Self-employed or business owner? Why you must set up a pension now

As a self-employed individual or a business owner in the UK, especially if you're still in your 20s, 30s, or 40s planning for retirement may not always be at the forefront of your mind. It’s easy to kick pensions and retirement planning into the long grass but every time you do it’s costing the future you and your family in the long run.

Setting up a pension is a crucial step toward securing your financial future and it doesn’t even have to cost you. In this blog post, we will explore why it's imperative to start a pension plan and all the more so if you're self-employed, working in the gig economy or running a small business.

We'll discuss how regular contributions, compounded over time, can yield substantial returns, examine the growth potential based on the UK stock market's performance, and highlight the tax advantages of pension contributions for both sole traders and limited companies.

What is a Pension?

A pension is a long-term financial plan that individuals establish during their working years to ensure they have a stable source of income once they retire. It is essentially a savings mechanism designed to support people in their post-employment phase of life.

Here's how it works: During your career, you regularly contribute a portion of your income, either voluntarily or through employer contributions, into a dedicated pension fund or account. These contributions accumulate over time, often with the benefit of investment growth, such as through stock market investments.

Once you reach retirement age, typically around 65 in many countries, you begin to withdraw funds from your pension. This withdrawal can take various forms, including regular payments, lump sums, or a combination of both. The aim is to provide financial security during your retirement years, ensuring you can cover essential expenses like housing and day-to-day living costs.

Pensions offer several advantages, including tax benefits and the potential for compound growth on invested funds over the years. They provide individuals with peace of mind, knowing that they won't be solely reliant on state benefits or family support during retirement. Instead, they can enjoy a measure of financial independence and maintain their standard of living as they transition into their golden years.

The Power of Compound Interest

One of the most compelling reasons to start a pension as a self-employed individual or business owner is the magic of compound interest. Compound interest is the concept where your investment earns interest on both the initial principal and the accumulated interest. Over time, this compounding effect can lead to significant wealth accumulation.

Let's consider an example: Suppose you start investing £100 per month in your pension fund at age 30, and your investments grow at an average annual rate of 6%. By the time you reach age 65, your pension pot would have grown to approximately £176,000. This demonstrates that even small, regular contributions can compound into a substantial retirement fund.

UK Stock Market Growth

Historically, the UK stock market has shown robust growth over the past two decades, despite occasional market downturns. For instance, the FTSE 100 index, which tracks the performance of the UK's top 100 companies, has delivered an average annual return of around 5-6% over the long term. This underscores the potential for healthy returns on investments made within a pension plan.

Tax Advantages for Sole Traders

As a self-employed individual, contributing to a pension comes with significant tax benefits. You can claim tax relief on your pension contributions, effectively reducing your taxable income by the amount you invest in your pension. The amount you can contribute and receive tax relief on is subject to annual limits but these are generous and currently capped at £60000 per year in the UK. By contributing to a pension, you not only save for retirement but also lower your immediate tax liability, which can lead to substantial savings.

Tax Advantages for Limited Companies

If you're a director of a limited company, you can make pension contributions through your company. These contributions are treated as an allowable business expense, reducing your company's taxable profit. This approach not only benefits your retirement planning but also reduces your corporation tax liability. It's a tax-efficient way to reward yourself and invest in your future.

Conclusion

Whether you're a sole trader or a limited company owner in the UK, setting up a pension is usually a wise financial decision. The power of compound interest, coupled with the historical growth of the UK stock market, can help you build a substantial retirement fund over time. Moreover, the tax advantages of pension contributions provide immediate and long-term benefits to both your personal and business finances. Don't delay—start planning for your retirement today and secure a financially comfortable future for yourself as a self-employed individual or business owner. Speak to an accountant about the business implications and an independent pension expert and take your time picking someone to advise you if you do not feel confident choosing your own investments.

It's often said that the best time to set up a pension was 10 years ago but the second-best time is today. Even if you feel you’re late to the pension party – take the time to get one started there’s tons of info out there and it can take minutes to set one up.