Amid all the uncertainty about the short term, Tony Clark from St James’s Place Wealth Management advises that it’s also important not to forget long-term issues such as pensions when you’re self employed.
Despite rises and falls amid periods of recession, the number of self-employed people is on an upward trend, rising from 3.4 million (12.9% of the workforce) in 1998 to 4.8 million (15.1%) in 2017. Yet over the same period, the proportion of self-employed workers paying into a private pension has fallen from 48% to just 16%, according to the Institute for Fiscal Studies. Many self employed people, however, don’t think long term and invest in their pensions.
There are several reasons for this, including their exclusion from auto-enrolment and the income insecurity that can be a feature of self-employment. There’s also the hassle factor. There’s a lot to think about when you’re self-employed and starting and paying into a pension can quickly slide down the list of priorities. Similarly, self-employed earnings can be uneven and unpredictable, so it might be difficult to work out exactly how much to contribute each month and year.
Many self-employed people also expect their business to be their main source of retirement income. Whilst this is understandable, a business should form part of a broader financial plan and relying on it entirely is risky.
Ideally, any retirement plan should include a mix of pensions, ISAs, property, state pension, earnings and so on. If you’re self-employed, your business is part of that. Having other assets to call on can benefit your business planning as well, particularly if you’re approaching retirement and finding it hard to extract value from the business.
Diversifying also brings tax benefits. For example, when you take money out of a business, there will likely be some degree of Inheritance Tax (IHT) or Capital Gains Tax (CGT) liability. By contrast, pensions stay outside your estate for IHT purposes, which makes them more tax efficient than a business when it comes to passing on wealth to your family.
The 2015 pension freedoms increased the scope of pension death benefits and have made them an effective IHT planning tool. A personal pension is generally free from IHT and can be passed to a dependent or nominated beneficiary, subject to scheme rules, in a very tax-efficient manner.
The tax advantages of pensions can help you when it comes to maximising your contributions too, especially when you know your earnings can vary significantly from year-to-year.
There are ways to structure your pension contributions in such a way that you don’t miss out on tax advantages. You can also make sure that the direction of your business dovetails with your wider financial plans.
Each stage of your business requires financial strategies, including your retirement, so it’s one thing that’s wise not to put off until tomorrow.
The levels and bases of taxation and reliefs from taxation can change at any time. Tax relief is dependent on individual circumstances.
*Tony Clark is Senior Propositions Manager at St James’s Place Wealth Management.