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Self-employed? How to check that your pension is on track

Updated 16 March 2023

8min read

Nick Green
Financial Journalist

Pension saving among self-employed people is still too low, according to Unbiased research. But by getting a better understanding of your pension, you can build a more positive attitude towards it and maximise its tax-busting powers. Article by Nick Green.

Pension for self-employed

For many self-employed people, pensions continue to be the elephant in the room. Only half of the freelance workforce seems to have thought about them at all, and even those who do have active pension pots are still under-valuing them – and under-using them as a result. This is an uncharacteristic oversight by a community with a reputation for seizing opportunities. Research by Unbiased has revealed just how much self-employed people are missing out on the tax benefits of the pension saving system.

There is a perception (or myth) that being self-employed means there is less need to prepare for retirement, since one can just keep working. The reality rarely works out that way. Retirement can be delayed but few can put it off forever, and then income must be found from somewhere. A pension remains by far the easiest and most cost-effective way to achieve this. And – perhaps even more attractively for the self-employed – it’s probably the single most effective way to safeguard money from the taxman, without actually breaking the law.

We asked a sample of self-employed people (owners of one-person businesses) about their plans for funding their retirement. The answers were mixed, to say the least, and in some cases a cause for concern. See if you recognise your own circumstances in the examples here – and see what you can do to improve your position.

Lower levels of pension saving among self-employed

‘I have no pension savings at all yet / I’m not currently saving.’

In this article we revealed that 51% of self-employed people appear not to have any pension savings at all – at least not yet. But 4 in 10 (38%) of the survey sample were under 45, meaning that a large proportion of this group will still have at least 20 years to build up some pension savings, even if starting from zero.

Something else to note is that not everyone in the survey who has some pension savings is still actively saving. Although 49% say they have a pension pot, just 42% have made contributions to it in the past year.

‘I’m not sure I’m contributing enough.’

So how much are self-employed people paying in? We looked at average contribution levels as a percentage of income, relative to age:

The average level of contributions was 4.1% of income, and – notwithstanding some anomalies in the 25-34 year old age group – tends to peak at nearly 7% among self-employed people in their 40s and decrease in later years.

An average of just over 4% isn’t terrible, but it compares poorly with those in workplace pension scheme (who make at least a contribution of 8% when their employer contribution is included). Of course the actual amount paid in depends on the earnings of the person in question – if a self-employed person earns a very large income then they might outdo their wage-slave counterparts. But this discrepancy hints at a bigger eventual mismatch between working income and retired income. In other words, the self-employed may need to brace themselves for a bigger drop in spending power when they retire.

What is encouraging is that younger self-employed pension savers seem to be contributing at above-average levels. Perhaps ‘FOMO’ is a factor here – seeing their peers in employment being auto-enrolled into pension schemes may have promoted them to save at a comparable level.

Lack of proper planning for retirement income

But, you might say, what if I don’t see the need for a pension at all? What if I plan to fund my later years in some other way? Plenty of freelancers are thinking along those lines, which may partly explain why only half currently have any pension savings. When asked where they expect their income to derive from in later life, the self-employed rank private pensions only in third place:

‘I’ll rely on the state pension and keep working part-time.’

Unsurprisingly, 71% expect the state pension to be one of their four main sources of income from the age of 66 (or whenever they reach state pension age). But it’s interesting that 56% expect to be still working into their late 60s. Private pensions are the next most common expected source of income, yet just a third of self-employed people expect it to be in their top four income streams (meaning a large majority don’t). This raises the question of where else they plan for their money to come from.

‘I’ll look into other forms of investment.’

After private pensions, the next most popular option by some margin is ‘other investments’. This is slightly puzzling, for a number of reasons. Firstly, pension pots are by far the most tax-efficient way to invest for retirement, so in most cases it makes sense to use those (unless the intention is to access the money before the age of 55). Ordinary investments need to deliver pretty stellar performance to rival just the 25% boost of pension tax relief, which would typically require taking a lot of investment risk. Similarly, another option available for pension saving is the Lifetime ISA, which likewise gives a 25% government bonus, and can be used to hold investments such as stocks & shares. This, then, would seem an ideal home for these ‘other investments’ – yet hardly any self-employed people (5%) plan to use them. There is a penalty for accessing a Lifetime ISA before the age of 60 (except for buying a first home), but again this makes them tailor-made for retirement saving.

So it’s hard not to wonder if the ‘other investments’ option is a genuine plan among a quarter (27%) of self-employed people, or simply a vague hope that they will get around to making some amazing investments between now and retirement. There is otherwise no obvious explanation as to why they would avoid using either a pension or a Lifetime ISA, or both, given the massive bonuses they offer.

‘My home is my retirement fund.’

