WHY ARE THE SELF-EMPLOYED TURNING AWAY FROM PENSIONS?

15 December 2020

Many self-employed workers face a ticking timebomb with their retirement savings, warns Claire Trott, Head of Pensions Strategy at St. James's Place.

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.

The self-employed have largely been left to fend for themselves. This may seem reasonable. After all, they do have to take responsibility for things such as paying tax and National Insurance. But 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. 

In 1998, 48% of self-employed workers contributed to a private pension, but by 2018 this had fallen to just 16%.1 This drop has occurred despite self-employed numbers increasing by about a third over that period. 

With COVID-19 still stifling the economy, it seems reasonable to assume that the rate of savings has dwindled further as work has dried up.

Sacrificing pension contributions is not unusual for those just setting out on the self-employed journey and focused on building 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 reveals that over 60% of those who had been self-employed for more than seven years were saving into a pension in 1998/99; by 2018/19, it was just 23%. It appears that the length of time spent in self-employment is having less impact on the propensity to pay into a pension.

Trend spotting

So, why might this be happening? Self-employed workers may find tying up funds in pensions too risky in the current climate; but the IFS report shows that the decline in pensions savings has been mirrored by a fall in savings into other wrappers too, such as ISAs or shares.2

Pensions are something that we should all be considering, especially those who have fluctuating earnings, such as the self-employed. Yet, there is little that can be done to force the self-employed to save into their pension in the same way as auto-enrolment encourages contributions to workplace pensions.

Ideas have been floated in the past - such as increases in taxation or National Insurance - in order to build retirement funds for the self-employed, but both those options remove the freedom that attracts many to become self-employed in the first place.

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. 

If you don't have a consistent income each year, you will need to compensate for leaner years by making larger pension contributions in the years that you make good profits. This may not be feasible until the following year, once your 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.

Facing the consequences

It’s clear that the self-employed understand the benefit of having a pension at retirement; but they are also very aware of the consequences of not making contributions. The IFS reports that in 2006/7, 56% of self-employed workers expected to receive personal pension income, but by 2017/18 this proportion had dropped to 45%.3

Interestingly, this expectation is rising among employed workers, which can surely be put down to the high proportion who have been auto enrolled. 

It isn't clear, however, if self-employed people are fully aware of the benefits that making pension contributions can have on their income now. This is where financial advisers have a key role to play, working alongside an 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.

Awareness, advice and action are key to ensuring that the self-employed enjoy the retirement that their hard work deserves.

The value of an investment with St. James's Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.

1,2,3 Retirement saving of the self-employed, Institute for Fiscal Studies, October 2020