Auto Enrolment does not always benefit the self-employed, it is time to take matters into your own hands.
Friday 29 July 2022 Author: Owen Foulkes
The introduction of Automatic Enrolment for pensions in 2012 was a significant shot in the arm for the UK pensions savings. However, if you are one of the near-5m self-employed people living and working in the UK the burden of saving for retirement can still be entirely down to you.
According to the Office for National Statistics, just 14% of self-employed people are saving into a pension. That means around six out of seven risk facing a serious income shortfall when they want to stop working unless they take action.
Changes to pensions over the last 15 years mean that they now allow you to take a more flexible approach to retirement at a low cost. Furthermore, there are various features that could be particularly appealing to the self-employed.
Reduce Your Tax Bill
The single biggest benefit of making pension contributions is the tax relief added on top of your contribution.
Tax relief at 20% is automatically added, while higher (40%) or additional (45%) rate taxpayers can claim up to an extra 20% or 25% through their tax return.
The accompanying table shows you how much saving £100 in a Self Invested Personal Pension (SIPP) will cost.
Reducing Your Corporation Tax Bill
As a small business owner, you could consider using your company profits to pay directly from your business into your pension.
Pension contributions are business expenses, so your company would get corporation tax relief of 19% on each contribution. If you chose to make a payment to your pension rather than take profits as dividends then you also save on income tax.
Note this option is not available if you are a sole trader, although you can still make personal pension contributions.
Don’t Miss Out
If you are new to pension saving, you can make up for lost time by using up your pension allowance from previous years. Everyone can pay up to £40,000 per annum into their pension (or up to your taxable earnings amount it lower). However, if you would like to pay more than this into your pension, Carry Forward allows you to use unused allowances from the last three tax years to boost your contributions.
Carry forward is particularly useful for anyone who has set up a pension but has not been able to use up their available allowance. This is often the case for people who may need to prioritise investing in their business in the short-term over saving for the future.
Carry forward is a flexibility which allows you to make up for lost time. Provided you were a member of a pension scheme at the time, you are allowed to use up to three years of unused annual allowances in the current tax year.
That means you could benefit from an annual allowance of up to £160,000 using carry forward, including tax relief.
Pensions Are Now Flexible
Many people will view pensions as an inflexible option, with the historical trend of using your pension to buy a guaranteed income for life via an annuity still seen as the norm by many.
However, pension savers can now choose how to spend their retirement funds from age 55 (or age 57 from 2028). There are three main options:
Drawdown: take up to 25% of your fund tax-free, with the rest taxed in the same way as income when you take it out. Your fund will stay invested and you will need to think about a range of things including how much risk you want to take and how much income you can safely withdraw.
Ad-hoc pension lumps sums: take individual chunks out of your pension with 25% of each chunk tax-free and the rest taxed in the same way as income.
Annuity: hand your pension pot to an insurer and receive a guaranteed income stream in return. These can be over a fixed-term or for life, and you can add things like pensions for your spouse and inflation protection (although this will lower your starting income).
For many people, a combination of these income routes will provide the right retirement solution.
And while pensions are primarily designed to provide an income in retirement, ultimately it is your money and you can use it how you want. By leaving your pension in Drawdown, you can still take the income you need each year, whilst allowing the majority of your pension savings invested to continue to generate growth. The best of both worlds.