With no employer to fall back on, the self-employed are on their own when it comes to retirement saving. Irregular income patterns can make it harder to save regularly into a pension and commit to locking money away until age 55. Those who are building a business may see that as their biggest asset and prefer to invest in it rather than a pension. However, there is a growing feeling that something must be done to help the self-employed save for retirement.
What started off in the Conservative Party manifesto as a commitment to extend auto-enrolment to the self-employed is gathering momentum. For example, a two-day TechSprint event hosted by the Association of British Insurers, the Department for Work and Pensions and HM Treasury in March will discuss the next steps in solving the self-employed retirement savings challenge.
Given that auto-enrolment has brought around 10 million employees into the pension system, it is not surprising that it has inspired much of the current thinking. However, the self-employed have no employer to facilitate enrolment and match contributions, making it difficult to replicate. So what are the options? Do we need to create something especially for the self-employed or use what’s already available?
The tax system
Last year Royal London director of policy Steve Webb suggested that auto-enrolment could be replicated for the self-employed using the class 4 National Insurance Contributions system. “A year ago, we said why don’t we use NICs where people would pay a bit more of their NICs, with an opt out and that’s a sort of AE,” he says. “Then Philip Hammond’s first Budget put NICs up for the self-employed and five days later it was down again.”
Webb says using NICs is now ‘politically toxic’ and not the way forward. However, Barnett Waddingham senior consultant Malcom McLean still sees merit in the idea. He would introduce the class 4 NICs increase that Hammond U-turned on, but allow that increase to be automatically channeled into a private savings plan. “People would, of course, be permitted to opt out but very few would do so as they would lose the contribution while still having to pay the extra NI,” he says.
Having joined forces with Aviva for last year’s report, “Solving the under-saving problem among the self-employed’ Royal London now believes the key is to nudge the self-employed into saving through their tax returns. The idea is to default people into pension saving when completing their self-assessment. They could nominate a pension provider or scheme to receive 4 per cent of their taxable profits plus standard tax relief – 5 per cent in total – or opt out.
Aviva head of policy for retirement solutions John Lawson points that appropriate contributions would be deducted in line with known profits. He says: “In making automatic pension deductions via self-assessment we also hoped to harness some of the success of automatic enrolment; a default process which requires effort to opt out; harnessing people’s behavioural preference for inertia.”
Pensions and Lifetime Savings Association policy lead on DC pensions Tim Gosling was surprised the Government didn’t run with this, but got the impression that it thought presenting the self-employed with a large bill at one point in the year wasn’t going to have the desired effect. Webb points out there is a way round this, so rather than collect tax once or twice a year, the tax and pension contribution could be spread over a period of 12 months. However, he concedes this may not be popular with HMRC.
The Isa route
AJ Bell recently suggested removing the restrictions of the lifetime Isa to make it more attractive to the self-employed could provide a solution. In its current form, the Lifetime Isa has more limitations than a pension. Selectapension national accounts director Peter Bradshaw points out that you can only out £4,000 in it compared with £40,000 a year into a pension; you can’t pay into it after 50, you can’t withdraw it before 60 without penalty and it’s only available to the under 40s. Some commentators see no enthusiasm from Government in making the necessary tweaks to widen its appeal and wonder whether the creation of a new type of Isa would work better.
“A variant of the Lifetime Isa is a possible option, although it would need to find the balance between encouraging saving at a good level – a heightened cap and perhaps an increased government bonus for saving at or above the recommended level – while retaining some flexibility. Possibly a facility to borrow from it to support a business,” says EY insurance partner Stuart Wilson. However, others don’t think a product is the answer.
For The People’s Pension head of policy Darren Philp, the Isa route lacks the essential ingredients that made auto-enrolment a success – the ‘automatic’ element where you’re in unless you opt out and a way of ‘mimicking’ the employer contribution. He prefers the idea of using the tax system to default people into a pension scheme.
Blue sky thinking
Critics of using the tax system for this purpose see it as ‘old school thinking’ and want to see something fresh that will interest the self-employed. “There has to be some ‘blue sky thinking’. We need a more practical alternative to a pension; more of a lifetime savings product with some flexibility. The self-employed could use a percentage of it to help with mortgage and paying off loans.” Says Liberty Sipp director John Fox. However, Fox can’t see a way around having some form of compulsion if we are to solve the self-employed retirement savings problem for good.
Many understand the argument for compulsion but some are worried about its wider impact. Clifton Asset Management group financial planning & business development director Anthony Carty says small businesses are the biggest employers of individuals and crucial to the economy. “You could argue whether you start to disenfranchise the self-employed and business owners with compulsion and I fear the economic impact of that,” he says.
Lexington Wealth Management managing director Warren Shute believes the self-employed need to take financial responsibility for themselves. He sees financial education in schools and advertising as ways to increase awareness of the need to save. “It’s just like teaching children about not eating too much sugar or spending too long on an i-Pad,” he says.
For Moneyhub chief executive Samantha Seaton, the main problem is the reluctance to lock money away in a pension as having access to it provides a comfort factor. If technology, through things like apps, can identify money that would have spent on something else, she feels the self-employed may be more inclined to put it in a pension.
“If you normally travel to London for work but you didn’t go that week, the money you would have spent could be put into a pension. The way we’re heading with the digital world means we could set a default mode which flags up anything you would have spent normally,” she says.
Standard Life Aberdeen head of pensions strategy Jamie Jenkins highlights the importance of not rushing in to a solution only for it to fail. He points out that after Stakeholder pensions, it took many years before workplace pensions was on the Government’s agenda again with auto-enrolment.
“Stakeholder is a mark in the sand but it lacked the nudge of people being put into the scheme. Stakeholder didn’t achieve increased take up; it was the auto-enrolment by the employer that made a difference,” he says. “In plumping for one solution, the risk is getting it wrong and taking years for successive governments to look at the issue again. It’s better to explore all the options and get it right.”
Jade Connolly, head of advice, Ascot Lloyd
Regularly saving into a vehicle which you cannot access until the age of 55 creates a barrier for many of the self-employed, as the prospect of tying money up when work is uncertain is not an option that can be considered.
“The Lifetime Isa offered a way around this by allowing individuals to save up to £4,000 per year into the plan which received a 25 per cent bonus each year. You can access the funds before retirement if you need to but a penalty will be applied. The penalty is more than the bonus you receive and therefore again, this can often put individuals off saving into this type of product. Also, contributing £4,000 per year is unlikely to be sufficient for a comfortable income in retirement.
The Government therefore could consider an option which allowed regular savings to be made into a plan with only the loss of the bonus, rather than additional penalties to encourage those to save.
Fiona Tait, technical director, Intelligent Pensions
The concept of automatic-enrolment relies heavily on two behavioural patterns – having to actively opt out makes it easier to save than not save and opting out means there is a financial loss in the form of lost employer contributions.
The proposal to use National Insurance to mimic automatic-enrolment recognises that these two behavioural elements are necessary if it is to work in the same way for the self-employed. Firstly, they would be put into a position where they are automatically saving unless they chose not to and secondly, they would lose out financially by having to pay increased NICs.
However, the Chancellor has already fallen foul of his party’s manifesto pledge not to increase NICs. Even though his intention of levelling up NICs with the employed rate makes sense in the context of the new State Pension, any proposed changes would not take place until the next parliament. The Government would probably rather not go there without some strong evidence to support it.