Self employed workers need to be pension self-starters

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Are you part of the growing army of self-employed people that now make up 15% of the UK’s workforce? If so, what sort of thought have you given your pension?

There’s something inherently attractive about being your own boss, but it comes with significant pressures and the hefty responsibility of winning new business and satisfying clients.

And in the effort to meet these short-term demands it’s often difficult to step back and take the time to plan for your long-term goals. Perhaps the most important of these goals is creating a secure financial future and putting in place some proper plans for retirement.

Retirement planning is particularly important if you’re self-employed because no-one else does it for you. You won’t have access to a workplace pension scheme and you won’t benefit from employers paying pension contributions on your behalf.  

Income tax relief on pensions 

But it’s not all bad news and if you’re self-employed you’ll still get income tax relief on your pension contributions. If you’re a basic rate taxpayer then HMRC will add £25 for every £100 you put into your pension. Your pension provider will collect this tax relief automatically and if you’re a higher rate taxpayer you can claim further income tax relief on your pension contributions through your self-assessment form.

You can claim benefit from income tax relief on total annual pension contributions up to a limit of £40,000 for the 2015/16 tax year. This maximum amount is called your Annual Allowance and it’s normally possible to carry forward unused allowance from the last three years once you have contributed the maximum amount in the current year.

If you’ve got an irregular income, this can be very useful as it means you can put more into your pension in the good years when your income is high. But you must have been a member of a pension scheme in the years for which you want to carry forward any unused allowance from.

Your Annual Allowance applies to a period of time – normally 12 months – called a pension input period. In the past, pension input periods haven’t been aligned with the tax year and their exact timing depended on when you set up your pension. But this is changing and HMRC is in the process of aligning pension input periods with the tax years to simplify things.   

Pensions to consider when planning for retirement 

There are three main types of pension schemes for self-employed workers to consider.  The first is a personal pension, which is a type of money purchase arrangement. In a money purchase arrangement all of the pension contributions made go into your own personal pension pot and in later life you then use this money to generate a retirement income.  

The second is stakeholder pension – which is again a money purchase arrangement - and it has to meet minimum standards set by the government. The minimum standards limit charges, ensure it’s possible to make small and flexible monthly contributions, enable charge-free transfers and make it obligatory for the scheme to have a default investment fund where your contributions will be invested if you don’t want to actively make a choice.

The third is a self-invested personal pension, which is a pension ‘wrapper’ that works much like a personal pension. The big difference is that there’s a lot more flexibility and choice in terms of what you can invest in. If you want to set up a SIPP and manage it on your own then you should be very comfortable with making your own investment decisions.  

Basic state pension

In addition to any personal pension savings you build up, you’ll also be entitled to the basic state pension. The basic state pension is changing to a flat rate system in April 2016 and this works in favour of self-employed people who weren’t eligible for any additional state pension under the old system.

The new flat rate state pension will provide a solid foundation for your retirement plans, but the weekly maximum payment of £155.65 (2016/17) is unlikely to afford you the lifestyle you’d like in later life. And that’s why it’s important to make retirement planning a priority, despite the short term pressures of being self-employed.