BLOG: Top tips for pension planning if you’re self-employed
Complicated rules and regulations, an industry that has traditionally embraced jargon to a point of confusing consumers, and retirement potentially being a long way off, could mean you put your pension planning off for another day.
The coronavirus pandemic and ongoing uncertainty around the future of the jobs market and economic recovery has, as has been widely reported, had a more significant impact on some groups when compared to others.
The self-employed are one of these groups that have been adversely impacted according to official data. However, where your financial situation allows, keeping on top of your pension now could well pay dividends in the future.
1) Tax relief will boost your pension contributions
A pension is nearly always a sensible part of financial planning because of the tax relief you receive on contributions. Tax relief – one of those industry jargon terms – could also be thought of as free money from the government.
If you have a ‘relief at source’ pension then your personal contributions benefit from a government top-up. While the top-up is subject to your tax status, basic rate taxpayers should effectively see a £100 contribution turned into a £125 contribution with the tax relief. With higher and additional rate taxpayers able to claim additional relief.
You can benefit from tax relief on contributions up to an annual allowance (currently £40,000 for this tax year) or up to 100% of your annual earnings, whichever is lower.
2) Flexibility to suit your work pattern
Pensions from different providers may well vary, but most providers with a good online offering will be able to give you flexibility when it comes to making contributions. You can set up a direct debit, so your monthly pension contributions are taken care of without you needing to do anything; or make ad hoc contributions to suit your work and earning pattern.
At a time of greater uncertainty, such as we are in now, and remembering that money invested in a pension can’t be accessed until your 55 (expected to rise to 58 in 2028) you may want the flexibility of knowing that you can stop, start or change the amount of your regular contributions at any time.
3) Limited company owners can make contributions from the business
If you have a limited company, and your pension provider allows it, you have the option to make direct contributions to your pension from your company. These are called employer contributions, as opposed to personal contributions. If you top up your pension this way, you may find you’re better off thanks to savings on your corporation tax and National Insurance bill.
Employer pension contributions can count as an allowable business expense. So, subject to certain conditions being met, you can pay them out of your company’s pre-tax income, meaning they’re free of corporation tax. You can make up to £40,000 a year of employer pension contributions, although the sum cannot exceed your company’s profits.
4) Starting early could really help
Appreciating this is unhelpful advice if you’re no longer “young”, the truth is that starting early is the best thing you can do to help achieve a sizeable pension. A common rule of thumb is that you should work out how much your regular pension contributions should be by taking your age at the time of starting your pension and halving it.
So, if you start investing into a pension at 25, regular contributions should be 12.5% of your annual earnings, this would include any contributions made by your employer. If you wait until you’re 40, this figure increases to 20%.
A pension calculator could help you work out contributions based on how much you’re starting with, when you hope to retire and how much you’d like your pension pot to be.
Another advantage of starting young, is your pension will benefit from compound returns. Again, sorry for the jargon – but this means any returns on your investments will then be re-invested and generate more returns. Research group CLSA found that if you contribute to a pension from the age of 21 to 30, your pension pot will be worth more than if you put aside the same amount each month from the age of 30 to 70. This assumes that you stop contributing at 30, but the fund continues to provide returns at the same rate.
5) Think about risk
The amount of risk you are willing to take with your retirement savings is a big factor in determining how much you have at the end. Generally speaking, you may get a better return if you are willing to take more risk with your investments, but you may also experience higher losses.
The amount of risk you are comfortable taking is likely to be impacted by how far away you are from retirement. The theory is that a young person still has many years ahead for their portfolio to recover from the effects of a potential crash, while an older person might need that money sooner and may not be able to afford to wait for the recovery.
Kat Mann is savings and investment specialist at Nutmeg