Choosing a pension when you’re self-employed

Picture of my son skipping along the pebbles at the seaside for my post on choosing a pension when you are self-employed

Saving to skip off into the sunshine

 

When you’re self-employed, it can be a real struggle choosing a pension – whereas employees have it easy.

I wrote an article for last weekend’s Sunday Times about how to save for a pension if you’re self-employed, because the number of self-employed people paying into pensions has plummeted in recent years, from 950,000 to 350,000 in less than 10 years, according to HM Revenue & Customs. This is in stark contrast to the soaring numbers of employees signing up. Overall, the Financial Conduct Authority (FCA) found that half the self-employed don’t have any pension beyond the state pension – compared to just a quarter of employees.

Related post: What is a pension and why you should care

What causes the difference? Emma, who volunteered to be the case study for my article and blogs over at Emma and 3 and Mum’s Savvy Savings, just didn’t know where to start. I reckon a lot of it is down to purely practical reasons

Employees don’t need to lift a finger…

If you’re an employee, starting a pension is as easy as doing absolutely nothing at all.

Nowadays, thanks to auto-enrolment, your boss has to sign you up for a pension if you earn enough, unless you actively choose to opt out. Your boss then automatically bungs some of your pay packet into a pension and even has to add extra money on top, as employer contributions.

Most employees don’t even bother selecting a fund for their retirement savings. Despite the choice on offer, an overwhelming 88% of employees just stick with the one-size-fits-all ‘default fund’, according to IPSE, the Association of Indepent Professionals and the Self-Employed.

Now, there’s a whole debate about whether employees should actually be paying more into their pensions (yes), or saving elsewhere (maybe), or opting for alternatives to the default fund (probably yes). But fundamentally, if you’re an employee, do nothing and you’ll still be stashing some cash towards your retirement. Woo hoo!

…whereas the self-employed face bewildering choices and tricky finances

If you’re self-employed, you have to do it all yourself.

No boss to choose your pension or pay in money on your behalf.

Just a bewildering choice of pension companies, platforms and gazillions of funds and shares.

You have to do the research or find someone you trust to help – and pay the bill for independent advice. You have to choose when and how much to pay in, faced with unpredictable earnings and unexpected bills.

Now, the great thing about pensions is that the Governemnt is willing to pay hefty bribes to encourage people to save for their own retirement. The drawback is that you can’t touch the money until you’re at least 55.

If you’re self-employed with uncertain cash flow, it’s easy to see how the effort of choosing a pension can slip way down the ‘to do’ list. With the best intentions, years can slip by without setting up a pension – and the longer you delay, the more you will miss out.

The cost of delay

Delay in setting up a pension unleashes a triple whammy of financial damage: less free money as tax relief, less time to pay in and less time for the money to grow.

I’m keen on grabbing that free money from tax relief. For every £100 a basic taxpayer pays into a pension, you get an extra £25 added. If you’re lucky enough to be a higher-rate taxpayer, you can then claim another £25 back from your tax return, or £31.25 for additional rate taxpayers.

Starting a pension earlier, even with small contributions, can put thousands more pounds in your pocket.

For example, a 25-year-old paying £200 a month into a pension, increased to £250 by tax relief, will accumulate £706,261 when retiring at 68, according to calculations by Fidelity International. This assumes annual contributions rise by 3%, and the pension grows 5% a year after costs.

Wait until 45 however, and the pension pot will be significantly smaller, at £169,118. That’s a huge difference!

What on earth to choose?

One of the money questions I get asked most often is by self-employed people concerned that they need a pension, but don’t know where to start. Check out my Sunday Times article to see which companies the pensions experts recommended.

