If you’re a freelancer, chances are that saving for retirement is at the bottom of your to-do list – if it’s on your list at all. HMRC’s most recent statistics show that roughly only 360,000 self-employed earners contribute to a personal pension – that’s around one in nine sole traders!
Despite this low uptake, contributing to a private pension as early in life as possible can have some serious benefits down the line. For starters, giving your funds as much time as possible to compound will help grow the pot you’ll rely on later in life. As they say, time in the market beats timing the market.
Better still, the government offers tax relief on private pension contributions, as a way of incentivising saving so you’re less reliant on the state pension. While the state pension can be a valuable security net, it may not be enough to cover your living expenses when the time comes (we’ll discuss why in just a tick).
So how do private pensions work? How do you get started? How much should you be contributing? And what happens when it’s time to withdraw your private pension funds? Great questions all. Here’s everything you need to know:
- What is a private pension?
- Why should you contribute to a private pension?
- How does tax relief on private pension contributions work?
- Hnry makes contributing to your private pension automatic
What is a private pension?
A very long time ago (the 12th century, to be exact) various groups and communities began recognising the value of supporting those too old or injured to work. These were some of the earliest recorded “pensions” in the UK, granted by churches, guilds, or even the king, to support individuals who had contributed to society throughout their lives. These early pensions weren’t always financial – sometimes it was a gift of productive land, or a cushy position. Not everyone was afforded a pension, and there were definitely more than a few who fell through the cracks.
Fast forward a few centuries to the current pension system, where we’ve basically papered over those cracks. Modern retirement is funded by both state and private pensions, which work together to help take care of people in their old age.
State pensions
A state pension is a regular stipend paid out to individuals once they reach state pension age, as long as they meet certain requirements. It’s administered by the government, and the government has the power to tweak the system as needed – for example by raising the age at which you’re eligible, or increasing the amount of money you’ll receive.
The state pension is financed through National Insurance contributions and general taxation.
Private pensions
A private pension is just that – a pension that is private. It’s essentially your own savings for retirement that have been invested on your behalf by a pension provider, and locked away until you’re eligible to access them (typically at minimum pension age, with limited exceptions).
While the government can do things like incentivise private pension contributions, change the age at which you can access your savings, or tax the funds when they’re withdrawn, they have less control over private pensions than state pensions.
Contributing to a private pension is one way to help make sure you’ll have enough to live on come retirement, without relying solely on the decisions of the government.
Why should you contribute to a private pension?
Great question. There are actually a few good reasons:
1. You can claim tax relief on contributions
State pensions are a huge chunk of public spending - £124 billion in FY 2023/24, to be exact – and the amount needed to maintain the current level of funding grows more and more every year.
It’s why (in part) the government offers tax relief for private pension contributions – it’s a way to incentivise people to save for their own retirement, hopefully easing some of the strain on the state pension system. The more people contributing to private pensions, the more breathing room the government has.
If you’re a basic-rate taxpayer, you’ll automatically receive 20% tax relief on all private pension contributions. If you’re a higher-rate taxpayer, you may be able to claim a further 20%, while additional-rate taxpayers may be able to claim a further 25% (but more on all this in a sec!).
2. Compound returns
You know how small habits performed daily lead to big wins in the long run? Good news: when it comes to investing, it’s the exact same story.
When you contribute to a private pension, your money will be invested on your behalf (or managed by you, if that’s more your speed). Ideally, this investment will net you returns.
💡 Very simply, returns are any gains (or losses) earned on an investment.
Instead of withdrawing those returns, they’re added to the capital and reinvested, in order to generate further returns. Returns earned on returns are called compound returns, and they’re magic. Compound returns can help grow your private pension pot far beyond what you can save on your own.
In theory, more of your own savings = more returns = even more compound returns. Investing regularly in your private pension helps you ride out market ups and downs, while building a bigger pot to benefit from compounding. Over time, this can make a huge difference!
Take advantage of this financial magic and blow your savings goals out of the water.
3. You’re less reliant on the state pension
Like we said earlier, the government of the day has the power to change the pension system. This means they could raise the age of retirement (like they did in 2020 and between 2026-2028), or recalculate the amount pensioners receive.
Imagine working hard for years, only for the government to shift the goalposts on your ability to retire. If you were fully reliant on a state pension, you’d have less flexibility. Contributing to a private pension means you have more control over when you can start your golden years.
