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Five ways the self-employed can boost pensions and lower tax bills

Britain's army of self-employed freelancers, contractors, business owners and sole traders has grown to more than five million over the past 10 years - but terrifyingly, 3.5 million of them are not saving into a pension at all. 

This has left them out in the cold, as increasing numbers of people save at last something into a pension.

The policy of auto-enrolling all PAYE employees into a company pension means not only are they saving at least something towards their retirement, their employer is also contributing and they get the tax breaks on offer. 

There are lots of options for the self-employed when it comes to saving into a pension, but if money is tight or income unpredictable or lumpy, then locking savings into a pension can seem impossible in the short-term. 

There are benefits to making the effort to save into a pension when you're self-employed

The long-term cost of this is high, however. Money not contributed into a pension doesn't benefit from tax relief, automatic at the 20 per cent level of basic rate tax and stepping up to 40 per cent, then 45 per cent for the highest earners. 

If money isn't invested either, then savings are highly likely to be hit by the double whammy of value being eroded by inflation, at the same time as not benefiting from potential capital and income growth from being in the stock market long-term. 

While the barriers are many, there are also benefits to making the effort to save into a pension when you're self-employed. 

AJ Bell's Tom Selby: Pensions can also be used to lower your tax bill 

This is Money asked AJ Bell's Tom Selby for his top tips on saving into a pension when you're self-employed and how to use it to save money on tax at the same time.  

He says: Automatic enrolment has been successful in boosting pension participation among those who are employed but it does nothing for the UK’s five million self-employed workers.

With around one in seven self-employed people failing to make any retirement provision, there is a real risk we are storing up a future pensions crisis.

Relying on selling your home or your business to fund your retirement is hugely risky, leaving you a hostage to the fortunes of the housing market and the wider economy, both of which can both be volatile.

Below are my top tips on how to make the most of the pension benefits on offer. 

Top pension tips for the self-employed 

1. Make the most of ‘carry forward’ if you can

Most people can pay up to £40,000 into a pension, known as the ‘annual allowance’ (including basic rate tax relief, this is £32,000 of your contributions). 

When you’re self-employed, there may be some years when you can’t pay much into your retirement pot – when you need to invest in your business, for example. If you leave a little (or a lot) of your annual allowance unused, however, ‘carry forward’ could help.

In any tax year, you can make use of your unused annual allowance from the three previous tax years – provided you were a member of a pension plan at that time. That means you could benefit from an annual allowance of up to £160,000 (if you had earnings to this level) using carry forward, including tax relief worth up to £32,000.

 In any tax year, you can make use of your unused annual allowance from the three previous tax years.

One important point to note here is if you have flexibly accessed your pension already, you will be restricted by the money purchase annual allowance. 

This lowers your annual allowance from £40,000 to £4,000 and also removes the ability to carry forward unused allowances.

2. Lower your tax bill by paying profits into a pension

If you own a business you might also want to consider paying part of your salary directly into your pension as a company contribution.

The benefit of doing this is the pension contribution would no longer count as profit, meaning you can potentially reduce both your income tax and corporate tax bills in one fell swoop. 

3. It’s not just about pensions…

If you’re aged 18 to 39, self-employed and a basic-rate taxpayer, the Lifetime Isa could offer an attractive alternative to a pension.

You can pay up to £4,000 a year into a Lifetime Isa and this will be automatically topped up by 25 per cent - identical to the upfront bonus Sipp investors get via pension tax relief. You can keep contributing and receiving the 25 per cent bonus up until your 50th birthday.

You can then withdraw the money tax free from age 60, if you use the money towards a first home worth £450,000 or less, or if you become terminally ill.

If you access the money in 2020/21 for any other reason you will face a 20 per cent Government-imposed penalty, while from 2021/22 this is due to revert back to 25 per cent - meaning you might get back less than you originally contributed.

By comparison, up to 25 per cent of money saved in a pension is available tax free from age 55, with the rest taxed in the same way as income.

4. Save early and often, keeping your costs as low as possible

The best ways to achieve the retirement you want are also arguably the simplest. When it comes to building a decent-sized pension pot, saving early and often – taking advantage of the tax relief available and allowing compound growth to work its magic – can make the whole process a lot easier.

Conversely, if you delay then you will need to make bigger contributions to make up for lost time.

Alongside how much we pay into pensions and how we invest, the charges we pay are the final key component in determining how much we end up with in retirement. In fact, even reducing your charges by 0.5 per cent a year could add thousands of pounds to the value of your pension. 

5. Think about combining any old pensions you have 

Modern pension investment platforms are easy to use and offer a wide range of investments to suit your needs and risk appetite

Millions of people including those who are now self-employed have built up pensions over the course of their lives - for example from an old employer scheme - which they have now lost track of.

Locating these old pensions and combining them with a single provider can deliver a number of practical benefits, including:

Reducing your charges by 0.5 per cent a year could add thousands of pounds to the value of your pension.

· It’s easier to manage all your pensions in one place

· You could lower your charges - particularly if you have an older-style pension

· Modern platforms are easy to use and offer a wide range of investments to suit your needs and risk appetite

Before transferring any older pensions you might have, it’s worth checking the terms as some come with valuable guarantees attached which could be lost. 

Others may also have exit penalties which could erode the value of your pension if you leave before a set retirement age.

Selby adds: While clearly coronavirus has left many self-employed people facing severe cuts to their incomes and therefore less able to save than they were before, at some point we all hope to return to something vaguely resembling ‘normal’.

When that happens and the UK’s army of self-employed workers are in a better position once again to consider long-term savings options, it is important they are helped to understand the choices available and the risks associated with doing nothing.

The good news is that not only are there a range of low-cost, simple options with generous upfront incentives available, but pensions can also be used to lower your tax bill too. 

Best Sipps to invest your pension

Investing in a pension is a far simpler task than it once was, with a whole host of mobile, online and face-to-face options available today.

The right one for you depends on what you plan to invest in and how you want to manage your money. 

Charges and services vary and the best Sipp is the one that fits your personal circumstances. To help you work out what is best for you, we have highlighted the best and cheapest Sipp options in our guide.

> The best and cheapest Sipps to invest your pension

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