The Best Self-Employed Pensions in 2023
- What Is a Self-Employed Pension?
- How a Self-Employed Pension Differs From an Employer Pension
- Why Pay Into a Pension?
- Self-Employed Pensions
- What to Look For in a Self-Employed Pension
- The 6 Best Self-Employed Pensions in 2023
- Self-Employed Pension Tips
- Final Thoughts
A pension is a savings pot created to give you an income after you retire.
If you are employed, you are likely to have a workplace pension that your employer pays into and to which you make contributions from your salary.
However, if you are self-employed, it is up to you to create a pension fund for yourself. You are likely to live 20–30 years after you retire and you are going to need an income.
When you are considering the best self-employed pension in the UK or the US, you need to understand the basics of what to expect and what to look for in a provider.
The basic structure of any pension plan or retirement fund is that after you have chosen a provider, you pay in a set amount either monthly or annually. In most funds, this is then invested with the idea that it will grow, and the payments are tax-free (as is any growth).
Once you hit a certain age (from 55 for some pensions, for others it is from age 59.5 or when you retire), you can choose to withdraw the funds as a lump sum or set up a monthly payout as income.
In the UK, it is the law that your employer has to offer you a pension as part of your employment contract. In most cases, you will be auto-enrolled into your workplace pension. In the workplace, you contribute to your pension from your salary before tax, and your employer also matches your contributions into your pension. The minimum contribution in total is 8%, and your employer must contribute at least 3%.
In the US, retirement funds are often a perk for employees that you can enroll in. These are similar to the UK version in as much as the employer makes contributions and there may be a voluntary element for employees.
Broadly speaking, there are two types of pension plans:
- Defined benefit – A guaranteed amount is paid upon retirement based on earnings and years of service
- Defined contribution – The specific amount available on retirement depends on the performance of the investment
The main difference between workplace pensions and self-employed pensions is that you need to organize it all yourself. While this can put extra pressure on you while you are trying to run a business, it also gives you the freedom of choice as to how you want to invest your pension funds.
In both the US and the UK, there is a government-sponsored pension available – so self-employed people might not think that they need a pension.
In the US, the social security pension is funded by workers who pay taxes into a fund. This fund is used to pay retirees and people who cannot work through disability.
Each year that you have worked will earn you credits towards becoming eligible for social security pension benefit. You need at least 40 credits to earn a pension (which relates to about 10 years of employment).
The social security pension replaces a percentage of your average earned income from the highest 35 years of employment; on average this works out at 40% of your pre-retirement income.
In the UK, the state pension is based on your National Insurance payment record and not everyone will be eligible unless they have completed 10 years of payments. Currently, the full state pension amount is £179.60 per week, but not everyone will receive the full amount. You can check online to see how much you will receive as well as what age you will receive it.
While both of these pensions allow for some income, it is not likely to be enough to allow you to live comfortably. The best practice is to ensure that your retirement fund is enough to provide you with 80% of your pre-retirement income for at least 25–30 years. Government pensions are a good foundation, but you need to contribute more.
In the UK, only 18% of self-employed people make contributions to a pension plan. In the US, at least 15% of self-employed people are not saving for retirement. It is understandable that when you are trying to establish and run a business, putting money in any other place than the business might be difficult.
Investing in a pension plan gives tax relief in so many ways. Not only can you invest pre-tax profits, but you also won’t pay tax on the investments or the growth. There are some limits on the tax relief available, but in general, pensions are a tax-free way to save and invest.
Pension contributions can also be offset against your profits in your tax return.
In the US, self-employed people have almost the same options for their retirement funds as their employed counterparts.
This plan is most suitable for a sole proprietor with no employees, or a spouse who is working for the business. It is essentially the same as a 401(k) offered as a company pension, but as a self-employed person, you can make contributions as both the employer and the employee.
The Simplified Employee Pension Individual Retirement Plan (SEP IRA) is probably the easiest to establish and operate. You can contribute up to 25% of net earnings (annual profit less than half of self-employment taxes).
You can also vary the amounts of contributions through lump-sum payments, and there are usually no annual funding requirements.
