Self-employed pension plans explained

There are almost 4.3million self-employed people in the UK, meaning that more than one in eight adults works for themselves. But research from IPSE show that 14% of these are not saving anything for retirement. 

That means 600,000 people - equivalent to the entire population of Manchester - could be heading into their post-work life with nothing more than the state pension to support them. 

But setting up a pension needn’t be complicated and it’s one of the best ways to make sure that you’re financially comfortable enough to stop working when you choose. 

Read our guide to learn what kinds of pension are available, how much you should contribute and what to consider when choosing a provider. 

Why do I need a self employed pension plan?

Saving for retirement gives you the freedom to stop working in later life and still maintain your lifestyle. 

If you choose not to save privately, the state pension is all you will have to rely on. In the UK, the full state pension is currently just £203.85 a week. This works out at less than £10,000 a year, if you have at least 30 years of qualifying national insurance contributions. 

Typically, experts recommend that you need an income of at least two-thirds your salary to be comfortable when you retire. That means that anyone earning more than £15,000 a year is likely to need some personal savings on top of their state pension. If you’re planning to rent in your later years, you may need a higher amount.

The longer you leave it before you start saving – the higher percentage of your income you’ll need to set aside to hit your goals. Small savings while you’re young can make a huge difference later on thanks to cumulative interest. 

Those without savings may find they have to keep working far longer than expected. They may also need to adapt their lifestyle to reduce bills so that their pensions income stretches further.

People who are employed by another company are automatically enrolled, which means that their employers put them into a pension scheme and contribute money to it. Unfortunately, self-employed people don’t automatically start saving a pension and they don’t have an employer to add to their contributions.

That’s why it’s even more important to start saving early. There are tax benefits too, meaning you’ll get free money towards your pension in the form of tax relief.

How much should I save in a self employed pension plan?

There’s no hard and fast rule about how much you need to save into your pension. That’s because the income you need is dictated by things like how much you earn and where you live. 

The most sensible thing to do is draw up a budget and think carefully about what kind of income you will want. Typically, you’ll need less than your full salary, with lots of experts saying that two-thirds is usually enough. 

That means that if you earn the average UK salary of £38,600 (for full-time employees) you’d want a pension pot big enough to give you an annual income of around £25,750. If you qualify for the full state pension, then your private savings will need to be big enough to pay over £16,000 a year. If you retire at 68 and live to be 95 – that means you’ll need more than £432,000 set aside in total.

The Pensions and Lifetime Association’s Retirement Livings Standards look at the average amounts people need for later life: 

• Minimum retirement: Single - £10,900 a year; Couple - £16,700 A ‘minimum’ lifestyle covers all your needs, with some left over for fun and social occasions. You could holiday in the UK, eat out about once a month and do some affordable leisure activities about twice a week.

• Moderate retirement: Single - £20,800; Couple - £30,600 A ‘moderate’ lifestyle provides more financial security and more flexibility. You could have one foreign holiday a year and eat out a few times a month. You’d have the opportunity to do more of the things you want to do.

• Comfortable retirement: Single - £33,600; Couple - £49,700 A ‘comfortable’ lifestyle that allows you to be more spontaneous with your money. You could have a subscription to a streaming service, regular beauty treatments and two foreign holidays a year

What is the annual and lifetime allowance?

How much you can save into a pension tax free is determined by the annual allowance, lifetime allowance and your earnings.

The maximum you can put away is either your annual earnings or £40,000 a year (rising to £60,000 from April 6, 2023) – whichever is lower. 

If you run a limited company, only your salary is counted towards the limit, not anything you pay yourself in dividends. If you earn more than £200,000 a year, your allowance will be lower.

If you go over your annual allowance, you must pay the tax due. However, you can usually carry over any unused allowance from the previous three tax years.

If you go over the lifetime allowance you will also need to pay tax. The current allowance is £1,073,100 - but it's being scrapped from April 6, 2023 onwards. The rate of tax you pay depends on how the money is paid to you:

• 55% if you get it as a lump sum

• 25% if you get it any other way, for example pension payments or cash withdrawals

What is self employed pensions tax relief and how does it work?

