Being self-employed comes with the advantage of being your own boss. But it also means you don’t have the luxury of an employer setting up a pension and making contributions on your behalf. It’s not surprising, that for many people who have only recently become self-employed, the task of setting up a pension – and then making regular pension payments – has been pushed to the background while they focus on generating an income and growing their business.

According to 2020 research conducted by the Association of Independent Professionals and the Self-Employed (IPSE), less than one-third (31%) of the UK’s growing number of self-employed are actively saving through a pension. Right now, the state pension is just £179.60 a week (£9,339 a year), and IPSE warns that without starting a pension and making regular contributions, lots of self-employed people risk falling into “pension poverty” as they get older. Therefore, it’s important for anyone who is currently self-employed or thinking about becoming self-employed in the future, to consider the benefits of setting up a pension and making regular contributions.

Pensions remain one of the most tax-efficient, and increasingly one of the more flexible, ways to save for a comfortable lifestyle during retirement. Here are some of the benefits:

• The government will top-up your pension contributions with a tax-free amount, as we explain below.
• If you die before reaching the age of 75, your pension can usually be passed on to the beneficiaries of your estate as a lump sum without inheritance tax deductions.
• You have a number of choices over what you do with your pension pot when you reach retirement, including taking up to 25% of your pension as a tax-free lump sum.

Pensions are tax-efficient because for every contribution you make, the government will add a tax-free additional contribution on top. For example, taxpayers who pay income tax at the higher rate of 40% and make a pension contribution of £600 will have this topped up by an additional £400 by the government, taking their total pension contribution to £1,000.

For most people, the annual amount they can pay into their pension and still benefit from pension tax-relief is limited to £40,000. This is known as the annual pension allowance. It’s also worth noting that the annual allowance is tapered for high earners, including the self-employed. Anyone who earns an income above £240,000 will see their annual pension allowance gradually reduce by £1 for every £2 of income. In other words, this means that for every £10,000 you earn over £240,000, your allowance is reduced by £5,000, right down to an allowance of just £4,000 for those earning more than £312,000.

However, when you make contributions to your pension, you are also able to use the ‘carry forward’ rule, which means you can claim any tax relief you haven’t used for pension contributions made in the previous three tax years.

The good news is that the self-employed have several options when they decide to set up a pension. The government runs the National Employment Savings Trust (NEST), which offers workplace pension schemes to businesses and now also the self-employed. Other options include arranging a personal pension through a pension provider or setting up a Self-Invested Personal Pension (SIPP).

Stakeholder pensions
Stakeholder pensions are designed to be a simple, low-cost option with standardised features and capped charges for people who do not have complex pension or investment needs. Pension contributions start from as little as £10 a month, and the type of investments available to choose from can be quite limited.

Personal pensions
Personal pensions are private investments made available by some of the UK’s biggest pension providers – usually well-known insurance companies. Personal pensions have a wider choice of investment funds for clients to choose from and are usually categorised based on the investors’ attitude to risk (so adventurous, cautious, balanced, and so on).

Self-invested personal pensions
As the name suggests, self-invested personal pensions (also known as SIPPs) are the ‘do-it-yourself’ option for investors who want to have greater choice and control over where their pension contributions are invested. SIPPs are usually available through investment platforms, and while they offer a broader range of investments, they also come with higher charges. This is because it is easy to buy and sell and switch investments, and you can usually check the progress of your pension online in ‘real-time’ instead of waiting for annual pension statements.

Before starting their business, many self-employed people have already accumulated several smaller pension pots from their previous employers. It therefore might be worth combining these pensions into one. A single retirement pot could make it easier to keep track of your money, and it could also give you greater control over your investments and potentially save money on unnecessary charges.

However, there’s a note of caution here. Any previous workplace pension schemes you hold may come with valuable benefits that you would lose if you transfer the money out. Therefore, when weighing up your pension options, including pension consolidation, it’s crucial to obtain professional financial advice.

Investing for retirement may seem daunting, especially if you’re self-employed and unsure of your income or ability to put money aside regularly. But the sooner you start making pension contributions, the better. It gives your money, and the tax-free top-up from the government, more time to grow into a significant retirement pot. An Amber River independent financial planner can help you put together a retirement plan that lets you set aside an amount you feel comfortable with, and work with you to achieve the retirement that you’ve earned.

Remember that the value of pensions and any other investments, and any income you take from them, can fall as well as rise, and you may get back less than you invested.