Pensions: What Every Self-Employed Person Should Know

Self-employed people are at higher risk of not having enough money after they retire than employed workers, who will be part of an auto-enrolment pension scheme provided by their employer. Employees have to pay at least 5% of earnings into their company pension scheme, to which the employer adds a 3% top-up. However, this is often not enough to guarantee a comfortable retirement and many employees pay in more than 5%. But if you are self-employed how can you make sure running your own business will not leave you worse off in later life?

State Pension

For 2024-25 this is a maximum of £11,502 a year, or £221.20 a week. To get this you will need to have paid national insurance for at least 35 years. If you have paid at least 10 years of national insurance you will still get the state pension but at a lower rate. 

For most people this will not be enough. UK median earnings are about £35,000 a year and experts reckon you will need 60% to 80% of your earnings to be in about the same position in retirement. So most self-employed people will have to set up a private pension to stop their income collapsing when they retire.

Private Pensions: The Options

The three types of private pension are a stakeholder pension plan, a personal pension plan and a self-invested personal pension (Sipp). They all have tax advantages that investments, ISAs and property income do not, as basic rate taxpayers will get a 20% top-up, those on higher rate 40% and additional rate 45%. 

This is effected by your pension provider claiming tax relief from the government at the highest rate you pay. Thus if you are a standard rate taxpayer and pay in£4,000 to your plan in a year, the government will top this up to £5,000 (20%of £5,000 is £1,000).

Stakeholder Pension Plan

A stakeholder pension plan is great for people whose income fluctuates as it allows them to be flexible about their contributions. If trading is down one month, you can skip that month’s payment. You don’t need to be a stock market whizz for this; an investment manager will choose how your money is invested. Management fees tend to be lower than other types of pension at either 1.5% or 1%, as are minimum contributions and, often, the range of investments on offer.

Personal Pension Plan

You need to have at least £100 a month available to invest in a personal pension plan, which will often come with higher charges than a stakeholder plan. Your money is invested in a range of funds selected by your investment manager. You can choose which of the funds to invest in or leave it to the manager.

Self-Invested Personal Pension

As the name suggests you make the decisions about the money you are investing. Your options run the gamut of shares, corporate or government bonds, commercial property and ETFs (exchange-traded funds) and other funds.

Some Sipps will offer portfolios they’ve created; helpful if you are not sure what to invest in. Depending on the provider, other help and advice is available. 

If you feel confident about managing your investments you can opt for an execution-only service, which will have lower fees but leaves you to make all the decisions about what and when to buy and sell. A Sipp will require much closer attention than other types of pension and a knowledge of investments and financial markets is desirable.

One advantage of a Sipp is that it allows you to invest in your own business. While this gives you an easy way of accessing capital, you are to some extent putting all your eggs in one basket so people doing this need to be aware that they are taking quite a bit more risk with their money – and their future.

Lifetime ISA

This is worth considering if you are under 40. Lifetime ISAs were primarily set up to help younger people put aside money so they could afford a deposit on a property. The government will top up your payments by 25%, so every £4 paid in becomes £5. The catch is if the money you saved up is not spent on buying a home you cannot normally access it before you are 60 without paying stiff penalties. However, once you are 60-plus this could be a handy top-up to your pension.

How much do I need to have saved before I can retire?

This is the magic question. While everyone’s circumstances and expectations differ, there are some rules of thumb that apply. Experts say if you have reached retirement age and your pension pot is 10 times your annual profits (or income if employed) that should be enough, assuming you don’t still have a large mortgage to pay off or are paying high rent.

Given employees will be paying a minimum of 8% of salary (5% from them, 3% from the employer) you should certainly not be paying less than that. Aim for 15% if you can manage it. After all, people’s earnings often don’t peak at retirement age but some years earlier so it’s sensible to allow for the fact you may not be able to steadily increase your income until retirement age. There is a cap of whichever is the lower of £60,000 a year or 100% of qualifying earnings on tax relief for pension contributions.

Need help with choosing a pension plan?

Finsbury Robinson can give you all the advice you need in choosing a pension and in minimising the tax paid on pension contributions and withdrawals. If you are one of the estimated two in five self-employed people who do not pay into a pension or simply want some advice on making your pension savings work harder for you, please give our friendly team a call on 020 8858 4303 or email us at info@finsburyrobinson.co.uk

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Angus Walker 30.10.2024