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Are you getting what you need from a self-employed personal pension?

When you’re self-employed, it can be more difficult developing the best savings habit to grow your pension for the retirement you’ve been working hard for.

You don’t have the benefits of someone picking your pension plan for you, and you completely miss out on contributions from your employer. You don’t have the benefits of auto enrolment and, on top of that, you have to navigate irregular income patterns to ensure you’re saving enough for the future.

There are around 4.8 million self employed people in the UK, yet 45% between the ages of 35-55 have no private pension, according to the Money Advice Service.  

All you want is a comfortable income throughout your retirement, but you could be putting your future financial security at risk by not preparing for the future.

Why you need a pension

Having a private pension is crucial if you want to achieve the retirement lifestyle you’ve been looking forward to. Instead of letting inflation eat into the long-term value of your savings, you can make your money work harder for you on the financial markets.

The longer your time horizon, the more risk you can take with your money, which increases your scope for returns.

You can decide to save into a personal pension through a traditional pension provider or join the government-backed Nest scheme, which is designed around auto-enrolment. Although it’s been introduced for the workplace, it’s available for individuals too.

If you want to invest in a broader range of assets to benefit from diversification, have more control of cost, or even greater visibility, you can put your money in a self-invested personal pension (SIPP).

If you’re an employee of your own company, you may be able to make employer contributions into your personal pension. Since pension contributions count as an allowable expense, you can deduct them when you’re calculating your business’ taxable profits. You don’t pay National Insurance on pension contributions either, so you could take a chunk off your tax bill by paying into your pension.

How much you need for retirement

It’s generally thought that you need two thirds of your final salary to maintain your standard of living in retirement. After all, you’ll probably have paid off your mortgage by then, your children will be independent and you won’t have to fork out for commuting.

If you want to comfortably afford the essentials and a few luxuries along the way – like eating out and affording a European getaway every six months – you’ll need around £26,000 a year, research from consumer research group Which? Shows.

An annual income of £26,000 gross translates into a pension pot worth a minimum of £520,000, assuming you have no state pension income.

It’s reasonable to expect that you can earn an annualised return of 5% from a balanced and diversified portfolio over the long term. Assuming this is your return, you can then withdraw 5% from your pension each year and theoretically you’ll ever deplete the nominal value of your pension.

If you’re after a bit more of the high life when you reach retirement, you’re probably going to need around £37,500 a year. Remember, your priorities will change as you get older, and the jet-setting lifestyle will probably switch for better life insurance.

You’ll need a pension pot worth at least £750,000 when you retire to withdraw 5% for an annual income of £37,500. If you’re more on the conservative side and reckon you can earn 4% a year, you’ll need a pension pot worth at least £937,500.

Self-employment and the state pension

Once you hit state pension age, you’ll be eligible to get income from the government to see you through retirement – as long as you’ve contributed to national insurance (NI) for 35 years. A new flat rate state pension was introduced in April 2016, which is based entirely on your national insurance record. You’ll probably get a proportion of your state pension if you’ve between 10-35 qualifying years of NI contributions. 

If you reached the pension age after 5 April 2016, you’ll get £164.35 a week from the new state pension. This adds up to around £8,500 a year, which probably won’t be enough to help you enjoy the retirement you deserve. The new state pension increases each year by either UK wage growth, inflation, or 2.5%, whichever is higher. This is known as the state pension triple lock. 

If you’ve ever worked for somebody else in the past, you might have built-up some entitlement to the additional state pension under the old system. You can check on the government’s website.

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If you’re self employed, you can’t rely on auto-enrollment or a workplace pension to help you save enough, either. Instead, you should look to supplement your state pension with income from a personal pension.

Pension tax relief

Personal pensions have generous tax benefits attached to take advantage of as you save for your future, as you build up your savings, and as you draw from your pension savings in retirement.

To encourage you to save for your future, the government offers tax relief on your pension contributions relative to your income tax band, which can boost your pension savings by 25%.  

If you’re a basic rate taxpayer, you’ll get 20% tax relief on your savings, whilst those in the higher tax band get 40% relief and additional rate taxpayers get 45% relief.

Essentially, this means a basic rate taxpayer only has to pay £8,000 into their pension to make an overall contribution of £10,000. Over the long-term, this can make a real impact to the size of your pension pot.

When you come to draw from your pension savings, you can take 25% of it tax-free from the age of 55. The rest of your pension income will be subject to income tax. Remember, whilst you may qualify for higher tax relief (40%) when you’re building up your savings, you’re likely to fall back to the basic band during retirement (20%).

How to invest your pension

SIPPs can be expensive and hard work to manage yourself, especially if you’re managing your investments yourself. For busy people juggling their careers with family life and other money management, it’s sometimes more reassuring to let the experts do it for you.

Digital wealth managers like Moneyfarm are shaking up the traditional industry. Gone are the days where you have to accept the expensive fees attached to SIPPs that eat into your long-term return, reducing the money you have for your retirement.

At Moneyfarm, we match you to a pension portfolio based on your investor profile, attitude to risk and time horizon, all for a low-cost.

Quick fire questions

How much should I be saving each month?

The simple answer is as much as you can. A couple in their 30s who want to have an annual income of £26,000 during retirement will need to put away £198 a month, or £424 a month for an annual income of £39,000. Find out more about how much you need to save into your pension with our pension calculator.

Can I access my pension savings at any time?

No, once you’ve put your money in your pension you can’t access it until you get to the age of 55, although you don’t have to draw from your pension until later.

What is my annual allowance as a self-employed person?

As a self employed person you have the same allowances as an employed person. There’s a cap on how much you can contribute to your pension to receive tax relief each year. In the 2018/19 tax year, this limit is £40,000 or your annual salary – whichever is lower. The government applies a tax charge, called the annual allowance tax charge, if the total contributions to your pension savings for a given tax year exceed your annual allowance.

Can I transfer my other pension savings to my Moneyfarm Pension?

You can transfer money from your other pensions into your Moneyfarm Pension, including from SIPPs and workplace pension schemes, so long as you haven’t started to take income from them. You won’t be able to transfer defined benefit schemes, also known as final salary schemes.

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