If you have employees, you must make contributions on their behalf with a SEP IRA.
A Savings Incentive Match Plan for Employees (SIMPLE) IRA is a cross between an IRA and a 401(k) pension. This tends to work best for a small business (with less than 100 employees).
Employers and employees can both contribute but the employer has to match the employees’ contributions up to 3%, or 2% if the employee does not contribute. Employers can put all their net earnings into a SIMPLE IRA.
This is sometimes known as an HR10, qualified or profit-sharing plan. It is the most complex to set up but often offers the most potential retirement savings.
A Keogh plan is for unincorporated businesses set up as a sole proprietorship, LLC or partnership and really benefits high earners who can make greater contributions.
Keogh plans can be set up as defined-benefit or defined-contribution plans and are funded on a pre-tax basis.
As deductibles for personal health insurance plans tend to be high, a Health Savings Account (HSA) can be created to save for out-of-pocket medical expenses and funded with pre-tax dollars.
If you do not withdraw from this pot, it could become a retirement fund. The fund will accumulate if you do not use the money for medical expenses, and you can withdraw it for any reason after the age of 65.
Anyone with employment income can set up an IRA. A traditional IRA is funded with pre-tax dollars and a Roth IRA is funded with after-tax dollars.
These are individual plans designed for private individuals, so they can be as simple or as complicated as you need them to be.
As in the US, most pension types offered as workplace pensions in the UK are also available as self-employed pensions. These are stakeholder pensions and Self-Invested Personal Pensions (SIPPs)
Stakeholder pensions usually have a lower, more flexible minimum contribution than many other pension types.
The charges and fees are often low as well, and the pension fund is invested in a particular way, so you don’t need to be involved in deciding where to put the money.
Self-Invested Personal Pensions (SIPPs) are a popular choice among the self-employed, and with research and advice, they could be a low-cost option with good returns.
With a SIPP, you will need to make the decision on how to invest your pension fund.
National Employment Savings Trust (NEST) is a government-created pension scheme designed to make simple workplace pensions available to employers and employees, but they are also available to self-employed people. This is a straightforward way to set up flexible pension contributions.
While the freedom of choosing your own pension plan means you can decide where to put your contributions, this also comes with the potential headache of making the best decision.
There are some aspects you need to consider when looking at different providers, to ensure that you are getting the best service and results:
Security – Is the institution you are choosing reliable and safe? Make sure that it is regulated in your country or state to provide retirement plans so that you are protected.
Safety – Building your retirement fund through investments means taking some financial risks. When looking at the right place for your capital, think about whether the investment profile matches your risk preferences.
Contribution levels – As a self-employed person, you want to put in as much money as you can, so a pension plan that allows for flexible contributions without penalty is probably more useful.
When you can access the funds – Some plans have a minimum age at which you can withdraw, whether you are still working or not. Many plans have allowances for hardship withdrawals such as critical illness, but it is important to understand the withdrawal procedure and if there are any penalties for early withdrawal.
Contributions from other sources – Pension schemes often offer interest and dividend payments to add to your investment. In the UK, taxpayers can receive 20% of their contributions in tax relief – so if you pay £100, HMRC adds £20.
What happens to your pension if you die? – In many pensions, your fund will become available to your spouse or children if you die, and this is not usually subject to inheritance tax. It is a good idea to check this out.
The Vanguard SIPP allows you to choose between 75 different low-cost funds to invest in. If you need some support, you can choose to invest in a ready-made portfolio designed for retirement.
There is a 0.15% account fee (capped at £375 a year) and no other fees. You can add to the pension fund whenever you want, with a minimum contribution of £100 per month. Existing pensions can be transferred across in most cases.
The withdrawal age for the Vanguard SIPP is 55.
Aviva is an award-winning pension provider, voted as the best in customer experience and the best by experts.
The Aviva plan is a SIPP, and you can spread your investments between a number of shares, fixed interest, property and money markets. It has a flexible contribution set up, where the minimum is £50 but you can pay in lump sums whenever you like. The withdrawal age is 55, and you can choose to withdraw as a lump sum or set up a monthly income (or a combination of both).
