Time to focus on getting 2020 pension vision for self-employed

To rise to the challenge of creating pensions for the self-employed, the solutions must consider not only the role of financial services products, but also labour laws. Through IR35, we have already seen the government making reforms that impact contractors and consultants, and it is possible that in the future there will be labour market interventions for gig economy workers.

However, for the traditionally self-employed – those who have a direct relationship with their clients rather than via a third party – it is possible that a ‘directive’ savings framework will one day be established.

Auto-enrolment will not work

Auto-enrolment is directive and it has been very successful, so the obvious challenge is: why not simply extend this to cover the self-employed?

That will not quite work due to three key differences between employed and self-employed workers.

We need to fundamentally rethink how we approach lifetime savings – introducing flexibility into the system so savers can access their own cash when they need it most would be a very good start

First, employed workers have a ‘someone else’ (their employer) making a significant contribution. Second, behavioural finance works if you are employed, but it is difficult to auto-enrol yourself without noticing you have done it if you are self-employed. Third, the tax treatment of the employed and self-employed is quite different.

It is probable that a product other than a pension will be required.

When I first started work in the industry, we had occupational pensions for employed workers and retirement annuities (or Section 226) products for the self-employed, and so the precedent already exists to meet the needs of the two groups through separate product structures.

Without an employer and a payroll system, other ways need to be found to make it easier for the self-employed to put money away into whichever product structure is deemed most appropriate.

It is likely that a technology-based solution will be required, and the role of banks, accountants and the payments industry will be explored by the government, with the goal to determine whether there are any touchpoints at which it would be convenient for the self-employed to make a retirement savings transaction.

What are the incentives?

Although there is not an employer contribution in the traditional sense, it is effectively possible, as many of the self-employed do employ themselves via their own limited companies.

The tax system also works differently, with many of the self-employed taking a salary of just £10,000 and then also taking profits from their business through dividends. They contribute to the exchequer through a combination of income tax, corporation tax, capital gains tax and value added tax.

Even if the existing exemptions for directors of limited companies did not apply, a small salary would put many below the qualifying threshold for auto-enrolment and would base contributions on potentially only a small proportion of their overall income/wealth accumulation.

It may be necessary to allow income and assets other than just salary to be considered for purposes of assessment or allowances, and it may be necessary for the government incentive to be based on a bonus structure, rather than one of tax relief or tax deferment.

The traditionally self-employed who are taxed on this basis face further complications. Unlike those operating through limited companies, there is no opportunity for their business to pay an employer contribution to get around the fact that the maximum tax relievable member contribution is the greater of £3,600 or 100 per cent of relevant UK earnings.

In addition, their relevant UK earnings are determined by the accounting period ending in the tax year in question. If they use a March 30 or April 5 year end, this can mean they do not get a definitive figure until well after the end of the tax year.

Time to focus on flexibility

We believe that wider reforms are required in order to address the challenge of people not saving enough, and those in or facing financial hardship. We need to fundamentally rethink how we approach lifetime savings – introducing flexibility into the system so savers can access their own cash when they need it most would be a very good start. 

People should not have to choose between financial security now and in their future. We have previously suggested that the introduction of a hardship facility that can be integrated with retirement saving, allowing savers to access up to £1,000 on up to five occasions, could help deal with times of financial hardship throughout their lives.

We believe this would also benefit the self-employed. Our research reveals that if they had access to their savings, it would increase the attractiveness of pensions. In addition, 45 per cent of young people who are self-employed said they would save more for retirement if there was a facility to have limited access to funds on a rainy day.

Realistically, it could take more than a generation for the required changes to make a material difference. So we need to build on the positive momentum of auto-enrolment, find ways to encourage greater engagement, and above all else ensure people understand the importance of saving more than the statutory 8 per cent if they want to have a comfortable retirement.

Peter Glancy is head of policy at Scottish Widows