Pensions, a self-employed secret weapon

A version of this article was first published in April 2021

When you’re self-employed, you quickly learn how to get the most from your budget. After all, it’s your hard-earned money.

Eeking out a higher margin. Maximising any advertising spend. Tweaking dividends vs. salary. Each small decision has big consequences for your bottom line.

You do everything you can to maximise your return. The question is, why do you do all this only to lose so much to tax?

Luckily, you have a little-known ally in your quest. Your pension.

Pension basics

Ok, let’s start at the beginning. Pensions are a confusing area and not everyone knows what they are or how they work.

Put simply, your pension is a tax-efficient way to save for retirement. For most, when they think of pensions they think of the State Pension. This is a yearly income paid to you by the government when you reach retirement age — currently set at 66, however, it’s likely this will increase from 2026.

To qualify for a State Pension, you need to have paid national insurance for 35 years — at which point you can receive a maximum of £221.20 a week — a little over £11,500 a year. For the majority of us, this simply isn't enough.

A private pension refers to any type of pension that isn’t the State Pension. There are main two types:

• Workplace pensions
• Personal pensions

If you've worked for an employer in the past, chances are you were enrolled in a workplace pension scheme. You may have forgotten that these old pension pots exist.

As someone who is self-employed, you’ll want to know about personal pensions. A Self Invested Personal Pension (SIPP) is a type of personal pension. A SIPP allows for flexible investing and gives you the most control over where your money is invested.

With a SIPP, you can make ‘personal’ or ‘employer’ pension contributions, or you even mix between the two. Your money is invested in a fund of your choosing where it can grow tax-free, ready for when you reach 55 years old (or 57 after 2028).

Right, this all sounds great, but your retirement might be a long way off. Why should you worry about a pension now when there are so many other things you need to pay for? Two words: Tax. Relief.

Why pensions matter

Working for yourself leaves you short on time — it’s no surprise that planning for retirement quickly falls down your list of priorities. But what if there was a way for you to benefit from a pension, today?

Currently, it’s estimated that only 20% of the UK’s self-employed contribute to a pension, compared to 80% of employed people. The outcome? A large proportion of those driving the UK economy simply aren't taking advantage of the benefits of saving for their future, with a 2024 study by the Institute for Fiscal Studies declaring a ”pension’s crisis” for the self-employed.

But here’s the real issue: it’s estimated that around £1.3 billion in tax relief is left unclaimed each year because not enough people know about the benefits of paying into a pension.

We’re here to break down exactly how you as a self-employed worker can dramatically reduce your tax bill with a pension.

How pensions reduce tax

First, you’ll get to take advantage of the tax relief at source. A ‘personal contribution’ into your pension saves you 25% in tax relief.

Let’s say for example you add £1,000 into your pension. The government will add an extra £250 — this is because you’ve already paid £250 tax (at the basic rate of 20%) on the £1,000 you contributed to your pension.

The government incentivises people to pay into private pensions by offering vast tax breaks on anything that adds up to the yearly limit. Most SIPPs claim this tax relief for you.

But that’s just the start.

Extra benefits for higher-rate taxpayers

If you are a higher or additional rate taxpayer, you can enjoy even more tax relief. Your contributions to your pension will automatically receive the 25% tax relief, but because you’re paying a higher rate tax above the basic rate threshold, the government will pay back the tax you’ve already paid by offsetting it against your self-assessment tax return.

This means that contributions of £1,000 into your pension will have £250 added on top by HMRC, and you’ll also be able to claim an extra £250 in your self-assessment tax return.

How much could my pension save me?

When you’re deciding how much to contribute to your pension each year for tax relief, it’s important to take into account your annual and lifetime allowances.

For most people, tax relief on pension contributions is capped at either their salary or £40,000 — whichever is lowest.

There is no limit to the value you can save in a pension, called the Lifetime allowance or LTA. The LTA was abolished from 6 April 2023.

Final thoughts

Pensions aren’t just a long-term investment to set yourself up for the future. They’re also a fantastic way to make sure you keep more of your hard-earned profits today.

The same could be said for business insurance. If you’re self-employed, having the correct cover in place can protect you from risks that could affect your business.

Superscript offers business insurance for all kinds of business types, from sole traders, freelancers and business owners, whether you’re a lone wolf or have employees.

You may also like:

• What is the retirement age in the UK?
• What types of pension schemes are there in the UK?
• National minimum wage: what employers need to know