Pension plans: Are the self-employed left to their own devices?

Being your own boss. Choosing your own hours. Taking on only the projects that really inspire you. Running your own business has a number of perks, but it has its downsides too, and having no employer to set up or contribute to your pension features amongst these. Don’t lose sight of the importance of saving for your future – read on to find out all you need to know.

In a year that tested everyone’s resolve, the announcement in June 2020 that an unparalleled number of people were paying into workplace pensions1 was positive news. This was a continuation of an upswing that started in 2012 with the launch of automatic enrolment, bringing millions of first-timers into the pensions system.

However, one key and fast-growing contingent of people was not included in auto-enrolment – namely, the self-employed.

The number of self-employed workers has expanded over the last two decades, increasing from 3.4 million (12.9% of the workforce) in 1998 to 4.8 million (15.1%) in 2017.2 Within the same timeframe, the Institute for Fiscal Studies reports that the proportion of self-employed people contributing towards a private pension has, however, dropped from 48% to just 16%.2

Bridge the gap

This essentially means that the UK is having to tackle a widening pensions gap, with the self-employed lagging behind as regards saving for retirement. This is based on factors such as their exclusion from auto-enrolment and the income insecurity that can be a feature of self-employment.

There’s a lot to think about when you’re self-employed, and the hassle factor comes into the equation too, as prioritising starting and paying into a pension can quickly slip down the rankings. Likewise, self-employed earnings can be irregular and erratic, meaning it might be difficult to calculate how much to pay in each month and year.

Tony Clark, Senior Propositions Manager at St. James’s Place Wealth Management, says:

“People will put blood, sweat and tears into getting their business off the ground, and it can be chaotic. So, it’s often hard to find the time to focus on the bigger picture when it comes to retirement finances.”

All things being equal

There’s also, perhaps, somewhat of an expectation amongst many self-employed people that their business should be their main source of retirement income. A reasonable viewpoint, yet a business should make up just part of a wider financial plan, and so it’s risky to totally depend on it.

Simon Martin, Chartered Financial Planner at St. James’s Place Wealth Management, shares his thoughts on the matter:

“Having your income and future retirement dependent upon the performance of one company can leave you exposed to societal changes, global crises and, very often, a lack of geographical, industrial and asset class diversification. If the business performance suffers, so does your present and future income.”

In a perfect world, an individual’s retirement plan should consist of a combination of pensions, ISAs, property, state pension, earnings and so on. As a self-employed worker, your business forms part of that. It can be advantageous to your business planning to have other assets to draw on too, especially if you’re nearing retirement and finding it difficult to extract value from the business.

“When you come to retire or take value from your business you may have difficulties selling or passing the business on. That’s where plans can come unstuck if you’re not diversified,” Clark warns. “Keeping a mix of other assets gives you a safety net, more time and more flexibility.”

Mutual advantage

Furthermore, tax benefits can be had through diversifying – for example, when you take money out of a business, it’s probable that there will be an element of Inheritance Tax (IHT) or Capital Gains Tax (CGT) liability. On the other hand, pensions stay outside your estate for IHT purposes, making them more tax-efficient than a business in view of passing on wealth to your family.

“The 2015 pension freedoms increased the scope of pension death benefits and have made them an effective IHT planning tool,” says Martin. “A personal pension is generally free from IHT and can be passed to a dependent or nominated beneficiary, subject to scheme rules, in a very tax-efficient manner.”

The tax advantages of pensions can be beneficial when it comes to boosting your contributions too, particularly if you know your earnings can markedly fluctuate from year to year.

There’s an annual allowance that limits how much you can pay into a pension each year; however there is flexibility within that. This is because of carry-forward rules, which entitle you to use any unused allowance from the previous three tax years to maximise your pension contributions in the current tax year.

“This means you can contribute to your pension beyond the current tax year’s allowance,” notes Clark. “It’s a way for you to catch up, and it removes some of the worry around being able to fund your pension as fully as possible.”

Action plan

Managing your longer-term finances can feel time-consuming when you’re running your own business. That’s why it pays to ease the burden and seek support from elsewhere, such as accountants and financial advisers.

Wellesley financial adviser can help you better understand how your earnings are playing out over the financial year and devise plans around that, including structuring your pension contributions to ensure you don’t miss out. Your adviser can also help you navigate the different stages of running your own business, while making sure it aligns with your broader financial plans.

Clark concludes by saying:

“Each stage of your business will require financial strategies, including your retirement strategy. You need a financial adviser to be on the journey with you. As you build your business, you’ll have various experts you call on – and an adviser should be part of that support network, helping you realise the outcomes you’re looking for.”

Sources:

1 Department for Work and Pensions, Workplace Pension Participation and Savings Trends of Eligible Employees Official Statistics: 2009 to 2019, June 2020
2 IFS, Retirement saving of the self-employed, October 2020

The value of an investment with St. James’s Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.

The levels and bases of taxation and reliefs from taxation can change at any time.

Tax relief is dependent on individual circumstances.

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