According to Statista, more than 4.2 million people in the UK are self-employed, with UK government figures confirming that they make up almost 13% of the workforce.
However, a recent interactive investor study has revealed an alarming lack of pension knowledge among self-employed workers, with those aged between 35 and 54 having the least knowledge.
Furthermore, the Association of Independent Professionals and the Self-Employed (IPSE) reports that less than a third (31%) of self-employed people have a pension arrangement. This compares to the 80% of employed people the government confirms are participating in employer-sponsored schemes.
In this article, read about some of the key facts that could affect you if you are self-employed and are looking to set aside enough to enjoy the retirement you’re working hard for.
There are a range of pension challenges if you are self-employed
One of the big advantages of being self-employed is that you are your own boss and have the utmost flexibility and freedom to do what you want.
But that freedom comes with a cost. Unlike employees, who have an employer to manage all the issues relating to their remuneration such as calculating tax and National Insurance (NI), you need to make all those arrangements either personally, or with the help of your accountant.
That includes managing contributions into a pension.
The 80% figure you saw earlier is primarily a result of compulsory auto-enrolment, which means workplaces now have to provide a workplace pension scheme and deduct and make contributions on behalf of their employees. There is no such equivalent for the self-employed.
Additionally, if you are self-employed you may not enjoy a regular monthly income. Your earnings could be irregular and unpredictable which can make it difficult to commit to regular contributions into any kind of retirement savings plan.
Unlike if you were employed, and having pension contributions automatically deducted from your salary each month, you may be tempted to put excess money into your business, especially in the early years when you are building your company. And, at times when cashflow is tight, stopping your pension contributions to free up money may seem an easy option.
It may be unwise to rely on selling your business to fund your retirement
One expression commonly used by the self-employed and sole traders when it comes to retirement planning is: “My business is my pension.” The theory behind this statement is that you will look to sell your business when you retire and use the money you accrue to fund your retirement.
However, that approach carries some dangers. For one thing, you will be putting all your eggs in one basket, without any guarantee of what the value of your business will be when you reach a time when you want to stop working.
There’s also the danger that your business could fail, which would create a big financial shortfall for your retirement.
The State Pension will not provide you with sufficient income to live comfortably in retirement
Research carried out by the Pensions and Lifetime Savings Association (PLSA) provides you with a good idea of how much income you will need in retirement to enjoy a particular lifestyle.
For example, its most recent report estimates that you may need an average annual income of £31,300 to live a moderate lifestyle as a single person in retirement.
The equivalent figure required to fund a more comfortable lifestyle is £43,100 a year or £59,000 for a couple.
If you were to rely solely on the State Pension for your income in retirement, you may face a shortfall of around £20,000 for a moderate lifestyle, and more than £30,000 if you wanted to live comfortably.
Indeed, a recent report by Scottish Widows revealed that 4 in 10 self-employed people are not even on track for the minimum standard of retirement living quoted in the PLSA research, equivalent to £14,400 a year for a single person.
While the State Pension is a good starting point, as well as being guaranteed to increase in line with the higher of inflation, wage growth, or 2.5% each year, it’s important to make your own pension arrangements to ensure you can enjoy the lifestyle you want once you stop working.
There are significant tax advantages to investing within a pension
One of the big advantages when it comes to saving for retirement, is that contributing to your own private pension is highly tax-efficient.
You get an effective 25% top-up from the government on all your personal contributions thanks to tax relief, up to a maximum of £60,000 gross (your Annual Allowance) or 100% of your earnings each year.
This amount is added automatically every time you make a contribution.
Furthermore, if you are a higher- or additional-rate taxpayer, you can claim your marginal rate of tax relief through your annual self-assessment tax return.
Additionally, unlike other investments you make outside a tax-efficient wrapper such as an ISA, any returns on your pension investments will be free from Capital Gains Tax (CGT).
All pension schemes allow you to make one-off contributions at any time, as well as regular monthly contributions. You can also “carry forward” any unused Annual Allowance from three previous tax years to contribute more to your pension in the current tax year.
This can be useful if you have a substantial lump sum you want to contribute to give your fund a real boost.
Investing, and realising the power of compounding
Albert Einstein is alleged to have said that compounding was the eighth wonder of the world. Whether this is true or not is uncertain, but when it comes to investing your money, there is no doubt of the value of compounded dividend declarations.
If you have not yet started making pension contributions, then the sooner the better. A long retirement savings time frame will help you maximise the size of your fund, and enable you to benefit fully from the advantage of pension tax relief on all your personal contributions.
These means that you will effectively be adding “free shares” to your investment portfolio, which then become subject to future dividend returns themselves, and so on – potentially on an annual basis.
In addition to this, as you read earlier, investments held in a pension are exempt from CGT.
Your investment strategy will be a key driver in growing the value of your retirement fund. Because of this, we would recommend you obtain expert advice not only when it comes to your initial strategy, but also throughout your working life as your goals and circumstances change.
Get in touch
If you are self-employed and would like to talk about your financial planning arrangements, please get in touch with us.
Please note
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
This article is for information only, it does not take into account your personal objectives, financial situation, or needs. Please do not solely rely on anything you have read in this article and ensure that you conduct your own research to ensure any actions you may take are suitable for your circumstances. All contents are based on our understanding of HMRC, which is subject to change.