I’ve been doing some research recently to look into some of the stats about how many freelancers and self employed entrepreneurs are not investing in pensions, and I’ve come across a number of videos and found some really incorrect information on YouTube about pensions. So I am here today to bust some of those myths about pensions when you are self employed.
I am a pension transfer specialist, so as well as being a qualified financial planner, this is my area of expertise, so I feel like I am privileged to understand a lot about pensions. But I also understand that it could be very complicated, particularly when you’re self employed, and particularly when you don’t have access to employer schemes. So I’m here today to give you some of the basics about how to get started with pensions when you are self employed.
Your Future Self
Let me just first of all say why it is so important that we don’t ignore pensions. Actually, what I want you to do, first of all, is just completely ignore the fact that I’m talking about pensions. Because if I said to you, ‘Right, who wants to understand how they could make and and grow money for their future self?’ More people would be interested in that. But as soon as you start putting the word pensions in there, people freak out. And it’s just semantics. The way the pensions work in simple terms is a little bit like a cup of tea.
If you are wanting to invest for your future, you cannot invest in cash because in cash it’s just going to get eroded by inflation. The cost of living is going up every year. You think about how much a Mars bar cost you back in 1970 compared to what it costs now 50 years later. So if you’re starting this journey in your twenties and you’re thinking about your financial future in your sixties and seventies, we’ve got to be thinking about not just sticking to cash.
And it’s a really common challenge for women, particularly women. There’s more women sticking to cash than there are men. So this is one of the reasons why I want to share this with you, because I want to get more of you thinking about investing.
Time for a Cuppa?
In terms of pensions, if you imagine that inside your cup right now, you’ve got a tea bag, and inside this teabag, you’ve got lots of herbs and all sorts of stuff. If you imagine that inside that tea bag, you’ve got Apple shares, Debenhams, John Lewis, Tesco’s, Waitrose, Shell, BP. Maybe some tobacco companies in there. There might be some pharmaceutical companies in there. They’re all inside that tea bag. It’s not the cup – the pension – this wrapper that sits around the tea bag that makes it bad.
A lot of people think pensions are bad. Someone told me recently that their pension lost money in the stock markets, so pensions are bad. It’s not the pension that’s bad. It’s what’s inside it that will make the difference between whether it’s good or whether it’s not good. So it’s how you actually select and put together the investments that sit inside the pension wrapper – inside this cup – that make the difference.
The reason that pensions are particularly great is because for every £80 you put into a pension, the government will give you £20, so it’s free money. They don’t give you £20 into a stocks and shares ISA if you put £80 into it. But in reality you could have exactly the same investment portfolio, one with a pension wrapper around it, one with an ISA wrapper around it, and the pension will always grow better because of the tax.
I didn’t call it tax relief because it’s not a relief. A relief is taking away. This is adding. If you imagine you had two of exactly the same portfolios invested in exactly the same way, the pension would always do better because of the tax add that we get from the government. If you’re a high rate taxpayer, you get even more, so for every £60 you put in your pension, the government give you £40. It’s 40% tax relief. So that’s one of the primary reasons why most people invest into pensions.
The second reason why pensions are really important is the inter generational wealth planning. Now one of the issues that many of us will face is the issues of inheritance tax. Inheritance tax legislation will continually change. But right now in the UK, if your estate is worth more than £650,000 if you’re in a relationship or married, or £325,000 if you’re single, anything over and above that is then chargeable to inheritance tax. Now there are some additional reliefs and things on top of that, but at a basic level that’s current legislation.
For most of us our properties are likely to be worth somewhere around that figure £325,000, so this could potentially cause some problems when you’re looking to pass on your wealth down the generations. Obviously, when you’re married, if something happens to one of you, your estate passes to your spouse and there’s no inheritance tax. But then when the second person dies and it then passes maybe to your children or family, then that’s when inheritance tax can become an issue.
You may not be in that position right now where it’s an issue, but think about how your estate’s going to grow. You might be buying bigger houses in the future. You’re building up your savings and your business, so this can become an issue. Anything that goes into a pension is ring fenced from inheritance tax. So this is your pension. Anything that goes into that is not subject to inheritance tax.