My own top tips on pensions for the self-employed are:

  • Just start. Pick a company, doesn’t have to be the perfect option or the perfect fund, just get started. You can  always move your money afterwards!
  • Look at the costs. The longer you save and the bigger your balance, the more the fees will make a difference. With pensions more than any other investment, you could be saving for so long that the odd 0.5% here or 1% there can really add up and gouge a huge hole in your retirement savings. Fees to look out for include:
    • Any initial fees, charged when you pay money in
    • Platform fees, for the company that runs the pension
    • Fund fees, for the specific funds you use with your pension
    • Any exit fees, if you move to a different pension provider
  • Top up with lump sums. If you are concerned about paying a big chunk into a pension each month when your income varies – don’t. Perhaps pay less each month, but then add occasional lump sums. I wait until after I’ve paid my tax bill at the end of January, and then pay a chunk of money into my pension when I’m sure I can afford it. Remember, taxpayers can claim tax relief on contributions up to 100% of earnings during a tax year, capped at a maximum of £40,000. People who have already joined a registered pension scheme can make even larger contributions when times are good, by carrying over any unused allowance from the previous three years. Even more reason to open a pension right now!
  • Save somewhere else. If you don’t fancy pensions with all the rules and regulations, fair enough. But pay into an alternative – individual savings accounts, buy to let or whatever else. Banking on your own home or your own business might not be the best plan. You’ll always need somewhere to live, and not all businesses succeed long term, so do set aside other money for your financial future.
  • Seek advice. OK you might have to pay for financial advice, but can you afford not to? You can track down professional advisers in your area via Unbiased.co.uk, and even ask for a free half-hour pension check. The Pensions Advisory Service and (for over 50s)  Pension Wise also provide info on pension choices for free – but you’ll need an adviser if you want recommendations for specific pension companies and funds to suit your circumstances.

Now – over to you. If you’re self-employed, do you pay into a pension? Or are you stumped about where to start? Do share in the comments, I’d love to hear!

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7 Comments

  1. August 22, 2018 / 11:25 am

    very good. Thank you for sharing!

  2. Eloise
    August 30, 2018 / 8:21 pm

    Good informative post, but I think to increase pension contributions by 3% (Fidelity reference) per year will be unreasonable with many people’s pay rises reaching nowhere near that. We have been getting 1-1,5% a year for ages, and some local Government workers have had no rise several years running.
    A tiny pension which I paid into for a very short time will yield (at age 65) just £15 a year – I’d need to live until I was 92 to recoup the whole pot! Unless the rules change, I won’t be able to get it in one payment either, because I’ve already commuted the maximum.
    personally, if I was starting out again, I’d put my spare cash into buying an investment property instead.

    • August 31, 2018 / 9:14 am

      Hi Eloise – Thanks a lot your comment, glad the post was informative. Are you looking at buying an annuity with your tiny pension? Appreciate rates are rubbish right now. Guessing you could still take out the first 25% tax free. I’ve got keener on pensions since the rules changed and the rest of the money can stay invested, and withdrawn as and when needed, rather than being forced to buy an annuity. Do agree it’s worth looking at different options to fund retirement. I’m intending to use a balance of pensions (glad to get the boost from tax relief), ISAs (accessible earlier if needed, and tax free when spent) and buy to let.

  3. August 31, 2018 / 10:04 am

    After several months of trying to make sense of it all I did as you suggest and just got started. I’m 27 and I’ve been paying into a pension with Nest since March of this year. I only pay in a small amount at the moment to suit my income, but will be doing a lump sum soon to help it out a bit like you say! What I did discover when I was researching, is that no option is “the best” or certain to give you a secure retirement, so I’m going to look at a couple of other options too to make sure my pension has some variety. Lifetime ISA and Stocks and Shares ISA are top of my list!

    • August 31, 2018 / 10:25 am

      Brilliant that you’ve got started! It’s tough making the choice, lot of info to take in. Great point that no option is “the best”. If you’re under 40 and a first time buyer, then a Lifetime Isa is a great way to get extra money from the Government.

  4. September 3, 2018 / 11:40 am

    Hi Faith, thanks for this post – it’s super useful. I must admit that a pension is something that I’ve sorely neglected, and it’s on my list of things to get sorted ASAP. I’m bookmarking this post and I’ll definitely be coming back to it soon!

    • September 3, 2018 / 7:00 pm

      Brilliant, glad the post is useful. I really think it’s worth starting a pension sooner rather than later, to grab the free money and benefit from a longer time for your pension pot to grow.

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