While the introduction of workplace pension schemes has been successful in getting many more people into some kind of pension plan, unfortunately the government has yet to tackle the issue of millions of self-employed workers who don’t make any regular retirement provision.
In fact, just one in three self-employed people has a pension, according to the government’s Money Advice Service. Unfortunately, people who work for themselves shouldn’t rely on the State Pension to provide them with a decent income in retirement.
So, if you’re self-employed getting your own pension sorted out is essential and a SIPP (Self Invested Pension Plan) is a great way of saving for your retirement, offering flexibility and control that is ideal for people working for themselves.
Here’s how to go about it.
How much do you need?
The average worker in the UK earns £30,800 per year and the ‘rule of thumb’ for a comfortable retirement is to aim for the equivalent of around two thirds of your annual working income when you stop working. So, anyone currently earning £30,800 a year should aim for an average retirement income of £20,500 per year.
At the current full State Pension rate of £175.20 per week, which is £9,100 a year, a retiree would have to make up around £11,400 a year themselves to meet the magic £20,500 figure. To generate this much money, based on an income equal to 5% of your pension, would require a total pension pot of around £250,000 at retirement. If the income dropped to just 3% of your pension, the pot would need to increase to £400,000.
These sound like big numbers, but it is by no means an insurmountable challenge. The most important thing you can do is get started with your pension saving straight away, because the earlier you start saving, the more you are able to put away and the greater the potential for growth.
You should also take a look at our article on “What age can I retire?”, which includes tips on working out how much you’ll need in retirement based on your expected outgoings and income.
With a SIPP you usually have much more control about how much you save and how you invest that money, compared with traditional pensions.
Consolidate your pensions
The average British worker is now likely to have 11 jobs during their working lifetime, with potentially each role having its own workplace pension. If you’ve started up your own business having being previously employed, you’re likely to have a number of workplace pensions with different sums in them.
With a SIPP you consolidate them in one place, which will help you keep better control of your entire pension savings, meaning you won’t have to pay different charges to different providers. You can also make decisions about how you invest the single pot, rather than managing multiple pots.
If you have old pension pots you’ve lost the paperwork for, the best place to start to track them down is the government’s pension tracing service.
The process of transferring pensions from old providers in to one neat and tidy pot can seem daunting, but it is fairly simple to do. It will require some paperwork, but your SIPP provider will be able to help you through the process. If any of your old pots are defined benefit pensions – or final salary schemes, as they’re sometimes known – the process can be more complicated, so you should speak to a financial adviser first.
When thinking about how much you should be contributing to your SIPP, there are any number of ‘rules of thumb’ out there, some more generous than others. A good place to start is to consider what your full-time employee counterparts would be putting aside each month.
Under the government’s auto-enrolment workplace scheme, employees currently have to contribute a minimum of 5% into their pension, while the employer has to contribute 3%. Ideally you should be doing the same, aiming to put aside at least 8% of your income into a pension each year.
This could differ depending on your age. If you’re 25 years old, for example, there’s a good chance you’ve at least another 40 years of work ahead of you. This means you can afford to put in less, so long as you contribute consistently.
If you’re older and either don’t have a pension or haven’t been saving that much, you’ll definitely want to think about seriously upping your contributions. One suggested calculation is to take your age and halve it, giving you how much you should contribute. So, for example, if you’re 36 years old, you should be putting aside about 18% of your income to a pension.
That being said, if you can’t afford to save that much as a proportion of your income, then try and put in what you can. As a pension is an extremely tax efficient way of saving, it makes sense to contribute as much as you can afford and feel comfortable with, within the tax limits. Think about how old you are and when you’d like to retire too as this will set the goalposts for you.
If you already have some pension savings that you’ve consolidated into your SIPP, then think about how much you want your total pot to be and work out how much you need to contribute to reach your target.
EQi’s retirement calculator can help you do the sums.
Take advantage of the bonus
Obviously, the government wants to encourage as many people as possible to set up a pension, which is why generous tax relief is offered, which also applies to a SIPP. You’ll get 25% tax relief on any pension investment up to £40,000 a year. For example, if you pay in £100, tax relief means that you effectively get an extra £25. If you’re a higher rate payer, you’ll get another £25 on top of this.
Make regular contributions if you can
With self-employed work, one of the bigger issues that makes paying into a pension harder is inconsistent income. Some months you may earn a lot more than others. It is likely though that you’ll have some sort of budgeting in place to manage this inconsistency.
Either way, you should make provision in your budget for a regular contribution to your SIPP. Making regular contributions instead of paying big lump sums has the benefit of smoothing investment performance in the long run.
Investment markets can experience short-term volatility, so the investments you make can rise and fall in value over shorter time frames. By investing regularly over time you’re doing something called ‘pound-cost averaging’ which smooths out the fluctuating price you pay for an investment from month to month.
of course, if you’ve got a lump sum of savings to use, don’t wait around to get it invested as it will likely be earning much less interest in a savings account than it could be invested in a pension for the long-term.
Pick your investments
Finally, once you’ve decided how much and how often you’d like to contribute to your SIPP, the next step is to make your investment choices.
Find out more on how to pick investments in our Five key things to consider when investing in funds guide.
Edmund Greaves is a consultant at MRM. Before entering PR, he spent nearly a decade as a journalist, most recently as Deputy Editor of Moneywise magazine & website. That wide-ranging role saw him cover the full spectrum of financial services, from investing, pensions and savings to day-to-day finances.