If you are self-employed, saving for your retirement is likely to be a low priority. However this can be a mistake. People usually need to save more than they think they do to finance the lifestyle they would like during retirement. Among the self-employed, the most common reason for not saving for retirement is an inconsistent stream of income. Self-employed individuals need to keep their finances flexible to ensure they have enough to meet daily living costs, business expenses and tax bills. For this reason, putting money into a pension plan may not be ideal, as it cannot be accessed until at least age 55.
This is an increasing problem. In a report published last December, the Department for Work and Pensions found that 4.75m people, or 15 per cent of the UK workforce, is self-employed and this number is growing. Yet just 31 per cent of the self-employed save for retirement. The proportion of people saving into a pension is consistently lower among the self-employed in every age group, compared with the employed. For example, only 25 per cent of self-employed individuals aged 60 to 64 save for their retirement, compared with 63 per cent of those who are employed.
People who run their own businesses often think of them as their pensions. However, Patrick Connolly, chartered financial planner at Chase de Vere, says: “This is a high-risk strategy as it means they are putting all of their financial eggs in one basket. This could backfire if their business does not perform well or nobody wants to take it over when they retire.”
He suggests that if you run your own business you should also think about your personal finances and build up long-term savings to ensure you have a financial safety net.
Although it is easier to save money for retirement if you are employed because you will be offered a pension by your employer, there are multiple savings vehicles for the self-employed to do this too.
But whichever option you choose, it is important to keep different pots of savings for different time frames. “We help our clients to understand that they need to save for the short, medium and long term,” says Nathan Long, senior analyst at Hargreaves Lansdown. “The long term is for retirement savings, the short term is for cash. Our rule of thumb is that everyone should hold somewhere between three and six months of their expenditure in cash for emergencies.”
When you have built up that level of cash you could then put further savings into investments that make your money work a bit harder and generate greater returns over the long term.
One of the most flexible options for saving and investing is an individual savings account (Isa). There are a number of different types of Isa, including cash Isas and stocks-and-shares Isas. The one you pick depends on the level of risk you want to take. Cash Isas are quite liquid and allow you to get your money out quickly in emergency situations. But cash can lose value over time due to inflation erosion, especially when interest rates are low, so cash is not a suitable asset for a long-term plan, such as saving for retirement.
Stocks-and-shares Isas allow you to put money into investments that can deliver growth over the long term, although are subject to short-term market fluctuations. Andy James, head of retirement at wealth manager Tilney, says: “Isas offer tax-free investment returns and tax-free withdrawals. While there is no upfront tax relief [as with pensions], most types of Isa allow you to withdraw your money before age 55, which can be important if you are self-employed.”
You can also switch Isa provider without losing your accrued status and they can be inherited by a spouse. A variable income means it is difficult to know how much you can put aside for long-term saving. But you can put large, one-off lump sums into an Isa, subject to the annual allowance, which is currently £20,000.
You can spread the £20,000 between different types of Isas, for example, paying into a cash Isa and a stocks-and-shares Isa each year.
But if you do not use your annual Isa allowance it cannot be carried forward to the next tax year. The ability to withdraw money from an Isa also means you may be tempted to draw it rather than save for retirement. There can also be charges for changing investments within your Isa or moving it to another company.
Lifetime Isas (Lisas) are designed to save for a first home or retirement, and work more like a pension. Individuals aged between 18 and 40 can open an account and save up to £4,000 each year into them until age 50. They also receive a 25 per cent bonus from the government on what they put in, so up to £1,000 a year. But you can only withdraw the money from a Lisa to buy a first home, otherwise you have to wait until age 60 to access it for free. If you withdraw it before that age, other than to buy a first home, there is a penalty of 25 per cent of the value of the amount withdrawn.
Another way to save for retirement if you are self-employed is a self-invested personal pension (Sipp). You choose the Sipp provider, and can choose when and how you invest in it. You choose what to invest the Sipp in, although it is possible to have them run by a financial adviser or wealth manager.
Different Sipp providers offer different investment options, and you can choose a full Sipp or low-cost Sipp. Generally, the more investment options you have, the higher the charges you pay for them. Full-service Sipps, for example, can be invested in shares, funds, investment trusts, exchange traded funds (ETFs) and commercial property. Low-cost Sipps tend to offer funds, and sometimes shares, ETFs and investment trusts.
You can choose how much and when to contribute to a Sipp via regular deposits or one-off payments. Government tax relief is given at your marginal rate of income tax on contributions of up to an annual limit of £40,000 or your taxable salary, whichever is lower. However, if you earn in excess of £150,000 a year, the amount you can invest in a pension each year with tax relief is tapered back. For every £2 of adjusted income over £150,000, an individual's annual pension contribution allowance is reduced by £1 to a maximum reduction of £30,000. This reduces the annual pensions allowance for anyone with adjusted income of £210,000 or above to £10,000.
A Sipp is also a good option if you have multiple existing pension pots and want to combine them into a single fund to manage yourself. “The government has promised to introduce the pensions dashboard to help people manage their pensions, but until this is in place everyone needs to keep track of their own pension pots,” says Jeannie Boyle, chartered financial planner at EQ Investors. “If you’ve had a few different jobs you might have a number of small pension funds. These can be combined into one fund to make managing the investments easier.”
And you can withdraw up to 25 per cent of the value of your pensions tax-free when you reach age 55.
But the minimum amount you have to invest in Sipps is different with each provider, another reason why you have to shop around to find the best one for you. You also pay two sets of fees: those for the Sipp wrapper itself, and those relating to the investments you hold within it, for example dealing charges and/or fund management charges. There may also be exit fees.
Mr Connolly says: “Annual charges, including both fund and wrapper costs should be less than 1 per cent a year.”
So it could be worth opting for a provider with capped charges.
Before opening a Sipp or a self-select Isa, also remember that managing your own investments can be time-consuming and tricky, especially if you are working long or irregular hours because you are self-employed.
Small and medium-sized business owners could consider setting up a workplace pension such as a group personal pension, a trust-based pension or a stakeholder pension. With these, you class yourself as an employee of your company, so are eligible to get contributions from your employer. This comes from the company’s profit before tax, reducing its tax load. The workplace pension provider could be an insurance company, an investment platform, a bank or a building society.
One of the biggest benefits of a stakeholder pension is that it must meet certain requirements set by the government. These include caps on investment charges, free money transfers and flexible contributions, which can be helpful if your income is variable. The minimum contribution for a stakeholder pension is also only £20.
Annual charges are capped at 1.5 per cent. But stakeholder pensions typically offer fewer investments choices than personal pensions such as Sipps.
If you used to work for an employer you might still be able to contribute to the pension you had with them, although you will no longer benefit from employer contributions. “If you have an existing workplace pension the first step should be to fully review this,” says Mr Connolly. “You have three main options: leave the pension as it is, add more money to it, or transfer the money to a different pension scheme. The right choice will depend on the terms and conditions of the pension and your personal circumstances.”
Most people enter self-employment around the age of 40 and have worked for an employer before, according to the Department for Work and Pensions’ report. And self-employed people have an average mean number of between seven and 10 jobs over a lifetime, meaning that they are likely to have joined at least one workplace pension.