When it comes to pensions, employees have a major head-start over their self-employed counterparts. In an era of ‘automatic enrolment’ (AE), employees who earn more than £10,000 per year have to be enrolled into a workplace pension chosen by their employer, and they benefit from a financial contribution into that pension from the firm. They do not have to take any active steps – as long as they don’t opt out, they will start building up a pension pot. As a result, the long-term decline in workplace pension membership among workers in the private sector has now gone into reverse.
The self-employed are not so fortunate. There is no employer with a duty to enrol them into a pension, nor to pay money into a pension, so unless they take active steps to plan for later life they can easily find themselves with little or no pension provision.
The proportion of self-employed people with a pension has continued to decline and only around 1 in 6 put money into a pension last year. With self-employment accounting for about one worker in seven in the economy, this is a big and growing problem.
Lessons from AE
Some self-employed people may feel they do not need a pension. If they have a business for which they can find a ready buyer at retirement, then their business could indeed be their ‘pension’ – always assuming nothing goes wrong with the business between now and retirement. Others may have chosen to invest in property, or via Isas or other investments, and have built up wealth outside a pension. This will certainly help them in later life, though it is easy to underestimate just how much you will need to support a retirement which could easily run 20-25 years or more.
But what about the millions of self-employed people in the middle, who may not have a business to sell and may have little or no other savings? How can we learn the lessons of automatic enrolment for employees and apply these to the self-employed?
A recent report jointly published by Aviva and Royal London surveyed the various ideas which have been put forward, and came up with a recommendation for a type of auto-enrolment for the self-employed.
The idea is to piggy-back on the annual tax return process to give a big ‘nudge’ to the selfemployed to put more money aside for later life.
The first step would be to make sure that any self-employed person who completes a tax return has to answer the question: ‘If you were to put money into a pension, where would it go?’ They could specify an existing pension they already had, talk to an adviser about a new pension, or opt to have a pension provider randomly assigned to them from an approved list. Either way, there would be a specific destination for any funds set aside for later life.
Second, when it worked out a self-employed person’s tax bill, HMRC would automatically include an extra sum – let’s say 4 per cent of their taxable profits. Unless the individual opted out, this money would be collected by HMRC and allocated to the pension account they had named. The taxpayer would top this up with an extra 1 per cent (this latter amount is equivalent to standard rate tax relief ).
There are many attractions to this idea. It is based around inertia, so unless people actively opt out they will start to build up pension wealth. Second, the amounts contributed go up or down each year, depending on how well the business has done. After a profitable year, taxable profits would be high, so the sum saved into a pension would go up. After a tough year when money was tight, less money would go in.
This would work well in the context of the ups and downs of self-employed business life. In addition, presenting tax relief as a ‘matching’ government top-up would help to explain the benefits in a relatively simple and attractive way.
Power of inertia
There are no easy ways to get the self-employed into pension saving if it is not to be made compulsory. But with the government undertaking a review of automatic enrolment this year, the case for including the self-employed is overwhelming.
Without this, many millions of self-employed people will face an unenviable choice between working on long past the point when they want to retire, or retiring anyway and seeing a big drop in their standard of living.
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