Updated 30 March 2022
The pandemic and resulting lockdowns have hit self-employed people especially hard – and one of the side-effects has been a fall in their pension contributions. Nick Green warns of the potential ‘long Covid effect’ on retirement income for the self-employed.
Freelancers, contractors and other self-employed Brits still aren’t thinking enough about their retirement. Despite reports two years ago that pension saving among them was on the rise, more recent findings suggest that the self-employed still have a big blind spot in this area. What’s more, the impact of Covid seems to be making it even worse.
New research1 by Unbiased has revealed that over half of all self-employed people currently have no private pension savings at all, and that even more are not paying into a pension scheme at present. This appears to have been the case even before the pandemic, but faced with a loss of income during lockdown, many more have reduced or even suspended their pension contributions so as to have more day-to-day income. Although this may seem like a solution to a problem, in reality it is simply postponing one.
Those self-employed people who do have pension savings, and who are actively paying into them, don’t necessarily have cause to feel smug. Most appear to be contributing at relatively low levels compared to employees, who are auto-enrolled into workplace pensions, obliged to contribute at least 5% of their earnings, and also receive employee contributions at a minimum 3%. As a result, the pension pots of the self-employed tend to be far thinner by comparison.
So far, so gloomy. But if you’re self-employed, it’s tempting to despair of pensions altogether when faced with the hard figures. And that’s the biggest mistake of all – because the study also shows that it doesn’t take much in the way of positive action to bring pension savings up to respectable levels.
The biggest red flag is that 51% of self-employed people who currently have no private pension savings at all. This is a group that has apparently never contributed into any pension scheme, and so has missed out on the huge tax benefits and growth potential. Why ‘apparently’? Because there is still a chance that some will have forgotten pensions from former employments, and could track these down and build upon them. There is little more to be said about this group, except that they really should start saving into a personal pension.
As for the 49% who do have something, things don’t look great – but may in fact be better than they look. A small minority (9%) know they have over £100k saved and can probably relax (see what income a £100k pension pot can buy). Slightly more (11%) have between £30k and £100k, and may be on the right track, while the same number have under £30k and might have to step up a gear. The remainder (18%) don’t know how much they have – so presumably are saving something, but should pay more attention to their annual pension statements.
Of course, the above figures don’t take savers’ ages into account. When we look at average pension savings by age group (excluding those who have no pensions at all) we see something quite interesting:
Older people have more money saved – no surprise there. But pension savings seem to rocket upwards in the 55-64 age group (with an average £136,700), despite apparently rising very little between 35-44 (average £33,300 saved) and 45-54 (£38,100). At first glance this suggests that older self-employed people have been much more conscientious savers than the up-and-coming bunch – and there may be an element of that.
However, one key factor is that big ‘Don’t know’ slice – 18% of respondents didn’t know how much they had saved, and 70% of this group are under-55s. These figures suggest that some self-employed people are reaching 55 or over, finally checking their pension savings and being pleasantly surprised at the amount. People are discovering that they have more than they thought.
But there is an even more interesting reason for the apparently huge leap in savings towards the end. People often underestimate the effect of steady saving combined with compound interest.
Let’s say Fiona is a 40-year old contractor, on an annual income of £40,000 and with the average pension pot for her age (£33,300). Let’s also suppose she makes the average self-employed pension contribution of 4.1%, and so pays in £1,640 per year. Tax relief boosts this to £2,050 per year. Again assuming 4% average fund growth (not unreasonable), how big would Fiona’s pension pot be when she turns 60?
The answer, remarkably, turns out to be £136,668. Looking again at the graph of self-employed pension savings by age, we see that the average for the age group 55-64 is £136,700 – a difference of just £32 from Fiona’s example. This shows that a steady habit of modest saving really can lift pension pot levels by a surprising amount, over a relatively short time period – especially when there are already some savings to build on. Thanks to compound interest, pension pots grow like snowballs – the larger they grow, the faster they grow.
However, the key thing to remember about pension saving is the importance of steady growth. It is the constant and regular nature of contributions that counts, so that you are adding to that snowball all the time. Like training for a marathon, it is no use just making big efforts occasionally and doing nothing for the rest of the time.
That is why the Covid lockdown may end up doing additional financial damage to the self-employed community, with the full impact not being felt until decades from now. Faced with an immediate loss of income, 22% of all self-employed people (meaning, half of those currently saving into a pension) chose either to reduce their pension contributions (10%) or suspend them entirely (12%).
Fortunately, 48% of self-employed pension savers were able either to keep their contributions steady, or even increase them (5%) during the Covid crisis. But this is still only 20% of self-employed people overall – of whom 58% weren’t paying into pensions even before the pandemic, though some appear to have done so in the past. It is this 58% who are most at risk of hitting hard times when age compels them to reduce their hours or stop work altogether.
Although in some cases it may have been necessary simply to make ends meet, reducing or stopping pension contributions should usually be a last resort. Paying into a pension should be viewed as essential spending – like food and utilities – quite simply because it is. This is the money that will be used to pay for such essentials when you are older.
Besides, decreasing your pension savings isn’t just kicking the can down the road – it actually costs you more. Firstly, everything you pay into a pension gets 20% tax relief from the government. Secondly, every contribution increase the pot’s overall rate of growth. If you reduce that rate now, it becomes much harder and costlier to catch up in the future. The danger now is that many self-employed people’s pensions will suffer from a kind of ‘long Covid’ effect as a result of this current drop in contributions, and fail to achieve the desired sums. So anyone who has reduced their contributions should aim to reinstate them as soon as possible.
Those who don’t yet have substantial pension savings may feel despondent, and feel that it isn’t worth starting to save at this stage of their career. But this research into self-employed pension savings reminds us that it’s never too late. Small, regular contributions can snowball into impressively large pension pots, so long as you keep on saving them through both the good times and the bad.
Talk to an independent financial adviser about setting up or optimising your personal pension.
1Research by Unbiased into 200 owners of one-person businesses, February 2021.