Tax relief on private pension contributions
The tax relief currently offered by the government could make a serious difference to your pension pot over the years. How much relief you’re eligible for depends on your earnings level. Here’s how it works:
Relief at source
If you’re a sole trader contributing to your pension, and you earn less than £50,270 annually, your pension provider will automatically be able to claim 20% tax relief for your contributions. This 20% will automatically be added to your pension fund on your behalf. Nothing further needed from you!
(It’s called “relief at source” because the tax relief is claimed immediately at the – well, source – instead of through a tax return.)
Let’s say you contribute £80 to your private pension. You’ll receive tax relief of 20%, meaning an additional £20 will be added to your contribution, for a grand total of £100 towards your pension fund. Whoo!
Additional tax relief for higher earners
If you live in England, Wales, or Northern Ireland, and you earn above the £50,270 threshold, you’re eligible for additional tax relief – but you’ll need to apply for this yourself through a Self Assessment.
While the first 20% of tax relief you’re eligible for will automatically be claimed for you, you can apply for:
- An additional 20% up to the amount of any income you have paid 40% tax on
- An additional 25% up to the amount of any income you have paid 45% tax on
If you live in Scotland, you can also apply for additional tax relief, just at different rates:
- An additional 1% up to the amount of any income you have paid 21% tax on
- An additional 22% up to the amount of any income you have paid 42% tax on
- An additional 25% up to the amount of any income you have paid 45% tax on
- An additional 28% up to the amount of any income you have paid 48% tax on
Whew! These rates correspond to the set income tax rates – in effect, claiming tax relief on your contributions is the equivalent of making contributions from your pre-tax income. Tada!
Workplace pensions
If you’re an employee as well as a sole trader, and you’ve signed up for your office’s pension scheme, the tax relief for your employee contributions is usually handled automatically by your employer or pension provider.
This will either be through the relief at source system, or through a salary sacrifice, where contributions are made from your pre-tax income. If you do the maths, it broadly works out the same.
Under auto-enrolment rules, the minimum total contribution is 8%, with at least 3% coming from your employer and the rest made up of employee contributions and tax relief. While you won’t be eligible for relief at source for your employer’s contributions, it’s still a good way to boost your overall pot!
One thing you’ll need to note, though, is whether or not tax relief is claimed through relief at source, or if your workplace opts for a salary sacrifice system. If it’s the former, you’ll need to claim any additional tax relief you’re eligible for yourself, through your Self Assessment.
Which brings us to –
How to claim tax relief on pension contributions
Like we mentioned earlier, relief at source is claimed for you automatically. But if you’re claiming additional tax relief, you’ll need to include all your pension contributions in your Self Assessment tax return.
📖 Never filled in a Self Assessment tax return before? Good news – we have a guide that walks you through the process.
You can declare any pension tax relief you’re eligible for in the pension contributions section of your tax return. Here you’ll need to state the total amount you’ve contributed to your private pension across the relevant financial year.
Once you submit your tax return, HMRC will refund the extra tax relief you’re entitled to by reducing your tax bill, or, if you’re a salaried employee, changing your tax code so you pay less PAYE tax this current financial year.
Whether or not you add any of this additional tax relief to your pension pot is completely up to you!
💡 If all this sounds like a lot of faff, hi! We’re Hnry. We’ll complete and file your Self Assessment tax return for you, including claiming any additional tax relief you’re eligible for on your behalf. See how it works.
Hi! We’re Hnry
We’re a tax app and service designed to automate tax and financial admin for sole traders. Wow, that’s a mouthful.
Basically, for 1% +VAT of your sole-trader earnings, capped at £600 +VAT a year, we’ll automatically sort all your tax bits and pieces for you. This includes calculating and deducting your:
- Income tax
- VAT (if applicable)
- National Insurance contributions
- Student loan repayments (if applicable)
We can even help you automatically contribute to your private pension every time you get paid. It’s a set-and-forget system that’ll have you saving for your future like a pro.
Better still, we’ll automatically complete and file your Self Assessment tax return when it’s due. We’re also Making Tax Digital compatible, meaning you won’t have to lift a finger to stay compliant.
If all this sounds good to you, brilliant! Join Hnry today.
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