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Pension planning for the self-employed

25 September 2019

4 minute read

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.

Who's it for? All investors

The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice.

What you’ll learn:

  • Why you mustn't neglect pensions if you work for yourself.
  • How tax relief can boost your contributions.
  • Which pension options you can choose from.

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

For those who are self-employed, it can be all too easy to push pensions to the bottom of their priority list, especially as they may feel the need to have some flexibility in their finances in case of a downturn in earnings.

All employees are automatically included in the Government’s auto-enrolment scheme, introduced in 2012, provided that they are aged at least 22 years-old and earn more than £10,000 per annum. Both the employer and the employee are required to contribute to the scheme.

Without an employer to contribute towards retirement savings, the self-employed are solely responsible for making sure their pension provision is sufficient to meet their income needs in retirement.

The current full State Pension in the 2019/20 tax year is £168.60 a week: provided that you have a minimum of 35 qualifying years of national insurance contributions.

At present, the State Retirement Age is set to increase to 68 for men and women between 2044 and 2046, however, a report commissioned by the Government in 2017 suggested that this increase could come into effect seven years earlier than is planned: between 2037 and 2039.2

Consideration should be given to whether the State Pension alone will be sufficient to provide you with a comfortable retirement and that you may not be eligible to claim this for several years after you plan to stop working.

Why pensions matter

The earlier you start contributing to a pension, the bigger your retirement pot should eventually be as your money will have a longer chance to grow and you will have paid more 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. However, you have to accept that there no guarantees; the value of your pension fund can fall as well as rise and with it the sum available to provide you with income in retirement.

One of the biggest advantages of saving into a pension is the tax relief on both your contributions and on any growth within your retirement fund. 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 on contributions made to personal pensions. This means that in the 2019 / 2020 tax year for every £80 you pay in, HMRC will provide £20 of tax relief, topping your payment up to £100. If you're a higher or additional rate taxpayer, you can claim additional tax relief through your self-assessment tax return.

Tax relief is only available on up to £40,000 of pension contributions each year, or 100% of your taxable income, whichever is lower. If your income is over £150,000 (in 2019/20), or you’ve already started taking a taxable income from any of your defined contribution (money purchase) pension, your eligibility to tax relief may be reduced. There is also an opportunity to make use of unused Annual Allowances from the previous three tax years, depending on eligibility.

Please remember we don’t offer personal advice on pensions, so if you’re unsure how to proceed, seek professional financial advice.

Different pension options

There are several different types of pension self-employed workers can choose from.

Stakeholder pensions

Stakeholder pensions have a fixed price cap 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.

Personal pensions

A personal pension is a type of defined contribution, or money purchase, pension scheme. This means that the value of the fund from which you can take benefits when you retire will depend on how much you save into it and the performance of your chosen investments, 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.

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.

Lifetime ISAs

The Lifetime ISA (LISA) is 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 taken out. If you’re a higher or additional rate taxpayer a pension will provide you with tax relief that is higher than the government bonus from a LISA. However, whilst withdrawals from a LISA are tax-free from the age of 60, only 25% of your pension can be taken tax-free, with the rest taxable at your marginal rate.

Investing for the long term

Any money you invest in a pension should be cash that you can afford to tie up for the long-term and in most circumstances you will not be able to access your pension savings until you reach the age of 55. This may change in the future because the Government has announced its intention to link this age to 10 years prior to the State Pension age. If this passes into law, the minimum pension age will increase in the future.

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 (2019-20) 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. There’s also the Lifetime ISA, designed to help those saving for their first home, or retirement, or both. You can put up to £4,000 of your overall £20,000 ISA allowance into a Lifetime ISA (LISA) each tax year until your 50th birthday.

It’s important to bear in mind that all of these tax rules can change in future and their effects on you will depend on your individual circumstances.

Please remember that this article is for general information purposes only. Smart Investor doesn’t offer personal tax or financial advice. you’re unsure seek professional financial advice.

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