Pensions for the self-employed

If you’re self-employed, saving into a pension can be a more difficult habit to develop than it is for people in employment. There are no employer contributions and irregular income patterns can make regular saving difficult. But preparing for retirement is crucial for you too, so read on to find out where to start.

Don’t rely on the State Pension

If you’re self-employed you’re entitled to the State Pension in the same way as anyone else. The full basic State Pension is currently set at £119.30 a week for those who reached State Pension age before 6 April 2016. To get the full amount you need 30 qualifying years of National Insurance contributions or credits (more if you reached State Pension age before 6 April 2010).

For those who reach the State Pension age on or after 6 April 2016, you’ll get the new flat rate State Pension which is a maximum of £155.65 per week.

But that’s the extent of your entitlement to the State Pension – you can only claim the additional State Pension if you’ve had periods of employment during your working life.

On its own, the basic State Pension is unlikely to provide you with anything like your current standard of living. So it’s crucial that you plan how to provide yourself with the rest of the retirement income you’ll need.

An efficient way to save for retirement

Over half (53%) of self-employed men and over two-thirds (67%) of self-employed women have no pension savings. Don’t rely on the state to fund your retirement.

One big attraction of being self-employed is that you don’t have a boss. But, in terms of pensions, that’s a disadvantage. Workplace schemes can be a convenient way for employees to start contributing to a pension and in many cases their employers will make contributions too.

If you’re self-employed, you won’t have an employer adding money to your pension in this way. But you’ll still get Income Tax relief on your contributions. If you’re a basic-rate taxpayer, for every £100 you pay into your pension, HM Revenue and Customs (HMRC) will add an extra £25.

Start as early as possible

The earlier you start saving into a pension, the better. It gives you more time to contribute to your fund before retirement, more time to benefit from tax relief, and more time for growth in your fund’s value due to investment returns and the power of compounded returns.

Starting early could double your pension fund. Someone saving £100 a month for 40 years (say from age 25 until 65) would put the same amount into their pension fund as someone starting 20 years later and putting £200 a month in. But the early starter would have a much bigger fund on retirement. Assuming 5% investment growth and a product charge of 0.75% throughout the term:

  • the person starting at age 25 would build a fund of around £123,000
  • the later starter’s fund would grow to around £75,000

What kind of pension should you use?

There’s a range of different types of pension scheme you can set up, including stakeholder pensions, personal pensions and SIPPs (Self invested personal pensions). Each has its pros and cons and you can find out more by following the link at the end of this guide.

Stakeholder pensions have a number of advantages. They have relatively low charges and are flexible - an important consideration if you’re self-employed and have irregular income patterns.

How much can you save?

You can save as much as you like towards your pension each year, but there’s a limit on the amount that will get tax relief. The maximum amount of pension savings that benefit from tax relief each year is called the annual allowance. The annual allowance for 2015-16 is £40,000. If you go over £40,000, you won’t get tax relief on further pension savings. You can usually carry forward unused annual allowance from the previous three years.

  • If your income varies significantly from year to year, unused allowances can allow you to maximise your pension savings in years when your income is high.
  • You must have been a member of a pension scheme during the years you want to carry forward your unused allowance.
  • Even with unused annual allowance carried forward, your tax relief is limited by your annual earnings for the year in question.
  • If you save more than your annual allowance you may have to pay a tax charge.

Pension ‘input periods’

Pension payments are made over 12-month periods called ‘input periods’ or PIPs. These previously didn’t always follow the tax year. But from 6 April 2016, these will now be reset to follow the financial tax year (6 April to 5 April).