Pensions for the Self-Employed

Jason Murgatroyd and Shamraze Ahmed join Craig to talk about pensions for the self-employed.

Why is it important that Self-Employed people set up a pension?

Self-employed people get overlooked in terms of pensions – it’s not like being employed, where your employer automatically sets up a pension scheme for you.

Unless you do it yourself, all you’ll have is your basic state pension. So it’s crucial to start your own pension fund – it’s a very tax efficient way of saving money for retirement.

Does it matter if you are a Sole Trader, a Partner, or a Limited Company Director?

Pensions are important no matter what your business set-up is. Having a limited company structure has its own advantages in terms of tax relief, but sole traders, partners, and directors can all pay into a pension. The terms of the tax relief that you receive might just differ a little.

The majority of directors take a small salary, with the majority of their income as dividends.

A director can pay into a pension directly from the limited company. It’s important to get advice on the most efficient way to set it up.

How does the tax relief work on a pension?

Any pension contributions you make from your income attract tax relief at your highest rate. So for most taxpayers, that’s 20% tax relief.

This can add up to a lot of money. Imagine putting £100 into a bank account as opposed to £100 into a pension. For a basic rate taxpayer, the tax relief is equivalent to £25 – instant growth. Meanwhile, with £100 in a bank account at today’s interest rates, it would take a hundred years to become £125.

For higher rate taxpayers, this figure grows to 40% tax relief – so the £100 in a pension instantly becomes worth £167. In a bank that would take you 220 years!

Why do people have a negative attitude to pensions?

Many of us have heard someone say, ‘don’t bother with a pension, mine was rubbish’. But really it wasn’t the pension that was the issue – it’s where the pension was invested.

You certainly need to take advice to ensure your funds are going into the most effective sort of investment that will grow to suit your needs in the future.

Some people are also put off pensions because they can’t access them until they reach a certain age. But funds today are far more flexible and you can draw funds from the age of 55.

How does the investment side of a pension work?

There are two sides of a pension: the ‘tax wrapper’ where the money you put in generates tax relief, and the investment side, where your funds are invested in stocks and shares to grow the overall size of your pension.

You can choose what your money is invested in, in line with your attitude to risk. As advisers, we will discuss this with you in depth and invest your money proportionately.

How much can I put in a pension?

You can put up to 100 percent of your annual income in a pension, up to a maximum of £40,000 in a year. We’re often asked how much you should contribute, but it is difficult to give an accurate answer without knowing your specific situation.

With occupational pension schemes, where people are employed, both the individual and the company are paying in. So you might aim for around 5% of your salary, topped up by your employer to 10%. But a self-employed person hasn’t got that luxury – they will have to aim for 10% themselves.

That’s one potential rule of thumb, but another good one to consider is to pay in half your age as a percentage of your income. So, for example, if you’re 30 years old, try to pay up to 15% into your pension.

Generally, the more you can put into your pension, the more you’ll benefit from tax relief and the more potential growth on your money. When you want to retire, you want as much in your pension fund as you possibly can get.

What are the benefits of setting up a pension for the Self-Employed?

The headline is tax efficiency. As a basic rate taxpayer, you’ll be getting a lot more for your money by putting it in a pension compared with a bank. Even investments can’t generate the same levels of growth as the tax savings. Plus, at retirement when you draw on these funds there is further tax efficiency.

Another benefit today is that new pension freedoms give people access to pension funds when they want them. The minimum age is now 55.

Why is it important to talk to an adviser?

Talking to an adviser is imperative. Everyone’s situation is different – they have different plans and goals for later life, they may or may not have money set aside, and pension planning can be very complicated.

Investment risk is a good example – it changes with age. Younger people might be more open to risky investments, but as you get older, you want to be invested in something that’s growing at a reasonable rate without too much risk.

The important thing is that we’re not just going to advise you on a pension – we’ll look at everything in terms of estate planning too. We’re not just providing a one-off solution – we’ll be there at your side, hopefully, right up until the day that you retire.

What is the process for setting up a pension?

Simply sit down with your financial adviser. They will look at your current situation, make some projections and explore your plans and goals. This conversation is aimed at getting you to think about later life.

Based on this discussion, the adviser will work with you to put in place further plans that are specifically tailored to your needs. It’s so important to take this time out to think about the future – so if this is something you know you need to look at, just give us a call.