How to solve the self-employed savings crisis

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Self-employment used to be the preserve of those in certain industries but now people in all walks of life, from childcare to technology, are working for themselves. A recent report by the Federation of Small Businesses found 4.6 million people – around 15 per cent of the workforce – are now self-employed.

But these people are not covered by automatic enrolment and many are not saving adequately for their retirement – if at all. Indeed, less than a third of those surveyed by the Federation of Small Businesses said they were saving into a private pension, while 15 per cent did not seem to be saving anything at all. The remainder are relying on other savings and investments, property and even the sale of their business to fund it.

One of the obstacles in saving for a pension when self-employed is that income levels fluctuate. It is often short-term needs that come first, making it difficult to save regularly for the longer term. But the self-employed still need money for their retirement. So what can be done to ensure they are better prepared?

Understanding the problems

Unlike employees who are covered by auto-enrolment, the self-employed do not have anyone encouraging them to contribute to a pension. They are not compelled to make contributions of their own and neither do they benefit from employer contributions, so many risk ending up with very little come retirement.

Boring Money founder and managing director Holly Mackay says: “There can be real advantages in the self-employed making contributions to a pension. Apart from the usual tax reliefs, it can push people below the higher-rate tax thresholds or enable them to retain other benefits. Child benefit, for example, stops at an income of £50,000.”

AFH group head of advice Austin Broad says encouraging the self-employed to save for retirement is complex as, on the flip side of perks such as better a work/life balance and working independence, are uncertain cash flows and a taxation system that works in arrears.

He believes educating the self-employed about the importance of retirement saving is the way forward, as overhauling the tax system to cater for a pension saving system could be highly complex, potentially making it more difficult to become self-employed.

A mandatory solution?

For Royal London director of policy Steve Webb, relying on things like advertising, incentives, awareness-raising and better products is unlikely to boost retirement saving among the self-employed, just as they did not really deliver for employees. He favours an increase in Class 4 National Insurance contributions paid by the self-employed out of their profits to fund retirement savings.

He says: “The only real solution is a variant on auto-enrolment: a big nudge using the Class 4 NICs system. This has the merit that it is sensitive to how profitable the business is at any point in time. If someone has a good year and high profits, then their Class 4 bill goes up and more of this can go into a pension, whereas less goes in during a lean period.”

However, not all agree Webb’s idea is workable. Aegon head of pensions Kate Smith, for example, fears the self-employed might see it as just another tax rise, while Portafina managing director Jamie Smith-Thompson also has doubts.

“Most self-employed people are cash hungry and the current government is not interested in building a large department of civil servants, which it would need to for this to work. I don’t think this will come in under the current regime,” he says.

But Sanlam UK head of employee benefits Elliot Silk thinks Webb’s idea does have legs.

“People will have got used to paying Class 4 contributions,” he says. “We also need to put the onus on accountants and business consultants to speak to their clients about retirement saving. Accountants have woken up to retirement and pension saving through auto-enrolment, so they have a better grasp of pensions.”

The Lifetime Isa

Some in the industry think the Lifetime Isa will help self-employed people save. However, others feel that its maximum age limit of 40 and the £4,000 a year limit to contributions make it unsuitable, along with the restrictions placed on accessing it before 60.

The Association of Independent Professionals and the Self Employed deputy director of policy Andy Chamberlain says: “We believe the Lifetime Isa should be extended to allow for larger maximum annual payments and should be made available for those closer to retirement. The self-employed should be allowed to withdraw a maximum amount without losing their bonus or interest so they have security as their income fluctuates.”

A pension for the self-employed

There are calls for Nest to develop a bespoke default pension for the self-employed, with contributions benefiting from tax relief to incentivise saving. The Tax Incentivised Savings Association strategy policy director Adrian Boulding says: “We need a separate self-employed pension to reflect the distinct characteristics of this growing segment of UK workforce. Self-employed people need a low risk pension, because their business is likely to be more risky than that of employed people. They may need a separate default fund with lower volatility.”

Boulding adds that the self-employed need the ability to access their pension pot at short notice to provide additional working capital. “As they don’t benefit from an employer contribution, or from the tax relief and NI relief employer contributions attract, they need an additional incentive from the government on top of the normal pensions tax relief,” he says.

Advice and individual needs

St James’s Place divisional director for pensions and consultancy Ian Price points out that not all self-employed people have the same retirement needs.

“There is a group of people for whom self-employment is a second career. They may have a pension from their previous employment and self-employment is way of doing what they want or earning some extra money,” he says.

The retirement needs of this group differ from those Price calls the “pure” self-employed. He believes pure self-employed people who have set up their own business and have no previous workplace pensions should work towards building pension contributions into their cost base.

“The last thing on your mind when setting up a business is a pension, because you’re making sure the business is successful and that your income is more than your outgoings. But as the business matures part of the planning should be looking at pension contributions as part of the turnover,” he says.

Smith-Thompson says: “The self-employed have been left to fend for themselves. In years gone by you had the man from the Pru knocking on your door to sell you a personal pension but because of tighter regulation we no longer have that. So it’s a bit more difficult for the self-employed; they are not given a lot of direction. Part of the role of the adviser is to really push what a client needs rather than what they want.”