How can the self-employed take better care of their pension?

As the number of self-employed people grows, but their pension contribution falls, IFAs explain the benefits of investing into a pension sooner rather than later.

It’s easy to be sceptical about financial services after the recent scandals over pension scams and mis-sold funds from providers.

This feeling is commonly shared among the self-employed that often are a little too late to set up a well-thought-out financial plan, including pension and taxation. This demographic, like their younger counterpart, often lacks the basic knowledge around pensions and how they work.

‘Self-employed people are very much like all other people. Often, they find pensions quite confusing and, potentially, a little bit boring,’ says Romi Savova, chief executive of pension provider PensionBee.

‘It’s really important to have a product that de-jargonises the whole experience. This will help the self-employed relate to saving for retirement by thinking 10 or even 20 years in the future, when their businesses have perhaps been passed on or when they want to wind down.’

Savova pointed out at the challenge of contributing into a pension pot when the income flow of a self-employed might not be consistent every month. ‘Having flexibility in terms of when and how you pay [into a pension], is something that the self-employed find really important. Of course, a pension needs to compete with your other obligations and your other financial goals.’

Slow and steady

One major change for the self-employed has been the introduction of the auto-enrolment reforms, where employers help their workers save for retirement. Currently, around five million self-employed workers are excluded from auto-enrolment, according to the work and pensions department. Overall, the savings participation of the self-employed workforce has steadily declined to 15% in 2017-2018, from 27% in 2008-2009.

The challenge that has risen since the integration of auto-enrolment is organisation, says Minesh Patel, chartered financial planner and managing director of EA Financial Solutions.

‘The most effective way to have auto-enrolment schemes will depend on the style and profile of the business, and the desire to keep employees. Of course, the challenge facing the self-employed, when it comes to auto-enrolment, is that they are not auto-enrolled. It’s only employees that are auto-enrolled. So, it is this idea that planning for the future is really about being slow and steady, gradual and regular, rather than waiting for something large to happen towards the end.’

There are ways in which a pension can become very tax-effective for the self-employed, whether they are a director of a company or not. For example, their contribution into a pension can be deducted as a business expense, meaning they can save 19% of corporation tax and 13.8% on their National Insurance contribution.

‘A lot of self-employed people think about the fact that, because they’re not employed by someone else, they’re not getting the “free” money from their employer,’ Savova says.

She says that even those that are not the director of a limited company can still make contributions into a pension. In some cases, for every £100 they pay in, the government would add another £25 directly through the pension provider. But Savova warned of other tax issues when it comes to pension contributions.

‘In our experience, we have found that most people don’t trip up on annual allowances and lifetime allowances. But if you do, the consequences can be large tax penalties. So, it’s important to bear in mind if you’re planning to contribute more than £40,000 into your pension. This is also the case if you’re a higher earner, with more than £150,000 including your pension contributions.’

Adapt and evolve

Ultimately, many business owners believe their businesses will make up their retirement pot once they sell it in the future. But advisers warn this doesn’t always look as good as it seems.

‘A lot of business owners in our experience, don’t get an independent value of their business. Therefore, they assume that it’s worth more than it actually is,’ says Chris Daems, director of Cervello Financial Planning.

‘If you are planning, as a business owner, to use your pension as your business, it’s important to get external advice, but know where you’re heading first so that you know what options you need to make with your business.’

Selling a business to fund retirement is also not a guarantee of success and it can’t solely form the basis of a person’s wealth. This is especially true since the labour market changes so rapidly and certain activities might not serve the same purpose in the future, or cease to exist altogether.

‘The most successful businesses I see are the ones that evolve continuously over time,’ Patel says.

‘My view is that, unless businesses now invest completely in technology and software, they’re going to be pretty obsolete. The millennials – the buyers of the future – will not consider businesses where there is an emphasis on old-fashioned methods like manual paperwork. It’s just not going to happen.’

Pull quotes

‘A lot of self-employed people think about the fact that, because they’re not employed by someone else, they’re not getting the “free” money from their employer’ Romi Savova, chief executive of pension provider PensionBee.

‘to use your pension as your business, it’s important to get external advice, but know where you’re heading first so that you know what options you need to make with your business’ Chris Daems, director of Cervello Financial Planning.