What Is A Self-Employed Pension? Do I Need One?

Your Financial Plan
15 mins

A pension is probably the best way to save for retirement for the vast majority of individuals. There’s tax relief on contributions at your highest marginal of income tax and any growth on your funds inside the pension wrapper is free from taxes such as income tax and capital gains tax.

You can’t touch the contributions you make into a pension until you’re at least 55, so a pension is a long-term savings vehicle. However, this means that your nest egg for retirement can continue growing for years if not decades incredibly tax-efficiently.

Do You Get a Pension if You’re Self-Employed?

If you’re self-employed, you don’t have as many pension options open to you as an employed individual, so it’s vital you make your own arrangements as early as possible so you don’t miss out in retirement just because you’ve decided to go it alone.

Thanks to auto-enrolment, it’s been a mandatory legal requirement for businesses with at least one employer to provide that employee with an auto-enrolment workplace pension scheme. However, there’s no such legal protection for self-employed workers.

Do The Self Employed Get The State Pension?

The New State Pension, which is paid to men born on or after 6 April 1951 and women born on or after 6 April 1953, isn’t paid in full unless you have at least 35 years of National Insurance contributions. If you have fewer than 10 years of contributions you don’t get the New State Pension at all. Some self-employed people may have a patchy history of National Insurance contributions, so might not get the full New State Pension.

It’s also only worth £203.85 in the 2023/24 tax year, so even if you don’t have your complete set of National Insurance contributions it may be a struggle to live off this in retirement.

Am I At A Disadvantage Because I’m Self-Employed?

Yes and no. Employees who are members of workplace pension schemes will benefit from employer contributions into their pot. Being self-employed you will miss out on employer contributions and will need to establish your own personal pension arrangements.

However, the self-employed still benefit from the same tax advantages on personal contributions as an employed individual. As mentioned, pensions are extremely tax efficient as they qualify for tax relief at your marginal rate of income tax.

For example, if you’re a sole trader paying basic rate tax of 20%, if you made a pension contribution of £800 the pension provider would automatically gross this up to £1,000 (you would still need to declare this on your Self Assessment tax return).

For a director of a limited company you could set it up so your company pays into your pension and those contributions are treated as a business expense for tax purposes.

Ultimately, if you’re self-employed it’s up to you to set up a pension and pay into it on a regular basis so you can build up a pension pot that allows you to live the retirement you deserve.

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What Pension Options Do Self Employed People Have?

Assuming you’re working for yourself without any kind of limited company setup — i.e. you’re not a contractor or company director — then as a self-employed individual a personal pension is likely to be your best option to save for retirement.

However, there are a number of different personal pension options to consider, so choosing the right one for you can be tricky.

Firstly, as a self-employed individual you’ll be saving into a defined contribution pension. This is a pension where your retirement income is defined by the payments you make into the scheme over the years and the investment performance of the underlying fund(s). There are two main types of self employed pensions under the defined contribution umbrella: a stakeholder pension and a self-invested personal pension (SIPP).

Stakeholder Pension

Stakeholder pensions have low charges capped by legislation and a default investment strategy for those who don’t want to choose which funds to invest in. Management charges in each year must not amount to more than 1.5% of the total value of the fund for each year until the 10th year of continuous membership in the scheme when the cap reduces to 1% per year.

Stakeholder pensions are also flexible regarding contributions, so this makes them a good option for self-employed people with irregular income patterns who aren’t sure how much they’ll be able to save from month to month.

The minimum contribution to a stakeholder pension cannot be set higher than £20 and contributions can be paid weekly, monthly, at other intervals, or they can be a single one-off contribution.

There are no penalties if the saver wants to transfer the fund to another pension arrangement and most stakeholder pensions have to accept transfers in from other pension schemes. This means if you have another scheme, perhaps from an old employer, you could potentially transfer it into your new stakeholder pension.

However, before transferring any old workplace pensions it’s best to check with an adviser first as some workplace pensions have valuable guarantees attached, such as guaranteed annuity rates or protected early retirement dates, which you’ll likely lose if you transfer out.

Self Invested Personal Pension (SIPP)

If you want to take a more active role in the investments in your pension fund, then a self-invested personal pension (SIPP) could be a good option.

Investing in a SIPP means you have more control over the investments in your pension, such as equities, investment trusts, real estate investment trusts (REITs), commercial property and National Savings & Investment products.