One of the best things about saving into a pension is that you get tax-relief, which is essentially bonus money from HMRC. The tax relief is worked out at your income tax rate. 

For instance, if you’re a basic rate tax payer, you’ll get 25% extra added to anything you contribute. So, if you save £100 each month, the government will give you £25 of tax relief. Even better, your pension company should automatically add this to your pension for you.

If you’re a higher or additional rate tax payer, you get extra tax relief. However, you need to claim the extra 20% or 25% back through your self assessment tax form. An additional rate tax payer would get £45 extra for every £100 paid into a pension.

In Scotland, the tax rates are slightly different. You get an extra £1.58 for every £100 paid if you pay the Scottish Intermediate Rate of 21% and a further £26.58 if you pay the Scottish Higher Rate of 41%.

If you have a limited company, you can choose to make contributions from the company, rather than from your income. One benefit of this is that you’ll also save on corporation tax because the pension contributions are treated as a business expense.

Choosing the best pension for self employed people

It’s really important to pick the right pension provider for your needs. There are several important factors to consider including cost and fees, investment options and how easy the website is to use.

If you’re not an investment expert, you should look for a private pension that has a retirement fund or default that is specifically designed for later life saving. This means that your investment choices are in the hands of experts and you don’t need to regularly manage a portfolio.

Generally speaking, you have three types of pension available to you:

• Personal pensions – these are offered by most providers. They are defined contribution schemes, which means that your retirement fund is determined by how much you save, the added tax relief, your investment returns and the fees and charges

• Stakeholder pensions – a type of personal pension with charges capped at 1.5%. These usually allow varied contributions

• Self-invested personal pension (SIPP) – a type of personal pension where you select the investments yourself

• Lifetime ISAs – technically these are not pensions, but they are another way of saving for retirement. The government will give you a 25% bonus each year and you can save up to £4,000 a year. The money has to be used either to buy a first home or for retirement. If you’re not buying a house, you have to leave the money where it is until you are 60 or you lose 25% of what you withdraw.

Things to look out for when choosing a self employed person pension provider

• Fees and charges – these can vary substantially depending on the provider. Stakeholder pensions offer the lowest charges, but you typically have limited or no investment choice.

• Investment choice – plenty of providers will do the investments for you, by offering a specific retirement fund. Some platforms will give you a quiz to determine your risk appetite and invest your pension based on that. A SIPP will give you full control over your pension, allowing you to pick and choose your investments, but some have wider ranges available than others

• Investment performance – if you’re considering a retirement fund, look at how it has performed in the past. This is not a guarantee of future performance, but can be helpful in deciding between providers. 

• Company contributions – not all pension providers allow for company contributions, so check this first if you own a limited company.

NEST

NEST (the National Employment Savings Trust) is a pension scheme created by the government. It was targeted for businesses to help them enrol their employees, but you can also set up a self-employed pension through the service.

How to set up a private pension if you’re self-employed

Once you’ve chosen your provider, setting up is easy. You register as a self-employed person and simply start saving. 

The process varies slightly depending on provider, but typically you need to give your National Insurance number to get started. If you’ve got a limited company, you will also need to give its details to make company contributions. 

You’ll also need your bank account details or your business’ bank details to make contributions. Some providers let you set up a direct debit so you can pay the same amount each month. If you can’t do this, make sure you set a reminder to transfer money regularly.

How to manage a self-employed personal pension plan

Once you’ve set up your pension, you should make sure that you’re saving enough for retirement. It makes better financial sense to spread your contributions throughout the year, so that you spread the risk.

Use our pensions calculator to work out whether you’re on track to meet your goals. When possible, increase your contributions, particularly if your salary or business profits increase.

If you’ve opted for a SIPP, make sure you’re managing your investments properly and choosing wisely. Do lots of research and check to make sure your strategy is working for you. Consider seeking advice from an Independent Financial Adviser (IFA)

You should also check if you’re on track to get the full state pension, using the government forecast tool.