Small business owners are cash rich but neglecting pensions: Here's what to do

Small business owners are stashing money in cash savings at the expense of their retirement pot, according to new research.

Auto-enrolment means many salaried staff now build up a retirement pot by default.

But if you’re self-employed, then it’s up to you to set one up and contribute to it – and a survey by Workwell and the Association of Independent Professionals and the Self-Employed (IPSE) suggests many are not.

Just 51 per cent put money into their pension each month, while three in four save regularly into cash accounts, the study found.

The self-employed are putting more cash into their savings than their pension pots each month

A survey by Interactive Investor in 2023 suggests this figure could be even higher, finding that as many as three in four self-employed workers are not paying into a pension.

While they might not have large pension pots, nearly half of the self-employed people surveyed were debt-free and had cleared any mortgages, credit cards or loans, according to the Workwell survey. Around a third owed less than £100,000 in total.

Among those who do invest in pensions, the average monthly contribution is around £218, compared with £215 a month going into cash accounts, £237 into Isas and £184 into other investment products.

While it might not be as simple as automatic enrolment, there are good reasons to invest in a pension as a self-employed person, and it’s never too late to start.

Becky O’Connor, director of public affairs at the pension platform PensionBee says: ‘I think most self-employed people are acutely aware that pension provision is a bit of black spot on the horizon for them, but few feel able to do much about it.

‘Being self-employed can be all-absorbing, so finding the time or inclination to think long term, beyond what’s coming in in the next few months, can feel like a stretch.’

If you’re self-employed and put thoughts of your pension to the back of your mind, we explain why it’s important to start saving into a pension and how to do it.

Why save into a pension?

Pensions are the best way to put money away for retirement. Even small monthly contributions can make a significant difference to your lifestyle in old age.

As well as the satisfaction of seeing your pot build, you also receive tax relief on pension contributions.

For most people, claiming the tax relief on their pension is pretty simple. If you’re a basic rate taxpayer, you pay 20 per cent income tax on everything earned above the personal allowance (£12,570).

However, if you put money into your pension, you are refunded on the tax you already paid.

For most people this works out as 25 per cent on top of whatever you pay in. So if you put in £100 a month, you will automatically get £25 on top of that via tax relief.

If you’re a basic rate taxpayer paying 20 per cent income tax, £125 before tax becomes £100. When you go to put this money into your pension, you are getting the income tax you originally paid back, so your £100 contribution becomes £125.

If you’re a higher rate taxpayer you’ll get even more tax relief, however you will need to claim this through your self-assessment tax return.

You can benefit from pension tax relief until the age of 75. Even if you’re nearing retirement age, you can still make a difference by opening a pension now.

Gary Smith, partner in financial planning at wealth manager Evelyn Partners says: ‘Where business owners aren’t making any pension contributions I would certainly encourage them to do so, as they could be missing out on tax relief on any personal contributions, and Corporation Tax on any contributions that are made through the business.

‘Furthermore, for those who own a limited company, making employer contributions is often a very useful method of boosting pension saving, especially if they only take a nominal salary from the business (say £12,000) which would restrict how much they can contribute personally.’

Benefits: Saving into a pension as a self-employed person has various tax advantages

O’Connor adds: ‘I wonder if there’s a mistaken belief that without employer contributions, there’s no point bothering with a pension and you may as well just opt for savings.

‘This might stem from not properly understanding the benefits of tax relief, and that you still get tax relief even if you are self-employed – and that it is very valuable. It is certainly more of an uplift than interest on savings accounts.

‘Thousands of PensionBee customers are self-employed, many with their own companies. Those who pay themselves on payroll often set themselves up with employee pensions through their own companies, too.’

Are the self-employed eligible for the State Pension?

If you’re self-employed, you’re eligible for the State Pension if you’ve paid at least 10 years of National Insurance contributions. You’ll need to have paid contributions for at least 35 years to receive the full amount.

If you’re not eligible because of insufficient contributions, you could make voluntary payments to make up for lost years.

The state pension is an important part of any retirement plan and the good news is that the amount has risen significantly because of the ‘triple lock’ – the policy of increasing the payment in line with the highest of wages, inflation or 2.5 per cent.

Last year the wages figures was highest meaning the state pension is set to rise by 8.5 per cent in April.

Currently, the maximum state pension is £203.85 per week (tax year 2023/24), which equates to £10,600.20 a year, but this might not cover all of your living expenses.

The Pensions and Lifetime Savings Association has estimates of what sort of lifestyle a single person or couple can expect when they retire, based on how much they’re able to save.

How much do you need to save? This shows what various annual pension amounts will pay for in retirement, based on a single person (Source: PLSA)

However these figures exclude housing costs, so you’ll need to think about putting some more cash away if you’re renting or still paying off a mortgage.

The PLSA estimates a couple would need to have £23,300 a year to live a moderate lifestyle and £37,300 a year for a comfortable lifestyle.

This means if you’re self-employed and have become used to a certain lifestyle, you might want to consider opening a private pension to supplement the state pension.

> How to start a pension from scratch and why it’s never too late to save

How the self-employed can set up a pension

It’s never too late to start saving for your retirement and thankfully, there are a lot of low-cost pensions available.

You will need to do your own research to ensure that you find a pension that works for you.

Some of the key questions you’ll need to ask yourself are:

If you already invest in an Isa, your platform will likely allow you to open a self-invested personal pension (Sipp), which allow you to control the investments that make up your pension pot.