Pensions for the self-employed: what you need to know

When you’re working for yourself it’s easy to get caught up in the day-to-day struggles of building a business. Planning for retirement can seem like a luxury if you have an income that isn’t consistent and no employer to top up your contributions.

But paying into a pension should be one of your main priorities if you’re self-employed. ^{Footnote [1]} Over the last 20 years, life expectancies have been increasing in the UK and with the state pension only providing a small income, having a nest egg of your own could make the difference between a comfortable retirement and struggling to get by in your later years.

But remember, as with all investments, there's an element of risk. The value of your pension could go down as well as up – and you may get back less than has been put in.

As a self-employed person, you have more freedom to choose your own pension, rather than having to use one provided by an employer. You can pick the pension provider you want and with a self-invested personal pension (SIPP) you can even choose the investments you want to include. Unlike an employee, with pension contributions taken from their salary, you're free to change how much you pay in month-by-month or add lump sums – so you’re in total control within the limits the government put in place.

The tax perks of a self-employed pension

When you're running your own business, being tax efficient is important. Paying into a pension is one of the best ways to invest your income.

As a self-employed person, you'll get tax perks on your payments. How this works will depend on the type of self-employment.

Any gains from your pension investments are also free from tax, unlike savings interest. And you can get access to your money sooner than you might think. If you want, you can take a tax-free lump sum at 55 (rising to 57 in 2028).

Sole trader

If you're a registered self-employed as a sole trader, your pension will come from your net profits and the government will add tax relief to top up your payments at the basic rate of tax (20%).

For example, for every £100 you contribute to your pension it really only costs you £80 with 20% tax relief. If you're a higher rate taxpayer you can potentially claim more tax relief using your self assessment form.

Limited company

If you run your business as a limited company (Ltd), then your pension payments normally come from your turnover as a business expense. So you'll pay less corporation tax, but none of the tax relief will be added to your pension.

Any returns on your pension investments are usually free from Capital Gains Tax and income tax.

Personal or SIPP pensions for the self-employed

As a self-employed person you can choose between a personal pension or a self-invested personal pension (SIPP). Both have their advantages, so it’s up to you to see which one you’d prefer.

With a personal pension, the pension provider will have a range of investments for you to choose from based on things like the risk you'll accept. Your pension will then be run by a fund manager with the aim of getting the best returns. All you need to do is make contributions, so it’s better if you’re unsure about the world of investments. Generally, the costs for a personal pension are lower than a SIPP.

A self-invested personal pension (SIPP) gives you a lot more control over the investments inside it. You choose and manage them yourself and can pick things like shares, bonds or investment funds. This takes more understanding of what you’re investing in, so you’ll need to do your homework about the performance and risk level of each investment. If you'd like see whether a SIPP would suit you, you can check out an Aviva SIPP here.

Every person in the UK gets the same annual allowance for tax-free pension contributions. In 2023 that increased to £60,000 in every tax year. As someone who’s self-employed, the ‘carry forward’ rule is really useful for you. It lets you tap into any of your unused annual allowance from the previous three tax years. So, for example, if you only invested £20,000 in the previous tax year, you may be able to add up to £100,000 to your pension this tax year. And if you invested nothing in the previous two, you could add £180,000 all at once. Your personal contributions are still limited to your relevant earnings/net profits in the tax year in which you pay your contributions, however much annual allowance you may have available.

So, if your business is really taking off after a few leaner years setting it up, you can tuck away more money in your pension, without going over your allowance.

Tax benefits are subject to change and are dependent on individual circumstances.

Exactly how much you should pay into your pension depends on how soon you start. The earlier you begin, the more you'll benefit from tax relief and the growth of your investments over the years. Starting late? You’ll need to save a lot more to have the same size pension pot on retirement.

A good way to work out how much you might need to save each month is to use a tool like My Retirement Planner. Then you can see what kind of income you could end up with, based on different monthly pension contributions.

Think of your pension as a vital part of your business and try and get into the habit of saving a minimum amount each month. Go with the flow, if things are good put more into your pension. If things are really good, take advantage of the ‘carry forward’ rule and pay in a lump sum.

Working for yourself is about building a future, so if you stumble with your saving goals try to imagine your dream retirement and get back on track.

Review your pension every six months to see what you’ve saved and if you could increase your regular contributions.

If you’re still unsure about starting a pension, you could also chat to a financial adviser. You can find one at Unbiased.

Or use Pension Wise from MoneyHelper. It’s a free, impartial, government-backed service. If you're 50 or over and you want to understand your retirement options, make it your first port of call. Visit MoneyHelper or call 0800 138 3944 for details.