Self-employment and freelancing continues to rise and rise in the UK, mirrored by a steep slide in the numbers of own-account workers saving into a pension. According to government statistics less than 20 years ago 38% of self-employed men had no pension, now the number missing out has more than doubled to 78%. The RSA estimates a similar picture for women.
There are several reasons for this shift. For a start, self-employed incomes have reduced at the same time as pension contributions have fallen sharply. The new self-employed have less spare cash to put away. One third expect to rely entirely on the state pension when they retire.
To date pensions for the self-employed have also not been included in the mandatory pension auto-enrolment regulations now being applied to UK employers.
For many self-employed and freelance people there are also far fewer incentives to invest in a pension. Without an employers’ top-up the new stakeholder pensions don’t quite have the same attraction for the self-employed. Over a lifetime the average self-employed person misses out on an estimated £91,500 of employer contributions, according to the Prudential. With an eye on the long-term implications of a shifting labour market and ageing population, those incentives are being provided by the State in some countries.
Self-employed State Pension
There is some good news for the self-employed state pension. Previously the self-employed could not access the second state pension; from 2015 a new level playing field was introduced for those who have made adequate National Insurance (NI) contributions for at least 30 years. But, it’s still not a lot and not likely to get any better.
The full State Pension is currently £168.60. It’s payable when you reach age 67. For growing numbers of self-employed people it will be all, or the bulk, of your pension entitlement. So you need to make sure, as soon as possible, that you will be entitled to the full amount.
You need to have at least 10 qualifying years on your NI record to receive any State Pension at all and you will need 35 years to receive the full State Pension. Your NI record qualifies any year you work and pay NI and also in some years where you’re caring for others or claiming work-related benefits. There are also partial deductions for past years when your employer may have been ‘contracted out’. Basically, it’s complicated. Luckily you can make sure that you are fully and accurately informed by using the Government’s ‘Check Your Pension’ tool. This will tell you how much pension you can expect to receive, when you will get it, and what you can do to increase it.
Difficulties accessing financial services
Accessing financial services in general can be a challenge for the self-employed. One in five say that they can not get a mortgage due to their employment status. Not surprisingly there has been a growth in the number of specialist providers and brokers, who deal exclusively with freelancers and the self-employed.
Committing to regular pension contributions is another concern, especially when income can be lumpy. And while it’s becoming easier to access pension pots earlier, many self-employed people like the flexibility of being able to access their capital when and if their business or family needs it.
Alternative ways of saving for the future
For those reasons alternative investments, especially property and ISAs are popular with self-employed people. In fact, research from the RSA finds that, while self-employed people currently have lower incomes on average, they have approximately three times the wealth of employee-only householders. For many, squirrelling away a nest egg is what has enabled them to become self-employed.
But of course the down-side of flexible savings means that when economic or personal crises hit, they can be eaten away much more quickly. While it makes sense to have relevant insurances as a buffer in those situations, more that 70% of self-employed people do not have life insurance and over 90% are not covered for critical illness.
In the long-run, a pension is still more tax efficient and generally delivers a better rate of return than alternative savings vehicles. Pension incentives for the self-employed could be better, but on-balance having a pension as part of your retirement planning still makes sense.
Private pensions for the self-employed
The UK’s State Pension is at the bottom of the international pensions league. The average across OECD countries is a State Pension of 63% average wages, in the UK it’s just 29%. Woeful. And let’s face it, it is unlikely to get much better and in the current and unfolding economic climate. It may even get worse.
Many of us choose to be self-employed in order to be self-sufficient. Now more than ever before, you need to apply this mindset to your old age planning.
On the positive side, there are great tax breaks for making pension contributions. For every £100 you contribute, the Government will add an extra £25. And if you’re a higher rate tax payer, they’ll give you another £25 on top of that. If you run a Limited Company, any pension contributions that the company makes on your behalf will also save the company Corporation Tax.
You can usually access your pension pot from the age of 55 and draw down a 25% lump sum tax free. However, the longer you leave your pension before drawing it, the larger your pot will become and the larger your long-term payments will be.
Most self-employed people who set up a pension plan will opt for a personal pension. The three main types are: Ordinary personal pensions; Stakeholder pensions and Self-invested personal pensions.
If you’ve been ambivalent about starting a pension because of uncertainty about the security of future earnings and the need to stay open to potential fluctuations, then a Stakeholder Pensions may be the best bet. Those have a maximum charge of 1.5% and you can stop and start contributions without penalty.
NEST Pension for the self-employed
Self-employed people (including sole director companies) can also use the government’s NEST (National Employment Savings Trust) pension scheme. NEST is run by a Trust on behalf of its members, it is not-for-profit. Charges are relatively low (averaging 0.5%) and you can adjust or pause contributions without penalties (as long as you maintain a minimum contribution of £10 per month).
NEST also have an easy to use online platform where you can track your contributions, make additional payments and update your details. You can find out more about signing up with NEST as a self-employed person here.
Choosing which self-employed pension route to go down will depend on your circumstances. Before you make a long-term financial plan it may be a good time to talk to a regulated financial adviser. Just make sure you do something and get started soon.