/20 being £40,000. You can carry over any unused annual allowance for up to three years. (Some pension pots may also be impacted by the lifetime allowance, currently £1,055,000.)
Don’t rely on the state pension alone
Currently, the full state pension is £168.60 per week, and to qualify for it you need to have made 35 years’ worth of National Insurance contributions. If you haven’t paid for the requisite number of years, you can pay voluntary contributions. You should also remember that the age at which you can start claiming your state pension is rising month-by-month; it is currently about 65½ and due to reach 66 in October 2020, 67 by 2028 and 68 by 2039. So, not only is a state pension alone insufficient to fund a comfortable retirement, you will probably not be eligible to receive it until you are approaching your seventies.
Planning for the future
Being self-employed, you may think that your income is too unpredictable to commit to a regular savings plan or contribute to a pension. Indeed, it is true that your finances are likely to be more complex than someone in employment. This is all the more reason to consult a regulated financial adviser, who will be able to make recommendations based on your individual situation and income stream. It is likely that you will be advised to start saving into a personal pension, which will allow you to choose from a range of suitable funds. This should be seen as a long-term investment to help prevent your income falling off a cliff when you eventually stop working.