The whole idea of a pension is that during your earning years, you put a bit aside to sustain you once you are too old to work. At this very basic level, everyone who is earning should be saving for retirement and the government is keen to encourage us with generous tax bonuses because they do not want us dependent on state benefits in our dotage.
The deal is you get back the income tax you paid on earnings that you put in a pension. So if you are a basic rate taxpayer and you pay £100 into a pension, you get a bonus of £25 added to your investment from the taxman – not bad!
If you were employed, you would automatically be enrolled into your employer’s workplace pension. At least 8% of your earnings would be invested into the pension pot of which you personally would pay 4%. With no employer to share the load, I am afraid it is all down to you, but this 8% of earning is a good starting point to make sure you are at least on an even footing with the minimum pension funding levels in the employed population.
These days people tend to reduce the amount of work they do as they get older, rather than choosing a specific date, working flat out right up to R day and then quitting altogether. I think this is especially so for freelancers who can flex the amount of work they take on. In line with this trend, pensions have adapted to provide flexible access to the pot, to top up income or maybe just provide a few one-off lumps to cover extraordinary costs once our earning capacity begins to dwindle.
It is important to know that you cannot access your pension before age 55 – even if you are desperate! So it is important to have an alternative and accessible pot to cover preretirement emergencies and spending plans.
All this fabulous flexibility is good to know about, but it does make the job of working out how much pension pot you need trickier to calculate. Much will be dependent on what you have in other resources and the pattern of spending you forecast in retirement.
There are plenty of calculators out there such as this one to help you plan: https://www.moneyadviceservice.org.uk/en/tools/pension-calculator
The trick to planning for anything that is many years away is to remember the effects of inflation. For example, if your household bills are currently £1,500 per month and you are considering your budget requirements in 28 years’ time, you should expect these bills to have doubled to £3,000 assuming inflation is 2.5% per year. Another way to think of this is that you need £20,000 in 28 years’ time to buy the same amount of stuff you can get for £10,000 today.
If your pension is invested appropriately the effects of inflation can be reduced by good returns on the investment. What the right pension investment is for you will depend on many factors; how many years it will be invested before you need access, your personal preferences about whether you are focused on cost management, or maybe having an impact on social or environmental issues. Do you want a no surprises ride or an exciting experience? Everyone is different and your pension pot needs to reflect you and your values.
As a freelancer, you are looking for a Personal Pension and there are hundreds of providers eager to sell you their plans but remember it is not the provider of the pension wrapper that is the most important factor – it is the investment option you choose within the wrapper. If you were auto-enrolled into an employer’s pension scheme you would have no say about who provided the scheme wrapper because your employer would have made that decision, but you would get to exercise choice over how your fund is invested. Same thing applies when you set up your own personal pension – make sure the wrapper you buy gives you access to investments that suit you and what you’re trying to achieve. It is no good buying a cheap wrapper from a provider who only offers index-tracking funds if you want to invest with a particular focus on say, high growth Indian funds or socially responsible funds.
In summary – Pensions offer a unique tax bonus that make an unbeatable option for long term investment. Pay in at least 8% of your earnings and when choosing your pension provider start with making sure you get access to the investment option that suits you and then find the cheapest wrapper that gives you access.
This information is not intended as an alternative to personal financial advice and it may well be worth getting some specific advice on the best pension for your needs and the optimum level of contribution.
Samantha Secomb FPFS
Chartered Financial Planner
Founder of Women’s Wealth