The Aviva Charge is an account fee that is up to 0.40% depending on your total fund. This is calculated daily and charged monthly. There is also a fund manager charge that depends on the investments you make.
The Legal and General Pension is a SIPP that has five ready-made funds available with differing levels of risk. Each fund is managed by award-winning experts, so you know that your investment is being looked after.
You can withdraw from age 55, and the online account makes it simple to keep on top of contributions and investments so that you know where your money is performing well.
This is a cheaper option in general for most people as the platform fee is only 0.15%, but the minimum investment is £100 so it might not suit smaller self-employed businesses.
The Fidelity Investments retirement plan is a 401(k) offered by a well-known online brokerage. It offers a no-cost way of investing and contributing, with no annual fees, no opening or closing costs, and no commission on stock or ETF trades.
It also offers a wide range of retirement resources including calculators and education that investors might find useful.
You can withdraw from the fund when you turn 59.5 years of age, or if you become disabled. It is payable to your beneficiaries if you die before withdrawing.
The Fidelity 401(k) plan does not allow for Roth contributions and you cannot currently contribute electronically, just over the phone or through traditional mail.
E*TRADE offer a traditional IRA that is popular with self-employed people. As a subsidiary of Morgan Stanley, a respected online broker, they offer reliable investment options with no annual fee or account minimums.
Investments can be made in stocks, bonds, options, futures and ETFs.
The E*TRADE IRA offers more flexible withdrawal options – from age 59.5 like most retirement plans, but also for a first-time home purchase, higher education costs and certain major medical expenses.
Charles Schwab is another well-known financial company that offers a one-participant 401(k) with no monthly service fees and no account opening fees. There is also no minimum deposit, so you can start your retirement savings with any amount and make flexible contributions.
Charles Schwab also offers a number of online trades with no commission so you can decide easily where and how you want to invest without it costing the earth.
There are higher potential contribution limits offered by Charles Schwab, and the opportunity to make profit-sharing contributions as well as salary deferrals.
Charles Schwab defines a ‘triggering event’ as something that allows withdrawals from the fund. This includes termination of employment or retirement, without penalty, after the age of 59.5. If you withdraw early, you may be subject to a 10% penalty.
Even small amounts are better than nothing, but the best thing you can do for your future is to make sure that you can provide yourself with a reliable income when you are no longer working.
In an ideal world, this would mean paying into one as soon as you start a job – as early as your first paper round.
Once you know that amount, divide it over the number of years you plan to continue to work (how many years until you retire) and that will give you a rough idea of how much you need to put away.
For example, if 80% of your current income is $20,000, you need to have a retirement fund of around $600,000.
If you are starting your pension at age 35, and plan to work until you are 65, that means you have 30 years of saving to do and need to fund at least $20k a year.
While the above calculation might seem difficult, you may already have some funds in workplace pensions that you could combine into your self-employed pension, making your capital higher and giving you more to invest in your chosen fund.
Consider the calculation used by Martin Lewis (the Money Saving Expert):
Take the age you start your pension and halve it. Then put this percentage of your pre-tax salary into your pension each year until you retire.
For example, if you start at 20, you should contribute 10%; if you start at 50, you should contribute 25%. The idea of saving before salary, before buying new stock for the business, and even before paying bills might not seem easy, but it makes sense because you don’t necessarily want to still be working at age 80.
The only real exception to this idea of paying as much as you can, as soon as you can, is if you have high-risk debts that could affect your capital or your assets. It is always a better idea to pay off your debts first. They will have an equally negative effect when you are retired, and you will be less likely to pay them off even on an 80% income.
For most self-employed people in the UK, a traditional personal pension is usually the most secure and attracts the best government top-ups (20% extra on each contribution can make a huge difference, even on a £50 payment).
In the US, a one-participant 401(k) is usually the preferred choice as it offers much more flexibility and is reasonably simple to set up.
Finding the right place for your retirement fund and the right self-employed pension provider to give you the most value in terms of final payment and flexible contributions will help you ensure a comfortable retirement – something that could be hard to achieve using state pension income alone.
Whatever method you choose, saving for your retirement is a necessity, so anything is better than nothing.