So for the wealthy, and I’m not talking about necessarily the super rich here, if you’re over that inheritance tax threshold, anything that sits in that pension doesn’t go into the inheritance tax pot, so from an inter generational wealth perspective it’s an opportunity for you to pass that wealth to your children or grandchildren, or whoever you want to pass that to, without inheritance tax. And inheritance could be massive: If your state was worth a £1,000,000 and £650,000 of that is not subject to inheritance tax, but let’s say £400,000 is, then 40% is the inheritance tax amount that your beneficiaries would potentially pay. That’s huge.
So inter-generation of wealth planning is another really good reason why pensions are fantastic.
I’m going to talk you through Pension Freedom, because a lot of people think, ‘it’s not worth it, it’s only gonna be worth £10k in the future.’ It is worth it. And I’m going to share with you exactly why at the end.
Now, when it comes to pensions for self employed, many of you may have pensions from previous employment, and I’ll talk a little bit in a moment as well about what to do with those.
But they’re are three main types of pensions.
- A personal pension. For some reason in the UK, we have like seven million different names for this personal pension! We call it a personal pension. It might be a stakeholder pension. It might be a defined contribution pension, and many others. but it’s actually pretty much the same. A defined contribution scheme is a personal pension.
- A stakeholder pension was just something that the government released back in the early 2000’s trying to encourage more people to save into a pension. And they just have set rules on stakeholder pensions that they can’t charge over a certain amount, that there has to be a minimum contribution of £20 per month. So if you have an old stakeholder pension, it’s just a personal pension.
- You’ve got personal pensions, otherwise commonly known as defined contribution schemes. The reason they’re called that is because they are defined by the contribution that is going into the pension. The opposite of defined contribution is a defined benefit pension. Another word for a defined benefit pension is a final salary pension. It’s the same thing. Why do we have so many names for the same thing? It’s crazy. So a defined benefit scheme is where the benefits that you get at retirement are defined by a number of factors. So many of you may be in current final salary schemes or have old final salary schemes. They’re defined by your years of service with the organisation and your salary.
Final salary schemes, or defined benefit schemes, are like gold dust. Think about it. They are guaranteeing you a set income at a set point in the future, based on your years service and your income! Schemes will have different rules, so some final salary schemes will base it on an average number of years, some in the final years, and many of you would have seen lots of changes with your final salary schemes. You’ve probably seen a whole ton of letters about changes over the years and probably have no idea what any of it means because no one really does unless you get into the finite detail of pension transfer work, which is the work that I get involved in a financial planner. But in reality, the reason why these schemes have changed is because organisations can’t afford to continue to guarantee this level of income to their employees because people are living longer.
Obviously, if Mr Smith is currently drawing £10k a year from his pension and he survives 40 years, that’s a pressure on that pension pot. If he only lives for two years, not quite so much.
There’s a lot of pressure on organisations, and they have to make sure there is a constant monitoring of how much is in these pots, and this is where we come across terms like whether schemes are underfunded or overfunded. Many schemes in the UK are underfunded because they can’t afford to carry on filling up this bucket for all these people that are going to take benefits from it in the future. So this is why schemes have had to change. They’ve had to think about, well how can we continue to keep this bucket as full as possible? Because people are living much longer, and so they’ve had to make changes to some of the rules.
But even despite all of those changes, they’re still fantastic pension schemes because they give you a guaranteed level of income. So those are some of the types of pension schemes. As a self employed freelancer or self employed entrepreneur, then it’s difficult to think about.
Where Do You Get Started with Pensions When You Are Self Employed
Essentially, you won’t be buying a final salary scheme because they’re backed by employers. You’ll be looking at a personal pension. One of the one of the common types of personal pensions is called a SIP, which is a self invested personal pension. It’s still a personal pension. Self invested just means that you have a bit more choice as to the types of investments that sits, going back to this cup analogy, inside that wrapper.
You’ve got more choice as to what you can invest in. Perhaps not initially at the start, but let’s say you get to really understand how to invest and you want to start investing in gold or property or something maybe a little bit more unique, then you could do that under a SIP because it allows you more choice.
Typically, self invested personal pensions are more expensive. So their annual charges are typically more expensive than a normal personal pension. Going back to this cup, you pay more for a Cath Kidston mug than you would for just a plain 99 pence mug from IKEA. So those are the types of schemes.
How Much Can You Contribute into Pensions When You Are Self Employed?