Other options, like downsizing or equity release, could theoretically free up enough money to live on in retirement. But this isn’t necessarily the case. It depends either on finding a much cheaper home and being willing to move there at the appropriate time, or being willing to sacrifice part of the equity of your home (and so reduce your family’s inheritance).

Also, these alternatives don’t seem popular enough to account for the two-thirds of freelancers who don’t expect to rely on a private pension. These people may well imagine that the state pension and their savings will be sufficient – but most retirees discover that this is not the case for them.

‘Pensions just haven’t been on my radar.’

The most likely explanation for the neglect of pensions among the self-employed is simply lack of awareness about their potential as a long-term tax-efficient investment vehicle. Company employees are bombarded with pensions information from the day they are hired, but for freelancers pensions are often seen as a chore that can be postponed.

Self-employed people who haven’t saved from day one may think it’s too late to start, and may also underestimate the added value that a pension brings over an ordinary investment. But here’s an example (see this article for more about where these figures come from).

How pension saving now gives you an income in retirement

Freelancer Fiona is aged 40 and has the average pension pot size for a self-employed pension saver of her age (£33,300). Her gross income is £40,000 and she makes the average contribution of 4.1%. Tax relief boosts this to £2,050 per year (though it only costs her £1,640).

If she keeps this up and gets an average 4% growth in her fund (a reasonable hope), then by the age of 66 she should have a pot of £187,545. So in just 26 years she increases her pension savings by a multiple between five and six.

What kind of income could Fiona expect from a pension pot of this size?

Option 1: Tax-free lump sum plus annuity

Fiona can take a 25% tax-free lump sum of £46,886. This leaves £140,659.

She uses this money to buy an annuity (a guaranteed income for life). She is offered a rate of 4.8% which works out as £6,751 per year.

If Fiona chooses to invest her lump sum and achieves 4% growth (not guaranteed) then she could take another tax-free £3,000 a year from that fund until the age of 90. But it might not last that long if the stock market performs badly.

This works out as a possible £9,751 a year from this pension pot if taken as a lump sum plus annuity, (with £6,751 of that per year guaranteed).

Added to her state pension (£9339 as of 2021/22 but set to rise with inflation) this means a total income of around £19,000. This is a reasonable amount that compares well to the average retirement income, but Fiona will have to spend carefully in retirement.

Option 2: Tax-free lump sum plus drawdown

Fiona takes the same tax-free lump sum of £46,886. But this time she puts the remaining £140,659 into a drawdown scheme.

Assuming 4% fund growth (again, not guaranteed) then Fiona could draw £9,120 a year from this until the age of 90, though this amount would be taxable. If she invests the lump sum as in the previous example, this makes a total of £12,120 from her private pension. Adding the state pension gives a (possible) grand total of £21,459.

The drawdown option has the potential to produce more income than the annuity route – but also runs the risk of producing less, and the fund can run out altogether. This is why it’s so important to take advice when deciding how to draw your pension.

5 tips to get a good self-employed pension

The examples above demonstrate two things. Firstly, it’s possible to build up a fairly substantial pension pot over the course of a working life by making affordable contributions, and to draw a respectable income from this in retirement. The second point is more sobering: without this private pension, most people will be wholly reliant on the state pension – which as you can see isn’t really enough on its own to live on.

If you’re self-employed, here are five simple steps to take to ensure that you have enough money when you finally stop work.

  1. If you don’t yet have a private pension, start one
    It really is never too late to do this. Even if retirement is only a few years away, you can boost existing savings by 25% or more by transferring them into your pension. If you have a SIPP, you can even hold your business property in your pension.
  2. If you have a pension scheme, aim to contribute at least 8% of your gross income
    Company employees enjoy a total of 8% contributions (at least) into their workplace pensions, so you should aim to match them. Remember, you’re gaining money not losing it, because everything you pay in gets income tax refunded on it.
  3. If you want retirement savings you can access in emergencies, set up a Lifetime ISA
    Savings into a Lifetime ISA receive a 25% government bonus. There’s a 25% penalty on withdrawals before the age of 60 (unless used to buy a first home), but if you need emergency funds this can be a more flexible option that a pension. You’ll still need a pension as well, however, as the savings limits for Lifetime ISAs are only £128,000.
  4. Estimate your retirement income using the Unbiased Pension Calculator
    We’ve created this pension calculator to help you get a rough idea of how much drawdown income you might get, based on your current pension savings and contributions. Try it!
  5. Talk to an IFA about your pension
    The most reliable way to ensure your pension plans will meet your needs in retirement is to set up your personal pension with the help of an independent financial adviser. They’ll help you find the right provider and fund, and recommend the ideal affordable level of contribution, so you don’t have to worry about whether you’re saving enough.

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About the author
Nick Green is a financial journalist writing for Unbiased.co.uk, the site that has helped over 10 million people find financial, business and legal advice. Nick has been writing professionally on money and business topics for over 15 years, and has previously written for leading accountancy firms PKF and BDO.