If you’re going it alone and are concerned your twilight years could leave you a little cash strapped, you’re not the only one.
Research commissioned by us shows that 32% of self-employed people worry about their financial future and half say they have no pension whatsoever1.
It’s natural to stress about maintaining a comfortable lifestyle after the 9-5 is no more. So, how can you maximise your retirement wealth?
Set up a pension to benefit from tax relief
A pension is often a cornerstone of financial planning because of tax relief on contributions.
If you have a relief-at-source pension, which is what Nutmeg offers, then your contributions benefit from a government top-up.
Thanks to tax relief, a £100 pension contribution effectively turns into £125 – or significantly more if you are a higher rate taxpayer. You can benefit from tax relief on contributions up to an annual allowance (£40,000 for the tax year 2019-20) or up to 100% of your annual earnings, whichever is lower.
If you’d rather wait until the end of the tax year to make your contribution, you’re allowed to pay into a pension in a lump sum. This can be a good option for freelancers and other self-employed people because it gives you flexibility. You pay in what you can afford, after you’ve worked out what you owe the taxman.
Own a limited company? Try employer contributions
If you’ve set yourself up with a limited company, you have another option: make direct contributions to your pension from your company. These are called employer contributions, as opposed to personal contributions (you can top up your Nutmeg pension with either, but the tax treatment is slightly different).
Employer pension contributions can count as an allowable business expense, which often makes them a tax-efficient way to invest in a pension. Subject to certain conditions, you can pay pension contributions out of your company’s pre-tax income, meaning they are free of corporation tax. You can use this method to make up to £40,000 a year of employer pension contributions, though the sum cannot exceed your company’s profits.
Some limited company owners use this method to make large pension contributions while taking only a small salary, which they top up with dividends – another practice that can be tax-efficient.
Consider drawdown over annuity
When you retire, you have the option to buy an annuity, which is a type of financial product that guarantees a fixed income for the rest of your life.
The security of an annuity income is reassuring but it comes at a cost. You’ll often need a very large pension pot to lock in the income you desire. Another option is not to buy an annuity but to take out the income you need from your pension while keeping the rest of it invested.
In drawdown, as this latter option is called, you have the potential to benefit from investment returns, which could increase the value of your pension even as you withdraw from it. However, you also incur investment risk because the value of your pension could decline if you suffer investment losses.
Take an appropriate level of risk
On the subject of risk, the amount of risk you are willing to take with your retirement savings is a big factor in determining how much you may have at the end.
The Nutmeg pension calculator reveals that the difference is enormous between an average investment return of, for example, 4% and 6% over the lifetime of a pension. Generally speaking, you may get a better return if you are willing to take more risk with your investments, for example by investing the majority of your pension in equities rather than bonds. However, you may experience higher losses if you take more risk, because the prices of financial assets can go down as well as up. You don’t want a stock-market crash to halve the value of your pension the day before you retire. For this reason, you might decide to take more risk with your investments when you are younger and gradually reduce risk the closer you get to retirement. The theory is that a young person still has many years ahead for their portfolios to recover from the effects of a crash, while an older person needs that money soon and cannot afford to wait.
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It is best to start early
This may not be helpful advice – unless you have a time machine– but the truth is that starting early is the best thing you can do to help achieve a sizeable pension.
Again, the Nutmeg pension calculator helps to show what a difference it makes to start investing in a pension at, for example, 30 instead of 40. A common rule of thumb is that you should work out your regular contribution by taking your age at the time you start and halving it. That number is the percentage of your salary you should contribute every year. So, if you start a pension at 30, you should contribute 15% of your salary each year until retirement. If you start your pension at 40, you ought to contribute 20% each year (any contributions made by your employer would count towards this total).
Lower your fees to minimise your cost of investing
This is a subject close to our heart at Nutmeg because we were founded to provide a low-cost alternative to traditional wealth managers.
By using efficient trading technology and investing in exchange-traded funds (ETFs) we keep our fees at a level well below the average of other discretionary fund managers. Other things being equal, any saving you make on the total cost of investing will improve your average annual return, which, as the pension calculator reveals, can have a big impact on your final pot. Reducing fees can be a powerful way to boost your retirement savings in the long term.
 Populus conducted on an online sample of 2,076 GB/UK adults between 2-4 July 2019. Data is weighted to be representative of the population of Great Britain. Targets for quotas and weights are taken from the National Readership Survey, a random probability F2F survey conducted annually with 34,000 adults. Populus is a founder member of the British Polling Council and abides by its rules. For further information see: http://www.britishpollingcouncil.org
Risk warning: As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Pension rules apply and tax rules may change in future. Please note that during any transfer, your investments will be out of the market. If you are unsure if a pension is right for you, please seek financial advice.