How do self-employed pensions work?

Are you self-employed and concerned about your retirement? It’s time to take control of your financial future. This week is Pension Awareness Week in the UK; a week for highlighting the importance of pension and retirement planning. Throughout the week our team will outline why taking pension advice sooner rather than later is beneficial for everyone.

Today we are explaining why pension planning for the self-employed. This is an issue often neglected by the government. While those who are employed benefit from the mandatory provision of a scheme and mandatory employer contributions, those who are self-employed receive no protections.

State pension

In the current year (2023/24) the full state pension is £203.85 per week (£10,600 annually). To achieve this, you will need 35 qualifying years of contributions. If you have less than 35 years of contributions the amount will be reduced proportionately. If you have less than 10 years of contributions, you will not receive anything.

How do you get contributory years?

If you earn between £6,725 and £12,570 your record will be treated as if you had paid without any payment necessary.

Once you start earning over £12,570 per year you will become liable for Class 2 national insurance contributions. Class 2 contributions are £3.45 per week and paid through self-assessment.

Earnings between £12,570 and £50,270 are liable to Class 4 contributions at 9% and income exceeding £50,270 are liable to Class 4 at 2%.

If you are not likely to reach 35 full years of contributions, you may make Class 3 voluntary contributions. Class 3 contributions will increase your state pension entitlement.

You may have contributions from past employment, you can check your contribution record here.

Self-employed pension

£10,600 is not a lot of money and it is likely you will need more to maintain an acceptable standard of living. There are 5 options for providing your own pension income.

The following list is ordered by the level of direct control you have over your pension.

  1. Stakeholder pensions
    • Stakeholder products are designed to be simple and low-cost
  2. National Employment Savings Trust (NEST)
    • • This is typically the same as an ordinary personal pension but is run by the government.
  3. Ordinary personal pensions
    • • Your investment will be managed by the provider just as a workplace pension would be.
  4. Self-invested personal pensions (SIPP)
    • A SIPP allows you (or your advisor) to take control of your pension, allowing you to decide how, when and what you want to invest in.
    • You are still limited to investment products – predominantly stocks, bonds and commodities.
  5. Small self-administered scheme (SASS)
    • A SIPP allows you (or your advisor) to take control of your pension, allowing you to decide how, when and what you want to invest in.
    • You are still limited to investment products – predominantly stocks, bonds, commercial property and commodities.

You will receive tax relief on your contributions – up to 100% of your annual earnings or a maximum of £100,000 a year. 

Remember: Your business might be able to contribute to your pension if it is set up as a limited company. Click here for more details on who can invest in a pension

Taking your pension

  • • The historic choice was to choose an annuity, you pay a lump sum and in return, you will receive a guaranteed, regular payment as you would with a salary. Unlike invested funds, these payments remain unaffected by market fluctuations. They neither increase with market highs nor decrease with lows. Your payments will continue until and cease when you die, however long or short that may be. The annuity income will be taxed at your marginal rate.
  • Pension reform rules mean you can take a one-off lump sum equal to 25% of your pension’s value. The rest of the fund can be taken at will but will be taxed according to your marginal rate.
  • If you want to retain your investments, you can choose drawdown. You have the flexibility to withdraw income as desired, the first 25% of it being tax-exempt. Although, the remaining 75% is subject to your marginal tax rate. On death, your fund will be protected from inheritance tax and can be passed on.

Get expert help

In conclusion, different schemes have their own pros and cons. If you are not confident about what product is best for you, or the best way to implement them, consider financial advice. Professional advice will protect you if; if the product you buy turns out to be unsuitable, or in the event of the provider going bust.

A pension is a long-term investment not normally accessible until age 55 (57 from April 2028 unless the plan has a protected pension age). The value of your investments (and any income from them) can down as well as up which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.

The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change. You should seek advice to understand your options at retirement.

The information contained within this article is for guidance only and does not constitute advice which should be sought before taking any action or inaction.

The information is based on our understanding of legislation, whether proposed or in force, and market practice at the time of writing. Levels, bases and reliefs from taxation may be subject to change.

A financial adviser can search the market for you and make a recommendation that’s personal to you. For any other enquiries about your retirement, don’t hesitate to contact us on 01903 534587.