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Pensions for self-employed

Why you can’t just rely on the state pension for your retirement

As a self-employed person, you may need another pension, aside from the state pension, to retire comfortably. You can take out a private pension, such as a personal pension or a stakeholder pension.

Before you choose a pension scheme, try to evaluate how much money you'll need each year of your retirement. Usually when people retire, they no longer have major outgoings such as a mortgage and so they'll probably need less to live on, although you must consider the possibility that you will be faced with other expenses as you get older.

You will need to consider the following:

  • The age at which you retire – in general, the earlier that someone retires, the lower the pension.
  • How much basic state pension you will receive
  • Your expected basic living expenses
  • Whether you are likely to have any dependent children
  • The lifestyle that you expect on retirement (eg where you live, your hobbies, travel plans)
  • Other assets you may have, such as savings and property.

It's important that you keep track of your pension. Throughout your working life your earnings will change and so you may want to adjust your level of contribution accordingly. Many people find that the nearer they get to retirement, the more they pay into their fund.

As a self-employed person, there are a few options of pension plans to choose from: a personal pension plan, a stakeholder pension scheme or a self-invested personal pension plan (SIPP).

A personal pension plan is an investment policy for retirement, designed to offer a lump sum and regular income during retirement. It is available to any UK resident who is under 75 years of age and can be bought from insurance companies, high street banks, investment firms and some retailers, such as supermarkets.

They are money-purchase arrangements, which means you make regular payments into a fund which is then invested on your behalf, however some schemes enable you to invest lump sums, which you may find useful if you have irregular earnings.

You will receive a yearly forecast from your pension service provider, which will tell you how much your fund is worth and how much you can expect to receive if you continue to contribute at your current level. The amount you'll receive at retirement will depend on how much money has been paid in and how well it was invested, as well as the age at which you retire. The companies that run these pensions will charge you for starting up and running your pension, which is usually deducted from your fund.

The member can retire at any age between 55 and 75. When they do retire, they can generally take up to 25% of the value of their fund as a tax-free lump sum. The remainder of the fund can be used to buy an annuity (a regular income for life) with an insurance company.

When choosing a personal pension plan, it's a good idea to shop around and consider the following:

  • Your current personal circumstances and future plans
  • The reputation of the pension provider
  • Past performance of the provider (although this is no guarantee of future success)
  • Penalties and charges that may be made if your circumstances change, such as if you fall ill or take a career break
  • How you pay into the scheme – do you pay a regular sum for a given number of years, or are you able to change this?
  • Whether you can control where the money is invested

A stakeholder pension scheme is a money-purchase arrangement designed to provide a lump sum and income during retirement. Like a personal pension plan, it is available to any UK resident under the age of 75 and can be bought from insurance companies, high street banks, investment firms and some retailers. These schemes are worth considering if you: are a moderate earner, have an irregular income, or wish to top up other pensions.

Stakeholder pensions are flexible and portable and have been designed to incorporate a set of minimum standards laid down by the government. These include:

  • A charging structure capped at 1.5% of the fund each year for the first 10 years and 1% a year thereafter
  • Flexible contributions, with no penalties charged on increasing, decreasing, stopping and re-starting contributions
  • No penalties on transferring the fund to another pension arrangement
  • A minimum contribution of £20, or sometimes even less

A self-invested personal pension plan (SIPP) follows the same basic rules regarding contributions, tax relief and eligibility. The difference is the investment freedom that a member has and the ability to borrow against the fund for further investments.

A conventional personal pension generally involves the plan-holder paying money to an insurance company for investment in an insurance policy. The choice of investments is limited to that offered by the plan provider. However, a SIPP allows the plan-holder much greater freedom in what to invest in and for the plan to hold these investments directly.  The plan-holder can have control over the investment strategy or can appoint a fund manager or stockbroker to manage the investments.

The SIPP itself is established under a trust where the trustee controls the investment under instruction from the member. It is possible for the plan-holder to be the trustee, however if this is the case, an approved administrator must be appointed to carry out investment transactions.

A SIPP can borrow money against the value of the fund for investments that the trustees consider will benefit the scheme, such as commercial properties.  It can borrow, at any time, up to 50% of the scheme's assets.

With SIPPs, you get tax relief on the money you pay in and you don't have to pay capital gains tax on any growth in your investment. You also get a tax-free lump sum when you cash in your pension.

Under new legislation, business owners are expected to automatically enrol and pay minimum contributions into a qualifying pension scheme such as the National Employment Savings Trust (NEST) for any worker aged 22 to 65 who earns more than £9,440 in a year (you can read more about some of the schemes in our guide to top workplace pension providers). Workers are automatically enrolled in such schemes and must opt out if they do not wish to participate.

They will also have to enrol and pay minimum contributions for any workers aged between 16 and 75 who earn from £5,564 to £9,440 in a year, if they ask to be enrolled.

The amount business owners need to contribute will start at a minimum of 1% of qualifying earnings (between £5,725 and £41,450), rising to a minimum of 3% by 2017.

The new duties are being introduced gradually over the next three years, starting with large employers and eventually affecting small businesses.

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