Self-employed missing out on £4 billion in pension contributions

The estimated figure highlights the gap in pension provision between self-employed people and employees.

There are around 4.3 million self-employed people in the UK missing out on an estimated £4 billion in employer pension contributions a year, according to analysis by interactive investor.*

This estimate is based on what self-employed people would probably receive from an employer if they were in employment, rather than working for themselves, and assumes they are missing out on employer contributions worth 3% (the auto-enrolment minimum) of gross salary. However in reality, many employers pay in more than this on behalf of staff.

An estimated four in five self-employed people are not putting any money in a pension at all.* Pension participation rates among the self-employed rose to 18% in 2019-20, up from 16% in 2015, according to the latest Family Resources Survey (see notes to editors).

Even so, that equates to roughly 3.5 million people who are not making their own pension contributions. As well as not getting employer contributions, they are also missing out on tax relief, which they could receive if they set up their own pension.

The tax relief foregone by these 3.5 million people is estimated to be around £1 billion a year (based on basic rate relief).

The scale of estimated total missed employer contributions underlines the need to address the huge gap in pension provision between self-employed people and employees, to prevent self-employed people facing poverty when they eventually stop work and becoming dependent on the state pension or pension credit; or alternatively, having to continue working past state pension entitlement age.

For example, for a full-time employee on median pay of £31,461, the total 8% pension contribution (% of gross salary) in one year would be £2,516, typically made up of an employee contribution (5%) of £1,573 including tax relief (1%) of £314 and personal payment of £1,258, as well as an employer contribution (3%) of £942.

Meanwhile, a self-employed person earning the same amount and paying in the same proportions of income would have to pay the additional £942, to put themselves on a level playing field with employed friends.

Becky O’Connor, Head of Pensions and Savings at interactive investor, said: “Pensions are likely to be the furthest thing from someone’s mind if they choose to go it alone. Especially during the pandemic, some hard-hit self-employed people have had more immediate and urgent things to deal with.

“But the amounts self-employed people could be missing out on in pension contributions through no longer being employed and receiving employer contributions are staggering.

“Self-employed workers are at a disadvantage when it comes to building up adequate retirement savings because they tend to earn less, but also because they don’t have an employer to set up a pension for them or pay in employer contributions. This is something the government needs to address as ultimately, the self-employed are more likely to depend on the state if and when they do stop work, if they haven’t set aside their own pension provision.

“But self-employed people can take action for themselves. It is important they are not tempted to cut the pension corner when they choose to go it alone – or else they may struggle for income when they get older (It’s safer to assume you will want to give up work at some point, rather than planning on working until you drop.)

“If you are self-employed, even if you don’t benefit from employer contributions, there is still the incentive of tax relief from the government – effectively free money - on contributions into a personal pension. Tax relief is equal to 20% of your contribution if you are a basic rate taxpayer, 40% if you pay higher-rate tax and 45% for additional rate taxpayers.”

Why do more self-employed people not pay into a pension? Some possible reasons

• Many self-employed people who set up businesses could plan to sell the business to fund retirement
• Some may feel they don’t earn enough to afford a pension
• Some might believe it isn’t worth it without employer contributions

Why you should consider setting up your own pension if you are self-employed:

• Self-employed people still get tax relief at their marginal rate of income tax on their pension contributions, so even without employer contributions, pensions are still worthwhile investments for self-employed people. As illustrated above, for someone earning £31,461 on a self-employed basis, tax relief on pension contributions worth 5% of earnings would be £1,573 over a year (4% personal contribution, 1% tax relief)
• You need something to live on when you stop work
• You may not end up working past retirement age, due to ill health or caring responsibilities

Becky continues: “Personal pensions are available from some of the UK’s biggest pension providers and Self-Invested Personal Pensions (SIPPs) are also a good option for those who want more choice and control over where their pension is invested (for example, if you want to invest in ethical funds).

“Many personal pensions require small contributions to get started. If you put in £80 a month with tax relief at the basic rate of 20% automatically added, your monthly contribution becomes £100 a month. Over the year, that would mean a contribution of £1,200 would cost you £960 in your contributions, with the rest added in the form of tax relief. Don’t forget, you should get some investment growth on top too, which should build up over time.

“Basic rate tax relief is automatically added by your provider, but if you are a higher or additional rate taxpaying self-employed person, you have to claim the additional relief through your tax return.

“While auto-enrolment has a minimum total contribution of 8% from employees and employers, when calculating how much to pay into your own personal pension, consider that some experts think that contributions worth more like 20% of salary are now required to generate sufficient retirement income for most people.

“If you are going self-employed and trying to work out how much you’ll need to contribute to make up for the loss of employer contributions, then find out what your employer was paying in as a percentage, then add this to what you need to pay in yourself.”

Notes to editors

• £4 billion based on number of self-employed people and 3% employer contributions of gross salary (not qualifying earnings)
• * Estimate based on Family Resources Survey
• Calculations based on median pay for full-time employees at £31,461 (Family Resources Survey)
• Minimum employer pension contributions 3% (of gross annual income)