What are my self-employed pensions options as a freelancer?
Freelancer’s Question: I have been a freelance animator for around six years, but I have no pension at the moment and this is a big worry for me.
I have looked into pensions for self-employed sole traders like me several times and got overwhelmed and confused with the options online, and abandoned the idea much to my frustration. Now, having just turned 37 years old, I need to finally sort something out!
The backdrop is that I recently took a year off for maternity leave and was about to start work again when coronavirus hit, so I’m now at home, with my baby, with little work for the time being. My recent income is very low, but the previous year’s profit was around £50,000, while the four years prior roughly had £35,000 profit each.
I have a sizeable mortgage and it seems better to overpay this than save at the moment with the appalling interest rates. Where I should start pension-wise, and what’s the easiest retirement savings model or product is to consider? It would mean a lot to me to have some advice please.
Expert’s Answer: Although 37-years-old is some way off from retirement, starting as early as you can be important. That’s because ‘compound growth’ will make a considerable difference to your final pension value. 'Compound growth' simply means that the interest you earn is reinvested into the scheme and used in further interest calculations.
As you have discovered, online research is a lesson in self-defeatism. You become subject you to a bombardment of jargon, mixed with conflicting opinions from numerous sources.
To reassure you...
Believe it or not, pensions needn’t be complicated! But what they are is unique to individuals’ circumstances. And in a specific situation like yours, no amount of generic advice is going to lead you to a satisfactory conclusion. You need to talk to a specialist, one who knows both mortgages and pensions inside out.
To reassure you though, new legislation introduced in 2015 has made pensions more flexible and appealing. Today, pensions act as a valuable tool for freelancers and sole traders to save tax efficiently. Here’s a glimpse of what that legislation could mean for you, but to get the bigger picture, you really need to make that call.
Current strategy, in line with future options
Based on the information that you have provided, it appears that a pension may well suit your situation. Regardless of your earnings, you can contribute up to £2,880 per financial year to your pension for tax relief purposes. This sum will immediately be increased to £3,600 when you include generous 20% tax relief.
The 20% tax relief is, if you like, a bonus from the government (or 40%/45%, depending upon the rate at which you pay income tax). You still pay the tax, but it goes into your pension pot, not to the government, as explained eloquently by Which?:
How pension tax relief works
If you are a basic-rate taxpayer and were to contribute £100 from your salary into your pension, it would actually only cost you £80.
The government adds an extra £20 on top – what it would have taken in tax from £100 of your salary.
Depending on your preference, you can make contributions via a series of regular payments, or as a one-off lump sum.
Your funding strategy can and should be reviewed as your profits and affordability change over time. When you get back to being a higher rate taxpayer—as you were in previous tax years—you will be able to reclaim an additional 20% tax relief through your self-assessment tax return.
Other/existing pension options
You mentioned that you have no pension at the moment, but you may have an old workplace pension from a previous employment which could be reviewed and taken into account. Quite often, these older schemes will be sat in very generic investment funds. Although they exist, they may no longer fit with how you want to position your money right now.
In that vein, it’s important not to confuse how pension savings accrue with how deposit savings work. Your attitude towards risk, lifestyle choices and the length of time you foresee yourself working all play a part in the amount you set aside for a pension and how it might work for you.
Also, do not forget the basic state pension! There’s certainly no guarantee it will exist in its current guise when you reach retirement but it’s worth knowing how much you are on target to receive and what age you will be getting it. I’d urge any freelancer sole trader running their own self-employed business who hasn’t done this yet to visit the government’s webpage on state pensions.
Mortgage Repayment: query
Repaying your mortgage is a matter of opinion, subject to your own circumstances, and which you should discuss with an independent financial expert or pension adviser, alongside your wider personal circumstances. Interest rates on mortgages are near all-time lows, but accessing them is another matter. You don’t want to jump out of the frying pan into the fire!
Ideally, your next step would be to take stock of the gravity of your whole situation and look at all the implications of any decision you make, relating to beginning to build a nest egg. Given your current circumstances, you should also include looking at your emergency cash savings and compare the amount of growth that they could achieve in other schemes or accounts.
It sounds very much as if you would benefit from an initial review with a specialist adviser. We have specialists in pensions to back up our mortgage acumen, and we do not charge for our pension reviews! You would emerge with a tailored strategy, based on your specific circumstances and your individual objectives. That’s what you want to aim for, whoever you take the plunge with.
Despite their appearance, pensions are far from daunting, as long as they are explained in simple terms, which the internet doesn’t do awfully well! A good adviser—specifically in your case, one knowledgeable about self-employed pensions and mortgages— will have you on your way to a more assured future in no time. Good luck!
The expert was John Yerou, founder of Freelancer Financials, a mortgage specialist for freelancers, sole traders and the self-employed.