You can manage these investments yourself, or you can pay a professional financial adviser to do it for you. This may be a good option if you’re new to investing and are thinking of branching out into more complex investments, such as commercial property.

National Employment Savings Trust (NEST)

NEST (National Employment Savings Trust) is a pension scheme set up by the government. It was established mainly to help employers with automatic enrolment (where firms now have to provide a pension to employees), but you can also join NEST if you’re a sole trader or the sole director of a company that doesn’t employ anyone else.

Once a member, you can carry on contributing to your pension this way even if you change jobs or stop working.

The main features of NEST are flexible contributions and low charges.

Self-employed workers need to set up their own contributions to NEST. You can do this online by Direct Debit or debit card. You can contribute as often as you like but the minimum contribution is £10.

If you’re self-employed and employ other people you can sign up to NEST as an employer to make the mandatory legal employer contributions for your employees.

How Much Can The Self Employed Save Into A Pension?

As a self employed worker, you get tax relief up to £60,000 per year of contributions or your annual earnings, whichever is lower. This is known as the pension annual allowance.

You can carry forward unused annual allowance from the previous 3 years. Self-employed workers often find their income varies from year to year, so you can use the carry forward rule to maximise your pension savings in years when your income is high.

I’m Self Employed And Have Pensions From Previous Jobs…

Many self employed workers will have been employed at some point and, if so, it’s likely they will have set up and paid into different workplace pensions over the years from different employers.

For many people it could be advantageous to consolidate their existing pensions into one plan. Pension consolidation involves bringing all of your separate pension plans together and combining them into fewer arrangements.

This makes it easier to keep track of your pension savings and see how your investments are performing. It could also reduce fees and charges you’re paying on multiple separate pots.

You may want to look at transferring your pensions from previous employers into your new self employed pension arrangement. However, before you do so, you should consider carefully whether this is the best course of action.

The old pension pot you’re seeking to transfer may charge an exit fee, or there could be attached guarantees, such as a guaranteed annuity rate or a protected early retirement age, that you’ll be giving up by transferring.

We’d recommend discussing your decision with a qualified pension adviser before undertaking any pension consolidation exercise.

How Are Self Employed Pension Contributions Taxed?

Tax relief on personal pension contributions made by a sole-trader operate in the same way as for employees. The pension scheme claims back basic rate tax at 20% and any further pension tax relief due — because you’re a higher or additional rate taxpayer — is claimed through your self-assessment tax return.

This means a basic rate taxpayer can expect to receive a gross £100 pension contribution with a £80 net contribution from your pocket and £20 in basic rate tax relief at source from the government.

If your a higher (40%) or additional (45%) rate taxpayer, then the same £100 gross contribution will only cost you £60 and £55, respectively. You’ll get £20 of tax relief automatically from the pension scheme and have to apply for the rest of your tax relief via your self-assessment tax return.

Am I Saving Enough Into My Pension?

If you already have a pension or you’ve recently set one up, then that’s a great start. But how do you know whether you’re saving enough for retirement?

After all, as you’re self-employed you’re not enjoying the same pension top ups from an employer as your employed friends and family will generally be, so how much should you be saving for retirement to compensate for this?

This is a tough question and ultimately depends on the retirement you want to have and the goals and dreams you want to achieve in your later years.

If you’re happy to live a fairly modest retirement then you obviously won’t have to save as much as someone who’s hoping to have a more luxurious retirement, perhaps paying for foreign holidays or helping children onto the property ladder.

It also depends on any other assets you might have that you could draw on in retirement, such as property, savings and investments or even pensions from a previous employer.

How Much Will I Need For Retirement?

Drewberry has built the below Pension Pot Calculator to work out how much your pension will be worth at retirement based on its current size and your current contributions, factoring in potential investment growth over this period also.

However, while this can give you a rough idea, it’s no substitute for proper financial planning. At Drewberry, we have access to in-house financial planning software that can model your current projected retirement down to the last penny. That way you can see how much you’ll have to live on in your retirement and whether you can afford to do all the things you want in your later years.

If it turns out you won’t be where you want to be in retirement, then you have time to fix it by increasing pension contributions today for a more prosperous tomorrow.

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How much will your pension be worth when you retire? Use our Pension Calculator to work it out and get a free copy of our Guide to a Richer Retirement.

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