Make the most of tax relief, your business premises and even your spouse when saving for retirement.
More than one in seven people working in Britain are self-employed and thus face a particular challenge in saving for retirement. Unlike those in full employment, contractors and small business owners do not benefit from an employer paying into a plan for them.
The responsibility, therefore, rests entirely with the individual to make adequate preparations for old age – and oversights are commonplace.
While some small-business owners envisage running their company through retirement or plan to sell up and use the funds to pay their living costs, the reality is many self-employed people wait too long to make arrangements.
It can be tricky when your income is irregular or you anticipate more pressing business needs in future. But a few smart moves can set you right fairly rapidly. Here, we look at six ideas to help self-employed workers boost their funds.
Use the tax relief allowance
Every year savers can put up to £40,000 into a pension fund without paying income tax on the money. Play the annual allowance system to your advantage.
Some people – those who have sold a new product, painting or received an advance, for example – may only in certain years acquire money to pay into a pension.
However, you can carry over unused allowances from the previous three years, provided you were a member of a pension scheme during that time. It’s worth setting one up as soon as possible. Old schemes count as “having a pension” and you can still use the carry-over allowances in a different (and probably cheaper) fund.
The rule means that people can save £120,000 in some years, generating significant tax relief.
Claim back missed relief
Typically, an £80 contribution to a pension will be automatically topped up with the 20% basic rate tax you paid. Pension providers claim this on your behalf from HM Revenue & Customs.
But that means higher-rate taxpayers must claim the remaining 20% through self-assessment. Many self-employed people are unaware or forget to do this.
But all is not lost; the rules allow you to claim tax relief for the previous three years. In practice, this means the deadline is four years after the end of the tax year for which you are claiming, so to claim tax relief in respect of 2011-12, you must request the money from HMRC by April 5, 2016.
It is therefore vital that you write to your tax office and make sure you include the tax year to which it relates, that you are claiming for higher-rate tax relief on personal pension contributions, the tax you have paid for that tax year, details of the bank account into which you would like to receive any payment due and your signature.
Employ your spouse
If your husband or wife is on the payroll, make sure you have a pension in place. You can pay up to 100% of their salary into the scheme, adjusting your own earnings to compensate.
However, as a couple, always try to make contributions on behalf of the higher earner to generate the most tax relief.
Your partner must have a proper role in the company as HMRC runs spot checks to ensure people are actually doing the jobs they are paid to do within small businesses, and will prosecute if this isn’t the case.
Put your business in your pension
Savers are blocked from putting residential property in a pension, but investing in commercial buildings is allowed. You can buy the premises where your business operates through a pension scheme to reduce your tax bills.
First, you will need a “self-invested personal pension”, more commonly known as a Sipp.
You need to have enough money in your Sipp to buy the property, but you can borrow up to 50% of its net value to help. Consolidate other pension funds to boost this amount.
The Sipp then becomes your “landlord” and you must pay it market-value rent.
In doing so you escape corporation and income tax at the same time as making significant pension contributions. You will also avoid capital gains tax when you sell the property. It is worth taking financial advice as small mistakes can incur a 55% tax bill – for example, if you underpay rent.
Recycle money after 55
Once you reach age 55, try pension “recycling” to boost your fund. Under this ploy you withdraw money from your fund and pay it back in to generate extra tax relief. It’s easier for self-employed people with more control over their incomes than company staff.
This is best explained in an example provided by Alistair Cunningham, of Wingate Financial Planning.
A higher-rate taxpayer pays £10,000 into a pension, on which 40% tax (£4,000) would have been owed.
When taken out, three-quarters of the fund is tax-free, with the rest treated as normal income.
That creates a total tax bill of £3,000, saving the higher-rate taxpayer £1,000.
When you start taking money from your pension the £40,000 annual allowance is cut to £10,000. But that doesn’t stop you making a quick £1,000 every year.
Use a cheap plan designed for companies
There are companies who provide low-cost pensions for people who just want to put money in the stock market, rather than in commercial property or other esoteric investments.
A little-known trick to cut costs to the bone is using Nest, the government-backed pension provider, which is open to self-employed people and charges only 0.3% a year.
A 30 year-old earning £25,000 a year could build a fund of £261,800 at retirement, the consultants Punter Southall calculate, assuming the person pays in 8% of their annual income and the fund grows 5% a year.
By comparison, the typical pension plan with charges of 1% would grow to £234,900. Note that Nest has a temporary levy of 1.8% on contributions, which is included in the calculations.