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Pensions and the self-employed

The recent Pensions Green Paper has some interesting things to say about the self-employed.

As with employed people, the self-employed can be subdivided into high-income people, for example, accountants and lawyers, who can broadly be relied upon to make provision for their own retirement, and lower-income people who can&#39t.

But there are two crucial differences between lowerincome employed and self-employed people.

The self-employed have no employer to sponsor and help pay for private pensions and the self-employed do not participate in state second pension.

So a lifelong lower-income self-employed person who makes no private pension provision is a racing certainty to be on means-tested state benefits from the moment of retirement.

The Green Paper raises a fascinating possibility, namely that the self-employed might be allowed to opt in to S2P in years when it suits them, with age-related contributions based on profits.

The Green Paper actually suggests that “this would be of particular benefit to those self-employed with lower profits, who would accrue state second pension rights equivalent to those built up by someone earning almost £11,000 a year”.

In other words, in years when you have low profits, opt in, but in years when you have higher profits – when you would get proportionately less value – don&#39t.

So it would probably be subsidised by other tax and National Insurance payers, namely employers and employees. The degree of cross-subsidy would depend on the basis of the age-related contributions.

One obvious basis is the contracted-out rebate which would be paid to a stakeholder or personal pension on behalf of an employed person of the same age and income as the self-employed person.

Given that many actuaries feel that this rebate basis is inadequate to justify contracting out, the converse is that it would be good value as a contribution basis for the low earning self-employed to opt in.

Another Green Paper proposal affecting the self-employed is something which is already in the pipeline. From May 2003, the DWP will automatically issue state pension forecasts and supporting information to self-employed people who have not had a combined pension forecast from their pension provider – in other words, most self-employed people.

The obvious motive is to make sure the self-employed realise how little state pension they are on track for.

Presumably the Government hopes that once the self-employed realise how little this is, they will be motivated to make additional provision. However, the Australian experience does not offer much encouragement.

In Australia, the self-employed do not participate in the compulsory private provision to which employees are subject. The self-employed were too tough a political nut for even Paul Keating, the legendary former Australian prime minister.

Instead, the Australian self-employed are offered generous tax relief to make voluntary private pension provision. I understand only about one-third do so and I bet its those accountants and lawyers again.

One possible saving grace for the UK self-employed is that many of them these days seem to move between employment and self-employment during their working lives.

The Pension Provision Group Report from December 2001 suggests that 94 per cent of those reaching retirement who have been self-employed will also have had at least one period as an employee.

So most such people will have had the chance of some employer pension support and, when classed as employees, will have participated in – or contracted out of – S2P or its predecessor, Serps.

The retirement savings problem for low-earning self-employed people is not helped by the pension credit.

If they want to build up some S2P, will it be sufficiently good value to outweigh the loss of 40p in the pound in the means test?

The same problem arises if the improved forecasts motivate them to consider private savings for retirement, whether called pension or not.

Adequate private pension provision is an increasingly difficult goal for everyone but for the lower-earning self-employed, it looks set to remain a particular challenge.

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