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Self-employed Pension: How Does it Work?

If you are self-employed you may find that saving a pension is more difficult than it is for those in employment. There’s no employer to decide which pension to pay into and there aren’t any contributions. What’s more, is irregular income patterns can make saving up quite difficult.

Self-employed Pension: How Does it Work?
Many self-employed people opt to have a personal pension plan. (© Pexels)

Preparing for your retirement is crucial, however, and this article can help.

What is the State Pension?

If you are self-employed you will automatically be entitled to the State Pension.

From 2016, a new flat-rate pension came into effect and it was based on your National Insurance record. At the time of writing (2019) the state pension was £168.60 per week.

If you were employed your entitlement to an additional pension would have been built up. However, if you were self-employed you are unlikely to get an additional pension. This means you may not have enough money to pay for the standard of living to which you have become accustomed. This means it’s vital that you ensure you plan ahead so you will have all of the income you’ll need.

Self-employed pension plans: which one is best?

Many self-employed people have a personal pension plan. With this type of pension, you can choose where your money is invested. The provider of the pension will have a range of funds to choose from. The provider of the pension will also claim a tax relief that’s at the basic rate. They will do this on your behalf and the tax relief will be added to your savings.

How much you end up receiving will ultimately depend on how much money you put in. It will also depend on the performance of your savings and the charges that you pay.

There are 3 types of pension plans, these are:

  • Personal pension, there are offered by many large pension providers
  • Stakeholder pensions where the maximum they can charge you is 1.5%. With these pensions, you can start and stop the premiums without being penalised
  • Self-invested personal pension – these have more investment options, but the charges seem to be higher.

If you do not know which type of pension scheme you should use, you may want to consult a financial adviser. They will help you make a decision based on your circumstances and your needs.

One of the benefits of having financial advice is you’re usually protected if the pension is unsuitable or the company goes bust.

Self-employed pensions: how much should I save?

This all depends on how much you can pay in. Many advisors think you can live on up to two-thirds of your income. However, the earlier you save, the better.

The sooner you have a pension the sooner you can start building your savings. You will have more tax relief and your pension pot can grow. If you were to start saving at the age of 30 there’s every chance that you can have 2 times more money than someone who started saving at the age of 50.

Self-employed pension tax relief

If you pay into a pension you could get self-employed pension tax relief of up to £40,000 each year. If you pay a lot of tax you could claim as much as £25 on every £100 that you pay in.

What is the annual allowance?

The annual allowance is the limit on contributions that can be paid into a specific scheme such as The People’s Pension. There is also a limit on the benefits that you build up, such as tax relief.

You can benefit from tax relief but in order to do so, you should not exceed the annual allowance. If you have taxable earning that is below the yearly allowance, there’s a chance you could receive 100% tax relief. This will be up to the allowance or £3,600.

The current allowance is £40,000. this includes tax relief, contributions and any employer contributions.

If you earn more than £150,000 in a year your annual allowance will reduce steadily. For every £2 above £150,000, your allowance will be reduced by £1. The maximum amount of money in the form of a reduction is £30,000. This means that someone who earns £210,000 will have £10,000 of annual allowance.

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