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. Because before you know it, you blink, and you’re 82.

Dramatics aside, many self-employed people 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.

Now this isn’t to scare you at all. It’s more of a non-threatening reminder that retirement planning 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 without affecting your cash flow in the here and now.

What actually is a pension?

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

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

How do you take money back out of your pension?

One option at retirement is to buy an annuity. An annuity is a financial agreement which converts a lump sum from your pension pot into a regular income over a period of time (usually for the rest of your life).

Alternatively, many people choose to keep their pension invested and withdraw money gradually, known as pension drawdown.

Most pensions will also allow you to withdraw a portion of the pot as a tax-free lump sum at retirement.

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. Have a read through and see which one is more suited to you. We know learning about financial products can be both boring and stressful, but it is very useful.

The state pension

Unless you’ve lived your life in a deep dark cave, you’ve likely heard of the State Pension. It’s an entitlement based on how many years of National Insurance Contributions (NICs) you make. You’ll need to have made contributions for 35 full years to receive the full state pension.

You can check your state pension entitlement online through your tax account, or through the HMRC app.

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. So basically, we expect you to be the Usain Bolt of the pension world – no pressure.

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.

The good news is it’s not confined purely to employed people so, if you work for yourself, you’re still eligible to contribute. Don’t confuse this with NICs (National Insurance Contributions) though. They might go towards your State Pension, but they’re an entirely different and separate thing.

Lifetime ISA (LISA)

If you’re scratching your head thinking ‘this isn’t a pension’, you would be correct. But we’re adding this in as a way of showing you that there are other options too.

Whilst a lifetime ISA isn’t a pension, meaning it doesn’t benefit from the tax breaks that registered pension schemes get, it’s 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. It’s why the government tops up your contributions – essentially putting you back to where you should have been, like this:

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.

Pensions can be even more efficient if you’re a company director because you can make employee contributions from the salary your company pays you, and your company can make contributions as your employer (and then claim tax relief for doing so).

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 £60,000, 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 – it’s your call.

If you are a high earner with income over £260,000, then your annual allowance might gradually decrease to £10,000 – 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.

Pension rules and allowances can change, so it’s always worth checking the latest limits or taking professional advice.

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 most of us like to think about, especially when most of feel like we need an adult despite (allegedly) being one. And if you’re running a busy business, it’s easy for your pension – or even understanding what one is – to fall to the bottom of the list.

That’s why it’s worth taking a little time to meet with a qualified pension advisor. They can help you understand your options and make sure your future is on the right track.

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