I’m not not talking final salary schemes here because that’s not going to be relevant if you’re self employed. But how much you can contribute is governed by what the rules state in terms of how much we can put in every year. So for every single person who is a UK resident and over 18, whether you are self employed or employed, or not working at all, even as a stay at home Mum, you are eligible to contribute into a pension. At the moment, what they call the annual allowance, so the maximum that you can put in every year, is £40,000.
So a bit like an ISA allowance of £20,000, you could put £40,000 every tax year into a pension. If you have sufficient money to make that level of contribution, and you want to pay even more into your pension, you could go back for the last three tax years and carry forward any unused contribution. There are a few rules around this, but you can carry forward three years of unused allowances. So for those who do think I’ve left it too late you can still go back and carry those forward.
At this point, I would just mention you may wish to seek financial advice or have some conversations with your accountant because they’ll be able to work out for you, depending on what kind of business you run, how to make that contribution in the most tax efficient way. So if you’re a limited company, for example, you may want to consider making an employer contribution rather than an employee contribution.
So that’s the annual allowances, but you don’t have to pay all this in a lump sum. You could make regular small contributions to a pension. Most pension providers will allow you to start with £20-£25 per month.
How Much Will I Get Back?
Let’s say you’ve been paying in regularly over 10, 20, 30, 40 years into that investment, and let’s say it’s worth £100,000. That’s actually fairly easy to achieve if you’re making that regular contribution over a long period of time, which is really what you’re doing when you’re making pension contributions. This is paying your future self.
Historically, before something called the Pension Freedom Act, the only option that you had was to exchange that £100,000 inside that pension for what they call a pension income or annuity. And the way that that works is you simply take this cup of tea, this pension, to a pension provider and you go to them and say, I’ve got this £100k, I’m a woman, I’m now 60, and I’m in great health. Or maybe not, maybe I’ve got some health challenges which actually means you get more pension.
On an annuity assumption, what they’ll do is they will take that pension pot and they’ll be like, okay, so how long do we think Catherine’s gonna live? She’s 60. She smokes like a chimney. She drinks like like a trooper. We think she’s gonna live for five years. Then they’ll do some quotes and they will come back to me. So right, Catherine, if you give us that £100k we’ll give you a fixed level of income until you die. That’s really the basics of an annuity.
Now, obviously, they will also take into account the average life of a woman of the age of 60 and they’ll compare my health to somebody else and they will come up with this estimate. And then I might tinkle along to the next annuity provider and ask them, ‘What would you pay me if I gave you this £100,000?’ And then they would give me an idea and I would basically go with the provider that would give me the highest level of income.
I would then receive that level of income fixed into my bank account either yearly, monthly, or six monthly until I die. And if I’m married at the time, I might want to buy a spouse’s pension. Therefore, my income would be lower because it’s not just going to continue for my life, it’s going to continue for my spouse’s life, so my income would be lower. And you’ll see this on your pension statements for any of you who have existing pensions.
One of the financial conduct authority rules is that your pension providers need to demonstrate and show you every year on your annual statement, how much your pension is worth and how much you would get in retirement. But here’s the thing: they’re making the assumption that you are going to purchase an annuity, which you may do. But you don’t have to purchase an annuity anymore. What the Pension Freedom Act basically does, as it says on the tin, is allows you more freedom to draw those benefits without having to necessarily be forced to buy an annuity.
So let’s say you’ve got £100,000, and you don’t want to buy an annuity. That could be because you are in poor health, for example, and you’re thinking, ‘Well, I don’t really wanna give someone £100k because I’m not in very good health and I think I’m only going to live a couple of years.’ Maybe you’ve got really bad family longevity. Maybe you’ve got some kind of hereditary illness or something in the family. Sounds awful to say, doesn’t it? But this could be a reason why you might not want to do that. It may be because you want to pass that bucket down to your children. If you buy an annuity, you can’t pass that down to children. So what Pension Freedom allows us to do now is to have that choice. So that choice now might be: I’m not going to buy the annuity, but I’m going to keep it invested.
So I’m not going to pull that tea bag – that income – out now, I’m going to leave it to brew. I’m going to leave it to sit there. But I do need a little bit of money from it now because I’m retiring. I’m going take 25% out, because that’s what you can take out tax free. I’m going to top up my cash, maybe go on a cruise. I might need to replace my car, or move house. Whatever you’re going to do with that. The other 75% that’s left in there, I’m just going to leave it in there, and I’m going to decide to draw down that income whenever I need it. That’s what they call income drawdown.
