Pensions: More Than Just a Job Perk? Navigating Retirement Planning For The Self-Employed
DISCLAIMER: This is NOT pension advice. The content here is my take on pensions as a Chartered Accountant (the tax stuff), and from what I’ve seen work for other business owners — and my opinion! Do seek professional input from an IFA if you require specific investment advice.
Thoughts on pensions and retirement
When you run your own business, pensions can feel like they’re just a perk for smug employed people… along with their holiday and sick pay. But the idea of diligently working somewhere for 40 years and then retiring on a comfy pension feels outdated, even for those people in jobs. And as self-employed people running our own businesses perhaps we often can’t even imagine retiring.
The backdrop to this is that the state pension age is shifting, people used to retire earlier, getting their state pension 65 (or until recently it was 60 for women) but its now moving incrementally to 68 and feels a little uncertain what will come next.
So why do you even need a pension?
I think of a pension as simply building up a pot of ‘money’ or ‘assets’ that will give you the flexibility in later life to retire – or as a financial cushion to reduce or change your workload. It’s all about being savvy through your younger years to plan what you will live on in older age. And to have a flexible on when you might stop working or change how you work.
This could be in the form of what we think of as a ‘standard’ pension scheme or it could be something else entirely…
Pensions are all about taking care of a future version of you! You could imagine putting funds in your pension as like buying a future weekly shop – so when it comes to it you can go around the shop, selecting lots of tasty goodies…
Will I get a state pension?
For full state pension entitlement you will need to have accumulated the relevant number of working years (35 qualifying years) …. to get your pension ‘stamp’. You can check how many years you have from your online HMRC portal and you can make voluntary NIC contributions to ‘catch up’ on missed years if desired. But be aware of 31 July 2023 deadline to fill in the gaps and make extra payments.
The current basic state pension for someone aged 66 now is £10,600 year. You can check the forecast tool here to see how much you could expect to receive in retirement. But thinking about your cost of living, aging population and the political scene, will this be still in place say 30 years from now?
That’s why its important to plan for your retirement and how you will fund the difference.
What are the tax benefits of paying into a pension?
You get tax relief on your pension contributions… this is in line with the tax you pay, and it usually appears as your pension contributions being grossed up for the tax saving. So for a basic rate tax payer that could look like an extra 20% in your pension pot (if you have tax relief at source scheme). For higher rate tax payers its a 40% gross up (but you will usually need to claim the difference by telling HMRC).
If you run a limited company you (and your partner, if they work in the business too) can have a company pension scheme. And then your company’s pension contribution on your behalf can be set against corporation tax.
Do I get taxed on my pension?
Yes – later in life you will be taxed when you draw your pension, based on the tax regime that is in place then.
How much CAN I put in my pension?
Annually, regardless of your actual earnings, you can pay in to your pension £3,600 gross (£2,880 actual contribution + £720 ‘tax saving’). And you can pay in up to £40k (soon moving to £60k) based on your actual earnings. This won’t feel that relevant for a lot of us – but if you are playing catch up on pension contributions or deciding what to do with some ‘windfall’ profits/income it might be more relevant.
To make contributions will need to open a pension fund suitable for a self-employed person (lots of products are available but nothing special – just a Personal Pension Scheme) if you don’t have one already.
How much SHOULD I put into my pension?
This depends on how much you want to be able to earn from your pension when you reach retirement and lots of other factors. There are lots of online pension calculators that help you to determine what the pension pot ‘ought’ to be in order to model a certain level of income in later life, based on your current earnings, life style and aspirations. You might find this Telegraph article a useful starting point.
I would say don’t get too hung up on how overwhelming the ‘ideal’ pension pot looks as a barrier to getting started – start now with what you can afford to pay in. And for advice tailored to your situation consult with an IFA.
What if I can’t afford to make any (or reasonable) pension contributions right now?
This is my opinion but you could think of it as breaking up your working life (and life in general) into phases. And in some phases pension contribution are not the priority, for example when you are establishing your business, have other big expenses or commitments in your life, like purchasing property or child care costs etc.
However, you ought to be planning for some years in other phases of life, when you compensate for this perhaps and divert or generate extra income to put in bigger pension contributions over these years.
As a self employed person, if you’re not sure through the year you can afford to commit money into a pension, you could transfer some funds into a separate account or ‘pot’ earmarked for your pension. It’s not fully committed to your pension at this stage so you can dip into it for emergencies etc if needed. But then you can decided towards the end of the tax year how much to pay them in to your pension (at which point they are committed!).
I think using various bank ‘pots’ to manage everything are a great idea – for example to ear mark funds for tax payments, savings, day to day spending, and for specific goals or spend. And you might want to look into the concept of Profit First if you like this idea.
This is my practical take on things when you simply can’t see a way to afford it now and I also cover some alternatives to pensions if you read on.
I think I have some pension funds already?
Don’t forget about any pension pots you have from previous employed jobs. It can be helpful to consolidate them if there’s lots of small ones with elusive paperwork to practically manage it. A service like Pension Bee can be helpful for this. They also have a handy podcast on self employed pensions.
Or you might be able to carry on paying into an existing pension you have open from a previous job (you will have to check the scheme details).
If you have any special ones like public sector pensions you may wish to keep those funds where they are and open a new scheme! You’ll have to look at the pros and cons of that yourself.
Are there alternatives to traditional pensions… like property?
There is what’s known as a ‘SIPP’ (Self Invested Personal Pension) where instead of a pension company investing your funds for you, you have a say in determining where and what it is invested in. SIPPs could be used to purchase commercial property to either buy and sell or to live off the rentals or income OR actually use the space in your business as say an office or workshop.
Also, instead of a pension you might buy a rental property, with the tenants paying the mortgage – such that you end up with an asset when you retire (this will have further tax implications of course!).
Or you might be planning on selling off an asset, such as downsizing your house, and living on the proceeds instead. This may or may not be a good idea depending on how far away that is, tax treatment and what it will be worth then etc. But this is a practical alternative should you not have the ‘recommended’ pension pot saved up depending on your circumstances and needs.
When do I need to decide by?
A key date to bear in mind is the end of each tax year – so you have up to 5 April to sort what you are doing for each year. This should be part of your end of year checklist.
Let’s finish with some helpful pension myth buster pointers to take away:
You can still have a pension as a self employed person AND…:
- Not be obligated to make fixed monthly payments.
- Not have a clue about when or how you will be retiring… but make a start!
- Retain flexibility on how much it makes sense for you to contribute at different stages of your life.
- Use it for tax planning (to reduce personal and corporation tax).
- Retain a say in where the funds are invested and benefit ‘two ways’.
And remember while people in jobs seem to get holiday pay, sick pay and pensions handed to them! They don’t always get much flexibility or autonomy or the chance to really be creative and make a difference. So there are certainly perks to the self employed life.
If you want to hear more on my take on pensions for self employed people you can watch the replay from my live Pension Q&A session.
Hi, I’m Harriet, your trusted CFO, Business Growth Specialist, and Finance Educator.
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Harriet Formby MA ACA