Why are the self-employed turning away from pensions?

Many self-employed workers face a ticking timebomb with their retirement savings. Of the pension saving incentives introduced in recent years, most have been focused on getting the young and low earners to contribute to pensions. What they have in common is that they are all targeting those who are in employment with the self-employed largely being ignored.

This may not seem unreasonable. After all, the self-employed have to take responsibility for things such as paying tax and National Insurance. However, according to the latest research by the Institute for Fiscal Studies (IFS), a further, worrying consequence of being left to their own devices is that pension savings for the self-employed are declining.

The IFS research says in 1998, 48% of self-employed workers contributed to a private pension. However, by 2018, this had fallen to just 16%. This drop is made worse by the fact that self-employed numbers increased by about a third over the same period.

Sacrificing pension contributions is not unusual for those just setting out on the self-employed journey and focused on building up their business. Yet, the longer they earn and the more they earn, the more likely they are to start and maintain contributions to a pension. That’s the theory at least.

The IFS report goes on to reveal that over 60% of those who had been self-employed for more than seven years were saving into a pension in 1998/99, that by 2018/19, it was just 23%. It appears the length of time spent in self-employment is having less impact on the propensity to pay into a pension.

Why is this happening?

The self-employed may find tying up funds in a pension is too risky in the current climate, but the IFS report shows the decline in overall pensions savings has been mirrored by a fall in savings into other areas too, such as ISA.

Pension and retirement planning is something we should all be considering, especially those with fluctuating income, such as the self-employed. However, there is little that can be done to force the self-employed to save into pension in the same way as auto-enrolment has encouraged contributions to workplace pensions for employees.

Government policy makers have floated some options/ideas in the past such as increases in taxation or National Insurance, in order to build retirement funds for the self-employed, but such options remove the freedom that attracts many to become self-employed in the first place. In addition, it seems the current annual allowance rules may also be an issue for the self-employed. In particular, the need to make regular ongoing pension contributions in order to utilise allowances before they are lost, as well as the limits on tax relief within the year in which the contribution is made, can create problems.

A degree of common sense needs to be applied here. If you do not have a consistent income each year, common sense says you will need to compensate for leaner years by making larger pension contributions in the years that the self-employed enjoy better years. This may not be feasible until the following year, once the accounts are finalised but by then, profits may have dropped, restricting what you can pay. This is one of the flaws in the current regime that caters better for those in employment with a more regular level of income.

It is clear the self-employed understand the benefit of having a pension at retirement, but they are also very aware of the consequences of not making sufficient pension contributions. The IFS reports that in the tax year 2006/7, 56% of self-employed workers expected to receive personal pension income, but by 2017/18 this had dropped to 45%. Interestingly, this expectation is rising among employed workers, which must be put down to the high proportion who have been auto enrolled into a workplace pension scheme.

However, it is not clear if the self-employed are fully aware of the benefits that making pension contributions can have on their income now. This is where financial advice is crucial and has a key role to play, working alongside other professionals such as the accountant. An accountant will process a tax return but is unlikely to get into the realms of tax advice, such as increasing or making contributions to claw back a lost personal allowance or to avoid the child benefit tax charge.

Being aware of how to operate in these complicated areas will be key to ensuring the self-employed enjoy the retirement that their hard work deserves.

For further information, speak to your Prosperis adviser on 01423 223640 or email us below.