I’m not a financial advisor nor am I pensions expert. I’m just someone who has been self-employed for over a decade and has been forced to learn how to manage my money both now and in the future.
If you’re puzzled by pensions, then you are probably not alone. I know when I first started out looking at my options for saving for later life I was so confused that I walked away from the whole subject.
When I plucked up the courage to address my pension I realised walking away was a huge mistake because I found myself in a situation where I was having to pay more of my income into my pension to make up for the years I had missed.
Annoying, yes. But I knew I was acting responsibly for future me.
If you are panicking about your pension then follow this guide to private pensions for the self-employed pensions to find an uncomplicated explanation about saving for your future life, how much you need to pay in and the easy way to set one up.
What is a Pension?
A pension is a pot of money that you pay into during your working life which you plan to use once you stop working.
It’s more than just transferring money into a savings account.
There are special types of investments you can make, specifically designed for people saving for pensions. These investments help your money grow at a better rate than just saving money in a regular bank account. They also offer special tax-breaks when you pay in and withdraw your money.
Always remember, the money you invest (your capital) is always at risk and the value of your investment can go up as well as down.
Do the Self-Employed Get a Pension?
Everyone in the UK, regardless of employment status, is entitled to claim the New State Pension, provided they have paid sufficient national insurance over their lifetime.
The state pension age is currently 65 years old (for both men and women) but there are plans in place to see this rise. Meaning you will be expected to work for longer before you can draw your state pension.
Self-employed workers are also entitled to open their own private pension, which can be accessed from the age of 55.
The New State Pension
When you reach the state pension age, you’ll be entitled to receive a fixed pension from the government, providing you have at least 10 qualifying years on your national insurance record.
That means if you’re self-employed workers you’ll need to have paid enough Class 2 national insurance, even if your profits were below the minimum threshold.
The full new State Pension for 2020/2021 is £175.20 per week, paid monthly. That means you’ll get £9,110.40 per year.
£9,000 per month isn’t really enough for anyone to live off if they want to stop working. So everyone needs a plan for how they will top this up to the level they think they will need.
Currently, it is estimated by the ONS that there are 5 million self-employed workers in the UK rights now and 4.2 million of them do not have a pension plan.
UK experts are warning that the self-employed, freelancers and sole traders will face financial problems when they want to retire.
Why are there so many without a private self-employed pension?
Unfortunately, pensions is not a topic that is taught to us at school and there are many people in their 20s and 30s without a plan in place for their retirement.
Without any legal requirement for the self-employed to pay into a private pension, it gets overlooked for various reasons:
- Retirement feels so far away;
- Having an irregular income makes it hard to save a consistent amount;
- Poor money management means important payments like tax and pensions get ignored;
- People are unaware of the tax breaks paying into a pension can bring both now and in the future;
- Pensions are confusing, with different types of funds, risk profiles and acronyms it can feel like an impenetrable subject, so people walk away, just like me.
Private Pensions for the Self-Employed
If you are self-employed or a sole trader, you’ll need to set up a personal pension to save for your retirement. You can start to access the money you have saved from the age of 55, in a variety of ways.
There are three main types of personal pensions that you can set are are:
Ordinary personal pensions
Ordinary personal pensions are also known as a private pension. It is the most common and popular type of scheme on the market.
Put simply you pay into your private pension and the company you choose to go with manages your investments for you.
Even though your money is not protected against losses your money is 100% protected if the company you choose to use goes under.
Self-invested Personal Pensions (SIPP)
A SIPPS is similar to an ordinary private pension, but you can choose which funds you invest in for yourself.
SIPPs are a good choice if you are comfortable managing your own pension pot, but the charges are usually higher.
Generally speaking you can choose from a wide range of funds to invest in from government bonds, blue-chip stock to property.
With a wide variety, if you are confident to manage your own money, you’ll find one to the level of risk you are will to take.
Stakeholder pensions can be a popular choice for the self-employed because you can pay money in flexibly, starting and stopping your payments as and when you need to. Great if you have an irregular income.
This type of pension has a cap on charges at 1.5% for the first 10 years.
How Much Should You Save in Your Self-Employed Private Pension?
The answer is it depends.
It depends on:
- How old you are now;
- Whether you have anything saved;
- When you plan to retire;
- How much you want to have each year for your retirement;
- The amount you can reasonably afford to save in your pension pot.
What you’ll need to do is to work backwards from you’re retirement age to calculate what you need to be setting aside.
If you are younger and further from retirement you have more years to set aside money, so could afford to pay less in.
But if you are older and need to catch up on your contributions, then you will need to consider paying a higher percentage of your income in.
