Archived article: Please note that tax, investment, pension and ISA rules can change and the information and any views contained in this article may now be inaccurate.
When you work for yourself, you don’t have the luxury of auto-enrolment and a HR department to sort a pension for you. Competing pressures on your time and the fact income can be lumpier than a regular salary can mean that saving looks different for you.
But pensions are not just for employees and the powerful tax perks they come with can turn even modest amounts each month into a substantial pot by the time you retire. Here’s how you can make the most of the freedom to choose your own pension.
Will I get a state pension?
What you’ll get from the state pension will be based on your record and the number of ‘qualifying years’ you have on your National Insurance record.
You’ll usually be making National Insurance contributions when you’re self-employed. This might be via your annual tax return, or by receiving credits when you claim support such as child benefits.
Although the full amount is unlikely to cover all your needs in retirement - and you might plan to stop working before you can claim the state pension – it can still form a foundation on which to build your own savings.
Pension tax benefits
Pensions offer the following tax perks:
- In a pension, your investments grow free of income tax or capital gains tax
- You can access the money you save in a pension from age 55 (rising to 57 in 2028). And when you do, you can take 25% of your pot tax free
- You (or your business) can get tax relief on the money you pay in. How tax relief works depends on your setup
Sole traders and partners
If you’re a sole trader, your pension contributions will come from your net profits (i.e. what you make after tax). You’ll automatically receive basic rate tax relief on what you pay in to a pension. It’s an automatic boost of 25% on your savings and it is claimed from the government by your pension provider. For example, if you pay in £80, the government adds £20, giving you a total of £100 in your pension pot.
If you’re a higher or additional rate taxpayer, you can claim back even more tax relief. This extra tax relief isn’t paid into your pension, but it reduces the cost of your pension contributions even further.
For higher rate taxpayers, this means getting that £100 into your pension pot could cost you as little as £60 from your post tax income. You’d still pay in £80 and get a £20 from the government but you’d also be able to claim an extra £20 directly from the tax man. The extra tax relief is not automatic – you’ll have to claim it, usually via your self-assessment tax return.
The same tax treatment and relief applies if you work in a partnership. Your contributions are treated as coming from your personally from your share of the business profits.
Limited company director
You can still pay in personally and get the tax relief benefits in the same way as a sole trader or partner. But there can be tax advantages to paying directly into your pension from your limited company as an ‘employer contribution’. Or you can do a combination of the two.
You won’t get the same upfront tax relief bonus from the government on an employer payment as a personal payment. But the value is treated as a business expense, meaning it can be deducted from your ‘bottom line’, reducing your profits for corporation tax.
Unlike salary payments, employer pension contributions aren't liable for employer's National Insurance of up to 15%. You also won’t be liable to income tax or National Insurance on the contribution as an employee.
Is there a limit to what I can pay into a pension?
How much you can pay into your pension depends on your earnings and the tax bracket you fall into. Each tax year, you can typically pay in up to 100 per cent of your earnings including any tax relief, up to £60,000. This limit, known as the ‘annual allowance’ applies to all contributions made to your pension – whether by you or by your company.
As self-employed income can, you might be able to make use of pension carry-forward. Carry forward lets you dip into unused allowances from up to three previous tax years, if you were a member of a pension scheme in the tax year you want to carry forward from.
If you want to use carry forward, you’ll need to make sure any personal contributions you make do not exceed your total earnings for the current year.
Your annual allowance will be low if you have income exceeding £260,000 a year or if you’ve already taken an income from your pension pot.
Learn more about paying into your pension
We’ve got two pension accounts to choose from at AJ Bell.
| Self-invested personal pension (SIPP) | Ready-made pension |
|---|---|
| This lets you control how much to put in and where to invest it – and you can get started with as little as £25 a month, and have access to our full range of investments. | This gives you all the tax benefits of pension investing, but without the hassle of managing your investments. There’s a simple choice of investments, managed by our in-house experts for a low ‘all-in’ annual charge. |
Read more about self-employed pensions
Lifetime ISAs
It’s not just about pensions – a Lifetime ISA can also be a good option for retirement saving if you’re under 40 when you first take one out. Some people like to open one alongside a pension.
A Lifetime ISA has an allowance of £4,000 each tax year, which counts towards your £20,000 overall ISA allowance. The government pays a bonus of 25% on what you pay in, meaning you could bank an extra £1,000 a year. If you open your first Lifetime ISA before age 40, you can then continue paying in until you turn 50.
If you’re a basic rate taxpayer, the 25% government bonus is worth the same as the tax relief you’d get on your pension contributions. But if you pay higher rates of income tax, pensions are more tax efficient, as long as you reclaim the extra tax relief back from HMRC directly.
Lifetime ISAs can be accessed free of any tax or penalties at age 60. Before then, a 25% government penalty charge will be taken from any money you take out. A pension can be accessed slightly earlier (age 57 from April 2028), but only up to a quarter will be tax-free. You will have to pay income tax on the rest.
Charlene Young: Senior Pensions and Savings Expert
Charlene Young is AJ Bell’s Senior Pensions and Savings Expert. She joined AJ Bell in 2014 from a wealth management firm where she worked with private clients and small businesses as a financial planner.
Charlene...
