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Self-employed? You're 'stumbling into pensions nightmare'
In a dangerous trend, entrepreneurs and freelancers are failing to save for their retirement. We outline four tax-efficient tricks they can use to boost their pension
By Katie Morley
6:57AM GMT 01 Nov 2014
Britain is being hailed as the "self-employment capital" of Europe, giving people who work for themselves plenty to celebrate. But, for many, enterprise will come at a cost, with inadequate pensions and lower incomes later in life.
More than a million people will not be fit enough to work into old age and have little or no pension savings, according to Telegraph Money estimates.
In a worrying trend concerning retirement savings, two thirds of entrepreneurs are not saving for a pension at all – and instead plan to work until they drop, according to the Resolution Foundation think tank.
Their decision not to save comes despite 40pc of over-65s developing a long-standing illness that will limit their capacity to work, according to Age UK figures that suggest any decision to rely on future earned income is hugely risky.
Common health complaints that may restrict the ability to work include arthritis, back and neck pains, high blood pressure and heart conditions.
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Pension fears for rising number of self-employed
Britain's rising self-employment vs rest of Europe
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A record 4.5 million UK workers are now self-employed, with the number growing rapidly in the post-crisis years as major employers retrenched or froze recruitment. Recent figures from the Office for Budget Responsibility show that self-employed people are more likely to be low earners, with 35pc earning less than £10,000 a year, compared with 20pc in 2008.
The Government has introduced pension reforms, in the form of "auto-enrolment", which will get millions of people saving into pensions for the first time. But not the self-employed. In fact, they stand to lose out. Unlike employees of firms, who will be automatically placed into a pension into which their employer and the Government will contribute, self-employed people get nothing under the flagship reforms. Instead, the changes will sting those who employ staff, as they will have to fork out for employees' pension contributions on top of their wages and other business expenses.
Self-employed people who miss out on a lifetime of employer contributions forgo an average of £91,500 in company pension scheme contributions, according to research by Prudential, the pension firm.
The Pru's research also found that almost a third (29pc) expected to be entirely reliant on the basic state pension when they retired. But in a further blow, when it comes to the state pension, self-employed people have been able to claim only the basic state payout and have not been eligible for the additional state pension that millions of employees have enjoyed. That will remain the case for anyone retiring between now and April 6 2016.
However, after that date, the playing field will be levelled as the self-employed will be entitled to the new state pension, which is more generous. This will start at no less than £42.40 a week, as long as they have made at least 10 qualifying years' National Insurance contributions – up to no less than £148.40 a week for 35 qualifying years.
John Allan, the chairman of the Federation of Small Businesses, has expressed concern about the lack of retirement savings among freelancers and self-employed people.
He said: "More needs to be done to support them if things don't work out as planned. The Government needs to build on positive steps to include the self-employed in the new state pension by also looking at how other statutory benefits can be extended to these workers, such as maternity pay and sick pay. Ministers also need to give more encouragement to the self-employed to save for retirement, as currently they do not benefit from the new auto-enrolment system."
Malcolm McLean, a consultant at Barnett Waddingham, the pension firm, said: "Despite more people saving into pensions because of auto-enrolment, the number of self-employed people with a pension is falling. The number of men belonging to a personal pension fell from 37pc in 2005-06 to 25pc in 2009-10. In 2012-3 it fell even further to 22pc.
"This continuing downward trend in pension saving by the self-employed is a matter of great concern, more so as the numbers of people opting to work for themselves appear to be on the increase."
He added: "This decline could be slowed or even possibly reversed if the Government were to offer further tax incentives for self-employed workers to join the auto-enrolment programme or find some other way of making savings provision for their old age."
Men account for about 70pc of self-employed people in the UK. The most popular occupation among the self-employed is taxi driver or chauffeur – there are about 166,000, according to the Office for National Statistics. Meanwhile, about 167,000 work for themselves in construction trades, while 144,000 are carpenters and joiners.
In a trend towards "going freelance" in later life, about 43pc of self-employed workers are now aged 50 or over. And the employment rate for 55 to 64-year-olds is around 60pc, compared with 70pc or more in some other countries.
Ros Altmann, the Government's adviser on older workers, said larger numbers of over-50s were turning to self-employment because they were being discriminated against by employers.
She warned that failing to make the most of the value of older people was a recipe for economic decline, and called for new attitudes to over-50s in the labour force.
Even if older self-employed people aren't paying into a pension plan, the extra years' earnings could make a big difference to their standard of living in later life. An average earner who retires 10 years early could see their pension pot shrink by up to a third and spread over a much longer period, figures from the Department for Work & Pensions (DWP) show.
The DWP also estimates that 12 million adults below state pension age are heading for an inadequate retirement income.
Are you an entrepreneur without a pension? Here are four tax-smart ways for you to get started building one
Use forgotten tax relief to start your pension
Because you're self-employed you will automatically receive 20pc tax relief at source on your contributions, even if you're a higher-rate taxpayer. Annoyingly, it's up to you to reclaim higher-rate tax relief via a self-assessment return.
If you weren't aware of this and haven't been claiming, don't worry, as you can reclaim tax relief from the previous three tax years. If you get a rebate you could use it to start, or top up, your pension fund.
Buy your business premises through your pension
There's nothing to stop your pension investing in the premises from which your business operates. So a vet, for example, could arrange for his self-invested personal pension (Sipp) to buy his surgery. It is relatively complicated to set up and normally requires the help of a financial adviser. However, it could save you thousands in unnecessary tax bills.
You need to have enough money in your Sipp to buy the property, but you can borrow up to 50pc of its net value to help cover the cost. And if you have any other pension schemes, you can consolidate them with it to increase its value.
Once your Sipp has bought the property, it becomes your landlord. This means you must pay it market-value rent.
In doing this you will avoid corporation tax or income tax, at the same time as making significant pension contributions. You will also avoid capital gains tax when you come to sell the property.
You do need to be careful to pay the correct amount every month, though (setting up a direct debit is advisable), as underpaying could leave you with a hefty 55pc tax on unpaid rent.
Carry forward unused annual allowance
Pension contributions might be low on the list of priorities when you set up a business, but leaving it too long before contributing may make it difficult to catch up in the future. The cap on how much you can contribute into a pension each year is £40,000, but you can carry forward any unused annual allowance from the previous three years, provided that you were a member of a pension scheme during that time. This doesn't have to be the same scheme to which the contribution is made. For example, an old paid-up company pension scheme from before you became self-employed would be sufficient. However, there must be sufficient profits in the tax year to cover the increased contribution.
Employ your spouse and boost his or her pension
If your spouse works for the company you can make pension contributions worth up to 100pc of his or her salary every year. Doing this will boost your joint income in retirement as you can take income from two pots. If they are a basic-rate taxpayer they will get 20pc tax relief on the money you contribute, and if they are a higher-rate taxpayer they will receive 40pc tax relief.
However, if you are thinking of paying your spouse to do a full-time job and then letting them get away with only posting a few letters, you should think twice.
HMRC runs spot checks to see if people are actually doing the jobs they are paid to do within small businesses, and they will prosecute if they find that they are on the payroll purely for tax‑dodging reasons.
Are you self-employed and have you found a smart way to build your pension? Send your story to katie.morley@telegraph.co.uk
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