Pensions for self-employed people – Part 3: Making pension contributions
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Posted: Tue 19th Apr 2022
In part 2 of this guide, we explained how to set up a pension when you're self-employed. Doing this as soon as possible is crucial, as your pension is your financial security for when you stop working.
But once you're set up, what then? How do you begin making the all-important pension contributions that will support you in retirement?
In part 3 of our six-part guide, we take you through when and how to set up and make pension contributions. We explain pension contribution calculators and how they can help you plan ahead. We also cover tax relief on pension contributions and other ways to offset the tax you might be liable for.
Listen to episode 2 of PensionBee's Pension Confident Podcast: Keeping your self-employed pension on track
When should I start my pension?
Ideally, you want as much time as possible to save for your retirement and give your pension fund longer to grow. With this in mind, it’s a good idea to start a personal pension as soon as you can. Even if you can only make small contributions at first, it's important to get things up and running right away.
Here's an example of why it pays to start your pension early:
You're 30 years old and you earn £30,000 a year from your self-employed job
You decide to save 15% of that salary into your pension pot
When you retire at age 65, your pension may be worth around £196,100*
But what happens if you wait 15 years?
You're aged 45 and your yearly salary is £30,000
You decide to make pension contributions of 15%
When you retire at age 65, your pension may be worth only £109,500* – that's a difference of nearly £87,000!
(*These figures are intended for illustration only. As with all investments, capital is at risk and the value can go down as well as up. We've assumed a retirement age of 65, that your plan earns a 5% return before the effects of inflation and have taken inflation of 2.5% into account.)
Because you're self-employed, you aren't getting the benefit of employer pension contributions as part of a workplace pension scheme. As a result, it's up to you to grow your personal pot for your eventual retirement.
How do I make pension contributions?
With a personal pension, it's really simple. You can:
set up a direct debit and have regular contributions going into your pension pot (every month, for instance)
make one-off payments by bank transfer
Whichever pension provider you go with, you'll be able to set these payments up online, at the provider's website or using its app.
Again, it's worth remembering that as someone who's self-employed, the amount saved in your pension pot is only what you've paid in yourself. Because you aren't enrolled in a workplace pension scheme, you aren't receiving workplace pension contributions from an employer.
Making pension contributions from your limited company
If you run your business as a limited company, you can either make personal pension contributions or company pension contributions. Both options have tax benefits, as we explain below.
Personal pension contributions
When you make personal pension contributions, the government usually provides tax relief. So, as a basic-rate taxpayer (you earn between £12,571 and £50,270), you get a 25% top-up automatically. That means for every £100 you pay into your pension, the government adds £25.
(Note: This will change in 2024, when the government lowers the rate of basic of income tax from 20% to 19%. As a result, the tax top-up will become 23.46% rather than 25%.)
If you're a higher-rate taxpayer (you earn between £50,271 and £150,000) or an additional-rate taxpayer (you earn over £150,000), you can claim further tax relief through your self-assessment tax return.
Although there's no cap on your personal pension contributions, there is a limit to how much you can contribute and still receive tax relief. For 2022/23, this is 100% of your salary or £40,000 (whichever is lower).
If you earn less than £3,600, you can still receive tax relief on pension contributions up to £3,600 gross (before tax). That means you can save up to £2,880 net (after tax) plus a 25% tax top-up.
Company pension contributions
As the director of a limited company, you can contribute company income (before tax) to your pension. Because these contributions are considered an allowable business expense, you can offset them against whatever corporation tax you owe. You'll receive tax relief on those tax payments, meaning you could save up to 19% in corporation tax (25% from April 2023).
It's important to understand company pension rules for allowable expenses. Like any business expense, to be an allowable deduction, your pension contributions have to be made 'wholly and exclusively' for the purposes of the business.
HMRC's guidance states that pension contributions will normally pass the wholly and exclusively test and qualify for tax relief, but may be restricted if there's a clear non-business purpose.
Another benefit is that as a limited company, you don't pay National Insurance on pension contributions. The National Insurance rate for 2022/23 is 15.05%, so by making contributions directly into your pension rather than paying the equivalent in salary, you save up to 15.05%.
That means, in total, you can save up to 40.05% by paying money directly into your pension rather than in the form of a salary. Though it will depend on your circumstances, it may suit you financially to make company pension contributions rather than personal pension contributions.
Do I pay tax on my company pension?
If you operate as a limited company and take both salary and dividends, the dividends don't count as 'relevant UK earnings'. Only the money you take as income is used to work out the limit of tax relief on pension contributions.
Taking a small salary and a large dividend means your pension tax relief limit will be low. If you exceed your limit, you'll pay more tax.
How much should I pay into my pension?
It's up to you how much you pay into your personal pension and how often. However, make sure you're clear on what the pension provider charges, as sometimes there can be fees for stopping contributions temporarily or leaving your pension to lie dormant.
The amount you save into your plan will depend on things such as:
how many years you'll continue to work (i.e. what age you plan to retire)
how much you can afford to contribute
what level of income you'd like when you retire
Consider each of these aspects when deciding on your level of pension contributions. If you have any other pensions (previous workplace pensions, for example), also think about how much you have saved in those.
As a general rule of thumb, try to pay 15% of your yearly salary into your pension. If you have some money left over each month, putting it in your pension pot can be a good idea, not least because the tax relief means you earn more than the interest you might get on other saving products. If your salary increases, also consider increasing your pension contributions.
What are the pension contribution limits?
Maximum pension contribution
The pension contribution limit for 2022/23 is 100% of your salary or £40,000 (whichever is lower). If you pay more than this into your pension, you won't receive tax relief on any amount over the limit.
Instead, you'll be liable for tax on that excess amount. This is known as an annual allowance charge, and will be added to the rest of your taxable income for the year when your tax payments are calculated.
Alternatively, you may be able to ask your pension provider to pay the charge from your pension benefits. In some situations, you may be able to reduce the charge by bringing forward some of your annual allowance from previous years.
Carry forward rule
Under this rule, if you reach your annual allowance (see Maximum pension contribution above) in one year, you can still make pension contributions and receive tax relief. You do this by using unused allowances from the three previous tax years.
You can't receive tax relief on contributions that exceed your earnings in any tax year. So, for example, if you earn £30,000 in a tax year, you can only contribute up to £30,000 to your pension that tax year.
No matter how much unused allowance you have from the previous three years, you can only bring forward £20,000 so your pension contributions equal your annual salary.
Claiming tax relief for previous years is particularly useful if your income changes from year to year, which can happen if you're self-employed.
Minimum pension contribution
Depending on the provider, there may be no minimum limit for paying into a personal pension. A cap only applies if you're making pension contributions to a workplace pension scheme.
What is a pension contribution calculator and how do I use it?
A pension contribution calculator is an online tool you can use to estimate how much your pension fund will be worth when you retire.
There are lots of these tools available, and they're all designed to help you plan effectively for your retirement and work out whether you're on track to save the amount you need.
You simply provide some basic details – such as your current age, retirement age, the income you want in retirement, and your current level of contributions – and the tool tells you what size of pension pot you can expect to have when you eventually stop working.
*This guide is sponsored by PensionBee. As with all investments, capital is at risk and the value can go down as well as up.
In part 4 of this guide, we look at how you can find and transfer old pensions from previous employment.
Read the other parts in this series:
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