You make the decision when to draw down the income. Now, the risk with this approach at retirement is that that bucket that has remained invested in the stock market might continue to be subject to the volatility of the stock market, so there’s a risk there. There might also be some risk that the income that you then decide to take from that will run out. So there are risks associated with income drawdown. There’s a few other ones as well, but those are some of the basics.
It depends on you
So what you get from your pension in the future, it’s just like your bank account. What you get is dependent on what you pay in, how long you invested for, and where you invest it. And think about if you’re in your thirties right now, the markets are going up and down, which they do, because that’s what markets do. You want them to do that otherwise you wouldn’t make any money. It’s very cyclical. They run on cycles – what they call boom and bust cycles, or bear and bull markets you may have heard of. They go up, they go down, they go up, they go down. You can minimise how much they go up and down by the level of risk that you take and the types of investments that you choose, and that’s the key here. This is what you choose as a self employed freelancer or entrepreneur, you have complete choice. So the timeframe you have will have an impact on what is available to you in that bucket later. How much you pay in charges is another factor because each pension provider has their own charging structure.
Being Aware of Pensions Charges
I’m a huge believer in the impact that charges has on your pension can make a massive difference. Don’t underestimate the difference that even half a per cent on a charge could make on that pot. Half a percent on £100,000 is a lot of money. And so you do need to be mindful ofwhat charges are being charged on the pension that you choose.
There are lots of fantastic easy to set up pensions available right now and particularly with what they call these robo advice propositions, companies like PensionBee, for example, fantastic easy propositions. But they’re not the cheapest. So what that means is that the charges will have an impact on the growth of that fund. So charges is a really important factor, don’t underestimate that. The other thing that can also obviously impact on how much your pot is worth in the future is where it’s invested.
I have a workshop coming up in April called Get Investing. I’m going to be talking about how the stock market works, what is risk, where you could be investing. Not giving you specific financial advice, but giving you financial education so that you understand when you leave that workshop, what your choices are and you feel confident to be like ‘Now I know what I’m doing.’
We’re going to talk about how much you need to invest for the lifestyle that you want to continue because, let’s face it, I have no idea what income I’m going to need in retirement. I have no idea. But I do know I want to preserve my lifestyle that I have worked really hard to build right now. So that’s a great starting point to think about. What lifestyle do you have? What income do you need right now? You’re going to need that at least in retirement, if not more, because you’re going to have more free time.
The state pension is £168.60 per week right now. That’s nothing. That would probably pay my food bill and my petrol to go and spend all my time seeing my friends when I’m retired. So I certainly don’t want to be relying on the state pension.
If you are interesting coming to this investing workshop, because investing is the principle that you can then apply to pensions, ISA’s, or children’s investments, then you can find out more here.
A word on state pensions.
So I think this is really relevant. The rules around state pensions now is you need to have had 35 years worth of national insurance contributions to be eligible for a full state pension. Now most of you will be eligible because you maybe worked before you became self employed, and even if you’re self employed, you are likely to be making national insurance contributions through your tax. If you’re not sure, then go and speak with your accountant about that.
But one of the big concerns for women is that we do tend to have gaps in our employment because we may have had families, or we may be carers for parents, which may mean that we’ve had to maybe retire earlier. So one of the ways to check is to go into the Gov.uk website and you could do a state pension forecast. You can do it via paper, or you can just use your government gateway log in which I know is a little bit like getting through Fort Knox! But once you’ve got your log in with your government gateway ID, you can have a look at your financial forecast for your state pension, and if there are any gaps in there will tell you. You can then make an inquiry with the insurance office as to whether you want to make up some of those missed contributions.
In terms of pensions, how you can access your pension currently, and again this can change, is at the moment you can take your benefits from that pension at the age of 55. That’s the minimum age. There is no maximum age – that pot could just stay there. Maybe you may never need to access it because you’re busy building up other semi passive income streams in your business.
One thing to check on existing pensions is to make sure that pension has got a nominated beneficiary attached to it. This is again relevant for any of you who are employed or have previous pensions that were attached to when you were working for an organisation. Who your nominated beneficiary is who’s going to receive that pension if anything happens to you. The number of times I’ve spoken to people who maybe have older beneficiaries named, maybe exes or people they don’t necessarily want to receive their benefits, or have no beneficiary selected at all, and it makes it very difficult for the pension trustees to know where to pay it.
