What is the best way to help the self-employed save for retirement? This is a question that has long perplexed the pensions industry.
The Spring Budget saw Chancellor Philip Hammond propose an increase in Class 4 National Insurance contributions paid by the self-employed on the basis they now have the same rights to the flat-rate state pension as employees.
The increase was never presented as part of a wider plan to create an equivalent to automatic enrolment for the self-employed but some commentators felt it could have paved the way for something along the lines of a partial rebate of NICs into a personal pension.
Hammond’s swift U-turn on the increase ends that speculation – for now. But does the fact the Government is looking at the contributions the self-employed make to the tax system and the benefits they receive relative to employees indicate something similar to auto-enrolment could still be on the cards?
Right policy, wrong time?
There is a feeling in the pensions industry that the Government mis-timed its attempt to increase Class 4 NICs. Last year, Royal London director of policy Steve Webb suggested an increase in Class 4 contributions could be used to mirror auto-enrolment for the self-employed.
According to Webb, the Government should have increased Class 4 NICs when it announced the self-employed would have the same state pension rights as employees last year. “But it did not and it also announced that Class 2 NICs would be abolished. So it improved the state pension for the self-employed and lowered NICs, making a rod for its own back,” he says.
Webb thinks the delay made it politically impossible to raise NICs and he is not impressed with the U-turn, particularly as it follows the reduction in the dividend tax allowance just a year after it was introduced.
Barnett Waddingham senior consultant Malcolm McLean believes the Government’s mishandling of the situation goes back further than that. He says: “It should have taken the initiative at least two years ago to bring the self-employed into the ambit of auto-enrolment and give them an opportunity to build up a private pension on top of what is now the new state pension.”
McLean thinks Hammond’s U-turn makes it less certain whether it would still be possible for an increase in Class 4 NICs to be diverted automatically as a minimum contribution into a private pension scheme.
He says: “The self-employed might see it as full compulsion to save into a pension at extra cost to themselves, whereas those in employment might argue it was more over-generous treatment of the self-employed, with the Government effectively making an employer contribution on their behalf.”
Aegon pensions director Steven Cameron says the fact the self-employed are not covered by auto-enrolment makes them second-class pension citizens.
“The Government should have taken the initiative at least two years ago to bring the self-employed into the ambit of auto-enrolment and give them an opportunity to build up a private pension on top of what is now the new state pension.”
He says: “Bearing in mind the growing population of the self-employed, the Government’s pension policy is unsustainable. There will be a big divide between the employed and the self-employed when they retire. A solution is needed – the equivalent of an auto-enrolment solution.”
Cameron hopes the delay in increasing NICs will give the Government time to come up with a plan. Like others, he believes this could involve rebating an increase in NICs to a private funded pension of the self-employed individual’s choice.
But Angela James, associate director of Contractor Wealth, a financial planning firm that advises the self-employed, contractors and freelancers, cannot see any form of NIC rebate or auto-enrolment solution coming into effect for the self-employed.
She says: “The Government has already taken steps to equalise the state pension, so anything else is unlikely to happen.”
Similarly, HW Fisher & Company private client principal Tim Walford-Fitzgerald thinks those among the self-employed mindful of making pension contributions will already be doing so, while those who are not are likely to opt out of an auto-enrolment system unless it is mandatory. This would, of course, reintroduce a level of unfairness, given it is not compulsory for employees.
So, is there any realistic prospect of a solution? Some commentators believe the Government will have a better idea of what to do about the lack of retirement saving among the self-employed once both the auto-enrolment review and the Taylor review on modern employment practices are published.
One of those is Scottish Widows head of industry development Peter Glancy, who believes you cannot look at the issues in isolation.
He says: “Twiddling around with 4 NICs would not make a significant difference because you need to look at the bigger picture. You need to look at the whole system of pension taxation. If you do different things for different people, you introduce more complexity. We need to find a simple solution that works for everyone.”
Hargreaves Lansdown senior pension analyst Nathan Long points out less than one-in-10 self-employed individuals are saving towards a personal pension. Given the backlash against the proposed rise in NICs, Long suggests a different solution.
He says: “When someone who is self-employed does a tax return, they could also calculate the amount they have to pay into a pension, exactly the same as an employee would. People could still opt out but they would have to go to the pension provider to get the money out. The logical place for it to go into is Nest. But we think people – both employees and the self-employed – should be given a choice of where their money gets diverted.”
Could the reduction in the tax-free dividend allowance from £5,000 to £2,000 also announced in the Budget steer self-employed business owners that pay themselves dividends towards the tax-efficiency of pensions?
Owner managers may currently find it more tax-efficient to pay themselves a mix of dividends and income but the 60 per cent reduction in the tax-free dividend allowance from April next year could mean pensions playing a bigger role in remuneration strategies.
Standard Life head of pensions strategy Jamie Jenkins says: “While taking dividends has generally been more tax-efficient than simply taking income, pension contributions are usually more tax-efficient again. The shrinking gap between salary and dividends makes the case for pension funding even greater.”
However, Crunch Accounting head of policy and public affairs Jason Kitcat does not expect much to change.
He says: “The regrettable cut in the allowance may push a few more directors to look at their pensions. But we doubt it will lead to much behaviour change, as pensions are seen as too inflexible for many of the self-employed.”
Technical Connection joint managing director Tony Wickenden agrees. He says: “The change means that less dividends will be tax-free but a dividend will still represent the preferable way of extracting funds from a company for personal expenditure compared with salary or bonus. There is no NIC on dividends.
“A pension represents the most favourable way of extracting funds if the owner manager doesn’t need them for personal expenditure, as there will be no diminution for corporation tax.
“But if you need funds for immediate personal expenditure, then the pension isn’t relevant unless you are over 55, when you would then pay tax on 75 per cent of what you take to counter the tax-relieved contribution by the company.”