Planning for your retirement when you’re self-employed

In a year that was short of reasons to be cheerful, the news in June 2020 that a record number of people were paying into workplace pensions1 was welcome. It continued an upward trend that began in 2012 with the launch of automatic enrolment, which brought millions of individuals into the pensions system for the first time.

But one important and fast-growing cohort of people was excluded from auto-enrolment: the self-employed.

The ranks of the self-employed have swelled over the past two decades, rising from 3.4 million (12.9% of the workforce) in 1998 to 4.8 million (15.1%) in 2017 2. Yet over the same period, the proportion of self-employed workers paying into a private pension has fallen from 48% to just 16%, according to the Institute for Fiscal Studies2.

Mind the gap

That means the UK now faces a widening pensions gap, with the self-employed falling behind when it comes to saving for retirement. There are several reasons for this, including their exclusion from auto-enrolment and the income insecurity that can be a feature of self-employment.

There’s also the hassle factor. There’s a lot to think about when you’re self-employed, and starting and paying into a pension can quickly slide down the list of priorities. Similarly, self-employed earnings can be uneven and unpredictable, so it might be difficult to work out exactly how much to contribute each month and year.

“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,” says Tony Clark, Senior Propositions Manager at St. James's Place Wealth Management.

Spreading the risk

Many self-employed people also expect their business to be their main source of retirement income. Whilst this is understandable, a business should form part of a broader financial plan, and relying on it entirely is risky.

“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,” says Simon Martin, Chartered Financial Planner at St. James's Place Wealth Management. “If the business performance suffers, so does your present and future income.”

Ideally, any retirement plan should include a mix of pensions, ISAs, property, state pension, earnings and so on. If you’re self-employed, your business is part of that. Having other assets to call on can benefit your business planning as well, particularly if you’re approaching retirement and finding it hard 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,” says Clark. “Keeping a mix of other assets gives you a safety net, more time and more flexibility.”

Not missing out

Diversifying also brings tax benefits. For example, when you take money out of a business, there will likely be some degree of Inheritance Tax (IHT) or Capital Gains Tax (CGT) liability. By contrast, pensions stay outside your estate for IHT purposes, which makes them more tax efficient than a business when it comes to 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 help you when it comes to maximising your contributions too, especially when you know your earnings can vary significantly from year-to-year.

While there is an annual allowance that limits how much you can pay into a pension each year, there is flexibility within that. This is due to 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,” says 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.”

Planning ahead

When you’ve got a business to run, managing your longer-term finances can feel time-consuming. That’s why it makes financial and business sense to seek support from others, such as accountants and financial advisers.

An adviser can help you understand how your earnings are panning out over the financial year and put plans in place around that. That can include structuring your pension contributions in such a way that you don’t miss out. An adviser can also guide you through the different stages of running your own business, while making sure it dovetails with your wider financial plans.

“Each stage of your business will require financial strategies, including your retirement strategy,” says Clark.

“Your adviser needs to be on the journey with you. As you build your business, you’ll have various experts you call on – and your adviser should be part of that support network, helping you realise the outcomes you’re looking for.

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.

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

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