Action step: Go and check your beneficiary statements.
Make a phone call to HR if you’re working or if you’ve got a previous employed pension, grab one of your statements and make a phone call. Just ask that question. Who does my pension go to if anything happens to me? If you want to update or change your beneficiaries, that would normally be just a simple form.
Am I too Old to Get Started?
Maybe you’re sitting here and you’re in your fifties or you’re in your sixties already and you’re thinking ‘Should I get started now?’ Absolutely. 100%. You’ll get tax added in from the government, you can keep that money. You don’t have to buy an annuity anymore. It could be passed to your beneficiaries with no inheritance tax liability, and also from an income tax perspective – if you die before the age of 75 your beneficiaries receive that pot tax free.
So if you’re if you’re reading this in your fifties or sixties, thinking I haven’t done it and I want to get started, it isn’t too late. Take all the things that I’ve spoken about in terms of choosing a provider that doesn’t charge the Earth, in terms of investment charges, and choosing investment strategy that’s suitable for you at your age. The reason I say this is obviously, if you’re starting a pension in your fifties or sixties, then your risk appetite is going to be potentially less because you haven’t got as long to remain invested before you maybe need to start taking benefits from that pension. But don’t necessarily think that because you’re in your fifties or sixties it’s too late.
And another great financial planning option for people if you’re in your fifties and sixties and you’ve got grandchildren, then you could be paying into pensions for them too. You obviously need to make sure that you’re checking that you’re not exceeding your annual allowances, and the same if you’re self employed, you need to make sure that you’re not breaching any rules with how much you can contribute. But I would imagine for the majority of you reading this you just want to get started, right? Or maybe you’ve got some old pensions and you’re wondering what to do with those now.
For those of you that are in my Money Circle membership, I did a whole bundle of videos around pension consolidations. What to check, how to read your statements, what things to consider, when you shouldn’t be transferring, and what you could be considering. Again, not as financial advice, but just to give you some guidance around things you should be taking into account.
If you are interested in coming to the Money Circle membership to get access to that then you can do so here. Alternatively, you can go and seek financial advice from an independent financial planner like myself or anyone who may be local to you.
The government do have a pensions help line that you can speak to if you have any questions, or you could just speak to your existing provider of those pension schemes. Just give them a ring and ask them. They won’t be able to give you financial advice. But if you’ve got a specific question, then they will certainly be able to help you with that.
When you’re looking at pension consolidation or pension transfers there are some things to be mindful of and to watch, because some pension schemes that you may have will have penalties associated with transferring away. Some of them may have added benefits or guarantees attached to them but if you then transfer you lose those guarantees. Pension legislation has changed so significantly, so there are a few things to watch out for. Guarantees and penalties are two of the main things to think about, but again, a simple phone call to your provider might answer those questions for you. Or, if you’re in any doubt, then reach out to a professional, independent financial adviser and they will be able to do some research for you on your specific schemes.
The Truth About Pensions: How to Get Started with Pensions When You Are Self Employed
Don’t ignore pensions just because because they’re called pensions. Don’t necessarily think that they’re not for me, whatever age you are. It’s just like a big bank account that has a whole heap of benefits attached to it.
You have so much freedom and choice now as to how you can make contributions.
You can start contributions from as little as £20-£25 per month, some even lower than that. Don’t worry too much about going into a SIP or personal pension – it’s the same thing. It may be more expensive to invest into a SIP because it gives you more bells and whistles and options.
The benefit of pensions over ISA’s is that you get that tax tax relief, but I don’t like calling it that. It’s not a relief, it’s an add. So that’s a massive benefit of pensions over ISA’s.
One of the other differences is that with ISA’s you don’t have the restrictions on how you take your benefits because you can access stocks and shares ISA’s whenever you want. You could literally could invest tomorrow and draw the money out in 10 years time or in two days time if you really wanted to. But you wouldn’t invest for a short period of time. Any investments should be considered over a longer period of time, because you want to have that time to ride out the ups and downs that you can have in the stock market.
ISA’s will go into your estate for inheritance tax purposes.
You can have the same investment strategy with a pension as you can with stocks and shares ISA’s, but access is obviously going to be very different.
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