This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice please consult us here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Being self-employed can offer greater flexibility and earning potential for many people. Yet it also presents unique challenges. Irregular income can make budgeting and long-term financial planning difficult. Another potential issue has been highlighted by the Institute for Fiscal Studies (IFS), warning that many self-employed people could be facing a pension shortfall of £250,000 or more. Below, our Burnley financial planners explore why this is the case and how business owners can protect their retirement goals. We hope this is useful to you and please contact us if you want to discuss your financial plan with an experienced financial planner in Padiham.
Why are self-employed people facing a pension shortfall?
The IFS has released evidence to suggest that nearly half of self-employed people who pay into a pension have kept their contributions flat for the last two years. Over the last nine years, about 20% of self-employed people said they had never raised their pension contributions in that time. By contrast, employees see their pension contributions rise with their salary (since contributions are taken as a percentage of a salary, which may go up each year or so). Employees now have to actively “opt out” of a workplace pension if they do not want to participate. The self-employed are not legally obliged to save into a pension. This makes it easier to forget about.
Another issue is that self-employed people do not have an employer who also puts money into their pension pot. In 2022-23, employers are required to contribute at least 3% of an employee’s salary (with the latter obliged to contribute a minimum of 5%). Self-employed people, however, typically need to open and manage their own pensions and are solely responsible for contributing to them. The national picture regarding contributions is different, however, depending on earnings. Self-employed people earning between £10,000 – £20,000 make similar contributions to pension accounts as those with a workplace scheme. However, self-employed people who are “middle earners” – e.g. those taking £45,000 per year in profits – contribute around 7% to their pension compared to 11% for employees.
How do I avoid a pension shortfall as a self-employed person?
One simple way to avoid insufficient retirement funds is for self-employed people to raise their own pension contributions. Another idea is to make them work harder for you (e.g. by reducing fees and picking a better investment strategy for your needs). To achieve a “moderate” lifestyle in retirement, the Pensions and Lifetime Savings Association estimates that a single person currently needs £23,300 per year (or £34,000 for a couple). To start getting an idea of how big your pension savings might need to be, try multiplying that figure by 30 (to cover a potential 30-year retirement). Then you will need to factor yearly inflation into your calculations to account for rising future prices. After that, you could subtract your expected yearly State Pension income (which you will build up via National Insurance contributions). You can start to see that you may need £100,000s saved in your pension to achieve a moderate retirement, depending on your goals, needs and circumstances.
Speaking with a financial adviser (e.g. ours in Padiham) can help you identify the correct “gap” between your current pension savings and where you want them to be. You can then devise a strategy together to make up the difference throughout your remaining career. This may involve raising your monthly contributions and possibly changing the asset allocation in your portfolio. For instance, if a self-employed person still has a long “investment horizon” ahead of them prior to retirement, then he might be able to take a more “aggressive” approach with his investments (assuming he is comfortable doing so). This is because there is more time for his portfolio to recover from market fluctuations in the short term.
Self-employed people generally have a wide range of personal (or “private”) pensions to choose from. These are usually set up as “defined contribution” pensions, where you build up a “pot” of money over time. Perhaps you already have pension pots set up – e.g. from past employers before you set up your own business. In which case, you could explore consolidating them with a financial adviser. This can help reduce needless costs, streamline pension organisation and generally make everything easier to manage as you move forwards.
It is worth noting that pension contributions cannot be treated as a tax-deductible expense by self-employed people. This is because they are not regarded by HMRC as a “business cost” and do not impact your profits. However, your contributions should receive income tax relief just like an employed person (although you need to indicate this on your tax return). One option could be to explore becoming a limited company. Here, the employer makes contributions to an employee’s pension and these can be treated as an expense when calculating corporation tax. However, changing the legal structure of your business is a big decision that can have knock-on effects on the rest of your financial plan. Speak with a financial adviser before taking any action.
Invitation
If you are interested in starting a conversation about your own financial plan or investments, then we’d love to hear from you. Please contact us to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Reach us via:
T: 01282 772938
E: info@elmfieldfp.co.uk
