As a freelancer or contractor, financial matters like taxes and pensions work differently for you than individuals employed by a company. It can all seem complicated, as a lot of these things have to be done independently by yourself, whereas most workers would have their taxes and pensions handled by their employer. However, it’s incredibly vital that you get your finances in order, so you don’t run into trouble down the line.
Your pension might not be your top priority right now, especially if you’re just starting out in the freelancing or contracting world. Or maybe you’ve got many, many decades before you even need to start to think about settling down and retiring, and you’re still trying to save up for more immediate things like a house or a car.
But, with 15 million people in the UK currently without any pension savings whatsoever, it’s paramount to start thinking about saving for your retirement as soon as possible, so you have plenty of funds to see you comfortably through your retirement years.
If you haven’t put even a penny aside for your retirement yet, don’t worry. There’s always time. Here’s Gorilla Accounting’s guide for contractors and freelancers for how to get started on saving for retirement.
Start Building a Pension ASAP
First things first; the sooner you start, the better. Don’t worry too much about the fact that you haven’t started yet, or the fact that the longer you put it off, the less you will be able to save. Just put aside some time to get online and get it all sorted as soon as you can.
Of the self-employed people in the UK, a staggering three-quarters have no pension, and 67% claim to be seriously concerned about saving for later life. This puts them at a serious disadvantage, as they don’t have an employer adding into a pension each month like those in permanent employment.
Currently, there is a lot of confusion amongst the general public as to how pensions work, and not just with those who are self-employed. Reports suggest that four in ten people aged 35-44 have no idea how much their company was paying into their pension pot, and around a third said they had not given any thought to how they would manage financially in their retirement. That’s why it’s so important to get a good grasp on your pension and start saving, so you don’t have to worry in the future.
The earlier you start saving, the better, as it’ll give you more time to contribute to your savings, allow you to benefit from tax relief and allow the savings to grow. There is no limit to how much you can save in your pension. However, there is a limit on the amount that will get tax relief. More on that later.
The Difference Between Personal vs State Pension
The state pension is a basic pension that the Government will pay out to its citizens when they reach a certain age (which is subject to change as life expectancy grows). In 2019/20, the full level of the state pension is £168.60 a week (£8,767.20 per annum) – following the changes to the state pension in 2016. A state pension is also only available to those who have a record of ten years of national insurance contributions.
Most people agree that this amount is not enough to live off alone. Estimates would put a comfortable amount of income to be able to cover essential expenditure at around £17,000 per year. Whereas if you want to factor in luxuries such as eating out and going on holiday, you’re looking at an amount closer to £25,000 per year.
If the Government state pension amount of £168.60 per week doesn’t sound like it will be enough to live on comfortably, you can subsidise your pension with a personal pension that you can make contributions to.
Employers will offer these kinds of pensions to their employees as workplace pensions, but for a contractor or freelancer, a pension is something you will have to arrange yourself. This is the case at least, currently, although the Government could offer an automatic enrolment for self-employed people in the future.
You can choose how to make contributions to your pension. You can make regular payments at various intervals, such as every month, or you can do occasional lump sums. Most personal pensions will not be available to use until you reach a certain age, normally after 55 years old. You can take up to 25% of the money in your pension as a tax-free sum, then you have six months to start taking the remaining 75%, which you will usually pay tax on.
Most self-employed people use a personal pension for their pension savings. You can choose where you want your contributions to be invested in from a range of funds offered by your provider. They will claim tax relief at the basic rate on your behalf to add to your pension savings. The types of personal pensions available are:
- Personal pensions
- Stakeholder pensions
- Self-invested personal pensions
Pension providers are often insurance companies, but there are also a number of independent providers to choose from.
Company Pension Contributions
Those with a limited company may choose to pay pension contributions from their company. This can bring significant tax advantages, as pension contributions can be treated as an allowance on expenses and offset against the company’s corporation tax bill.
By contributing to your pension through your limited company, more of your funds are exempt from having to pay national insurance contributions. So, making payments through your company is typically more tax-efficient than making them from your own funds.
Depending on your circumstances and business, this could be more financially beneficial than paying personal pension contributions.
Choose Your Provider
There are many different pension providers, and it’s important you choose one that works well for freelancers and contractors, due to the unique circumstances of their employment. Their services need to be flexible enough to reflect the chance that you will not always be a freelancer, and with the ability to stop/start/cease contributions on a month by month basis.