The easiest way to find your number is to try an online calculator like on the Money Advice Service. You enter your personal information into the calculator and what you would like to achieve for your retirement plan and it will tell you what you need to be paying in.
Tax Relief on Self Employed Pensions
The government are actively encouraging self-employed people to save into a pension by offering them certain tax breaks.
As a sole trader paying tax at the basic rate (20%), you’ll get £20 tax relief from the government for every £100 you pay into your pension during the tax year in the form of tax relief, up to maximum pension contributions of £40,000.
For example, if a basic rate taxpayer makes a £100 contribution into their pension they will receive £20 reduction on their tax bill, as a contribution from the government.
A higher rate taxpayer (40%) will benefit from a further £20 tax relief for every £100 they pay in.
You can also save £20,000 into an Individual Savings Account (ISA). ISAs are tax-efficient and are work well alongside a personal pension.
If you have a Limited Company you can pay your pension from your business bank account, which structured correctly will be treated as an allowable business expense means you’ll get corporation tax relief.
How to Withdraw from Your Private Pension Pot
Once you reach retirement age of 55 you can withdraw money from your pension in three main ways:
- Income Drawdown
When you are 55 you can choose to take out as much of your pension you like. All of it if you wish.
You’ll get tax relief on the first 25% you withdraw from your pension pot and pay income tax on the rest.
- You have a lump-sum of cash back in your control;
- Income tax rates historically have always gone up, so the sooner you pay tax the less you’ll pay.
- You’ll need to make sure that you have enough for your later life and spread this money;
- Your money will no longer be invested and continue to grow.
2. Income Drawdown
When you reach 55 years old, you can start to withdraw small amounts from your pension and leave the rest as an investment.
You’ll get tax relief on the first 25% you withdraw until it runs out, paying income tax thereafter.
- Your money remains invested while you are not using it and could continue to grow;
- The remaining money is tucked away for the rest of your retirement so you don’t risk running out.
- The value of your investment can go up as well as down, meaning your money remains at risk while you have stopped working.
When you can access your pension pot at 55 years old you can choose to roll this over to a pension company that then pays you a fixed monthly income.
- Your money remains invested while you are not using it and could continue to grow;
- You have a guaranteed monthly income.
- Annuity payments although guaranteed can result in a lower income.
You can also choose to do a combination of lump-sum, drawdown and annuity.
Which Option Should You Choose?
When it comes to choosing a pension when you’re self-employed you’ll want to pick one that offers you:
- Flexibility with no fixed monthly payments, so you have the option to pay more or less each month;
- Give you plenty of fund choices so you can decide where you put your money so it works best for you and suits your risk adversity;
- Reasonable charges because they reduce your pot of money;
- Accessibility so you can check on your investment, preferably online or with an app.
The Simplest Self-Employed Personal Pension for New Savers
Even if you are late starting your pension contribution, start small but start now. You still have time put a plan together if you are behind on your contributions to fix the problem.
Penfold is a simple way for you to get started right-away. It’s easy to set up and will get you into a good saving habit.
Then once you feel more confident you are free to move your pension pot over to a scheme you feel may give you better returns.
Penfold will give you £25 free to start you off when you make your first deposit, which can be just £1.
It works well for the self-employed because Penfold is a SIPP which invests your money on your behalf. Being a SIPP you can contribute as little or as much as you like each month, depending on your income.
Even if you are late to setting up a pension and you have calculated what seems like an unachievable number, start saving something.
Open up a simple private pension plan like Penfold and change your money mindset that is setting up your future self for problems.
You can’t go back and change the beginning, but can start where you are and change the ending – Lewis Carroll.
Pensions are a complicated subject and I am not a pensions advisor. If possible you should speak with a regulated pensions advisor to help you assess your situation and make a professional recommendation for you.
The money you invest (your capital) is always at risk and the value of your investment can go up as well as down.
New Here? Learn how to set up the financial side of your business with these easy to understand guides and resources:
- Sole Trader or Limited Company? – Download my free calculator to check which business structure would help you to pay less tax;
- Government Support For the Self-Employed During Coronavirus – Find out about the schemes available, which ones you are eligible for and how to claim;
- Tax Records and Bookkeeping – Understand what tax records you’ll need to keep and how to set up your own bookkeeping system;
- How to Fill In Your Tax Return Online – In this step-by-step guide, you’ll find everything you need to know to fill in your tax return online and beat the HMRC deadline.
- Self Employment Taxes Explained – Learn what taxes you’ll pay, how much and when;
- VAT Guides – From registration to de-registration, VAT schemes and thresholds, these guides will take you through the basics every UK small business owner needs to know;
- Invoice Template – Free template and step-by-step guide so you can get paid by your clients.