Do You Know How Much You Can Afford for your Self-Employed Pension?

Pension planning isn’t always top of most self-employed people’s priorities, but we can all benefit from making some extra provision for our later years.

Often, self-employed people will say that their business is their pension but that doesn’t always work out. Imagine if you invested in a Blockbuster franchise in the 1990s; you’ll be a bit stuck now. Add to the mix COVID and you can see how quickly your sound investment can actually disappear.

This means that a pension plan is a must for all self-employed people, but this begs the question – how much can you put into your pension?

In this article, we are looking at self-employed pensions and how to work out what contributions you can make.

  • What actually is a pension?
  • What types of pension are there?
  • A note about tax
  • Pension planning – don’t put it off

What actually is a pension?

The majority of pensions sold today are what are called ‘money purchase schemes’. This means that the individual makes contributions into a ‘pot’ and builds them up over their working life.

The pot can be increased by paying in regular small amounts, by making large payments occasionally, or a mixture of both (for instance at bonus or dividend time).

At retirement, the pot is used to buy an annuity. An annuity is a financial product that pays a regular income over a period of time (usually the life of the annuity owner) in exchange for a single one-off payment at the start.

Most pensions will allow a certain amount of the pot to be withdrawn at retirement as a lump sum.



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What types of pensions are there?

Although we use the general term ‘pension’ to cover these financial products, there are actually a wide variety of different types available today.


The state pension

The state pension is an entitlement based on how many years of National Insurance Contributions (NICs) you make.

To receive the full state pension (currently set at £185.15 per week) a person needs to have made full contributions for 35 years.

  • If you have fewer contributions on your record, then you will receive less in terms of pension.
  • If your income at retirement is low, then you may also be eligible for state pension credit.

You can check your state pension entitlement online.


Personal or private pension

A personal pension is provided by a private company, and works a little like a bank or savings account. The account can be set to take a regular amount out of your bank each month, or you can contribute annually once you know what your profit is for the year.

Typically, you will get a choice of different types of fund to invest in but little in the way of control other than that.

The charges and flexibility of a private pension vary widely and so it is very important to make sure you take qualified advice before you choose your provider.


Self-Invested Personal Pension (SIPP)

A Self-Invested Personal Pension Plan is a product designed for the more savvy investor. The money still goes into the pension pot but the pension plan holder chooses how and where it is invested.

There is a big health warning with this though – pension funds are invested by professional fund managers so you should only go for this if you think you can outperform them.


National Employment Savings Trust (Nest)

This is the government’s alternative to private providers of pension funds. The National Employment Savings Trust or NEST as it is commonly known, was originally set up as a way for employers to provide their staff with a simple pension solution.

However, it is not confined purely to employed people and if you work for yourself, you are eligible to contribute. Don’t confuse this with NICS though, it is an entirely different and separate thing.


Lifetime ISA (LISA)

We are adding this here as a way of showing that there are other options. A lifetime ISA isn’t a pension as such and as a result, it doesn’t benefit from the tax breaks that registered pension schemes get. That said, they are still very valuable when it comes to pension planning.

Your ISA allowance is separate from your pension allowance so it means that if you have the cash, you can make even more contributions.

A lifetime ISA can also be much more flexible in terms of contributions and just like a SIPP, you can retain micro-level control of your investments.

A note about tax

No discussion of pensions would be complete without talking about tax because a pension scheme is one of the most tax-efficient ways of saving money.

For self-employed people, the money paid into a pension plan comes out of your post-tax profits, so it has already been taxed.

The government tops this up by 25% which essentially puts you back to where you should have been, like this;

Pre-tax profit £125
Tax on profit at 20% £25
Net Wages £100
Contribution to pension plan £100
Government top-up at 25% £125


The other tax benefit of paying into a pension plan is that the funds aren’t subject to capital gains tax. This means that money invested in this way grows quicker, making it a very efficient form of saving.

So how much can you invest in a self-employed pension plan?

Everybody in the UK can invest up to 100% of their taxable income into a pension fund, up to an annual limit of £40,000 and still take advantage of the tax relief. You can pay in more than this, but the government won’t pay on anything extra that you put in.

If you are a high earner with income over £200,000, then your annual allowance will gradually decrease to £4,000; this is called the tapered annual allowance.

You can also carry forward up to three years of unused allowance into the current tax year to give your pot a boost.


Checking your finances

Good bookkeeping is at the heart of every business decision, because if this information is up to date and accurate, you’re more likely to make reliable decisions.

We say this because paying huge amounts of money into your pension might set you up for the future, but it could have severe consequences if you pay yourself more money out of the business than it can cope with!

Pension planning – don’t put it off

Retirement isn’t something we like to think about and when you are running a busy business you don’t often get time to consider the issue. But we’d urge you to make sure you take a little bit of time to sit down with a qualified pension advisor to understand what your options are.

Learn more about the time-saving advantages of using accounting software, and register for your free Pandle account.

Charlie Bilsborrow

A digital marketing executive specialising in graphic design, motion graphics and web development. When I'm not working hard making things look jazzy, I can usually be found making comics, playing games or stuck in a book.

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