There is no one-size-fits-all solution to pensions; you will need to pick the one that works for you based on your age, savings, earnings and what each provider can offer you. Don’t worry, you can always transfer your pension at a later date if you find a scheme you prefer, but you may have to pay a fee to do this.
As an example of a pension provider, self-employed people can sometimes use NEST (National Employment Savings Trust) which is the workplace pension scheme created by the Government for automatic enrolment. Although designed for employed people, they allow some self-employed individuals to save with them provided they meet certain criteria, such as whether they are the right age, work in the UK and are only subject to the social and labour laws of the UK.
NEST has no shareholders or owners; it is run for the benefit of its members. It offers a low-cost pension scheme that is simple to use, but the investment choices are restricted with few retirement options.
Consolidate Pensions from Previous Employment
You may already have some pension contributions from previous employment if you were automatically enrolled, or possibly multiple pensions if you had a variety of jobs. In order to get a better grasp of your pension, you could consolidate any pension contributions you’ve made, no matter how small, all together into one pot.
This is done by transferring your pensions into a single pension scheme, either into a new or an existing scheme. Some providers may charge for this service, so it’s important to look up costs and charges that you might come across. By being able to see all your pension contributions in one place, it will be easier for you to work out how much you have, and how much you need to save to get to the amount you think will be sufficient for your retirement.
How Much Should You Be Putting in?
You can put away as little or as much as you like for your pension. However, as a general rule of thumb to ensure that you have a comfortable retirement, it’s recommended that you put away 15% of your salary, but any amount is better than none.
That may seem like a lot; it may even seem impossible for you to do. But there are some steps you can take to ensure you can meet this amount. For example, you could consider re-evaluating your rates as a freelancer or contractor. You could be undercharging for your skills; your price should reflect your skill level, how in-demand the skill is, the equivalent benefits that you would get as an employee and, of course, your pension contributions.
Calculate how much you would like to bank for your retirement years and figure out whether your current rates reflect this goal.
Typically, when trying to decide how much to save each month, you should look at certain factors. For example, if you’re young, you’ve got many years to save and can afford to pay in a lower percentage, but if you start saving later in life, you will need to save much more to get to a good level of retirement income. If you start at age 50, you may want to consider saving 25% of your salary, rather than 15%.
Aside from a pension, there are other ways to invest in your future. These can include ISAs, stock, investment business opportunities and purchasing property. These are higher risk than setting up a typical pension scheme but could end up being more lucrative down the line.
Government Tax Relief
The Government will pay tax relief up to a certain amount on your private pension contributions, worth up to 100% of your annual earnings. So, some of the money you would have paid in taxes on your earnings goes into your pension pot instead. It is paid at the highest rate of income tax:
- Basic-rate taxpayers get 20% tax relief
- Higher-rate taxpayers can claim 40% tax relief
- Additional-rate taxpayers can claim 45% tax relief
The Government does put a limit on the amount of pension contributions which can earn tax relief, known as the pensions annual allowance.
For the year 2019/20, this has been set at £40,000.
Any pension payments made over the £40,000 limit will be subject to income tax at the highest rate you are eligible to pay. So, you can save 100% of your income into a pension to earn tax relief, provided it doesn’t exceed £40,000 in a year.
Managing Your Pension
As a freelancer or contractor, your income is likely to fluctuate frequently. So, a good strategy for your pension is to start small and make regular, manageable contributions into a pension by direct debit.
People are living longer than ever, so ensuring you have a good pension tucked away is more important than it’s ever been, as you’ll likely need it for at least a couple of decades. You’ll also need a decent enough pension pot to be able to enjoy retirement, which will be difficult if you only start planning a few years before you stop working.
If you’re uncertain about your pension plans and how to get started, you can get help from a financial advisor who can recommend a pension plan based on your specific circumstances.
We hope you’ve found this article helpful and that it inspires you to get started on that all-important pension today. At Gorilla Accounting, we are technology-driven contractor accountants who specialise in services for the freelancer and contractor industry. We can offer you the complete package for all your accountancy needs, including 24/7 access to our bookkeeping tool and your very own dedicated accountant.
Whether you’re a sole trader or own a limited company, our specialist accountants can help you to get your finances in order, so you don’t come up short. We work with a wide variety of industries including business, law, finance, creative sectors, and much more.
Contact us today to see how we can help you and your business, or take a look at our contractor tax calculator so you can calculate your take home pay.