How to navigate the minefield of self-employed pensions
If you're one of the 345,000 people in Ireland who work for themselves, you need to pay special attention to your retirement plans
Published 23/10/2016 | 02:30
Many self-employed people will be in a precarious financial position come retirement - because they have not set up their own pension.
Without their own pension, they will be entirely dependent on the State pension - provided they qualify for it. The full State contributory pension will be €238.30 a week from March 1 - a struggle for anyone to get by on.
Should you be one of the 345,000 individuals working for themselves, do not let your pension slide.
So where do you begin?
Choose your pension
You have two main choices of pensions when self-employed: a Personal Retirement Savings Account (PRSA - a personal pension policy) or a personal pension plan. Should you opt for a PRSA, you must decide whether you want a standard PRSA or a non-standard PRSA. With a standard PRSA, your fees are capped so you can't be charged more than a 1pc annual fund management charge (charged for the management of your pension fund) while the contribution charge (charged every time you make a contribution to your pension) cannot be higher than 5pc. With personal pension plans and non-standard PRSAs, the charges can be higher or lower than those of a standard PRSA - but you usually have a greater choice of investment funds in which to put your money.
"Typically, for people new to pensions, we would recommend a standard PRSA as it is meant to be easy to understand," says Gerry Stewart, partner with Dublin investment consultants Fagan & Partners. "For someone making regular annual pension contributions during their working life, a non-standard PRSA may be better as there is more investment fund choice than a standard PRSA."
PRSAs are suitable for individuals who want to pay into a pension - but who are not completely certain about their income stream or cash flow, according to Stewart. "PRSAs can be started and stopped at any time and easily allow for once-off or regular contributions," says Stewart. "We tend to use personal pension plans for self-employed people whose income is more fluid - and who want an even wider range of investment choices and potentially lower charges."
Self-directed pensions are another option but they tend to be only used by savvy investors. With a self-directed pension, you decide how your pension is invested. The charges on self-directed pensions are typically higher than on regular pensions, according to Aidan O'Neill, senior financial adviser at Clear Financial.
Be wary of charges
When shopping around for pensions, find out what charges you could be hit with. Your aim should be to secure a good pension - with the lowest possible charges.
This time of year can be the ideal time to get a good deal on your pension. Many self-employed individuals make contributions to their pension ahead of the tax return deadline (October 31 for paper-based returns; November 10 for online returns) - and some life assurers are therefore competing for business.
"Life assurance companies are trying to attract pension customers before the tax filing deadline so there are lots of special or bonus offers - such as a reduced management charge," says Stewart.
When saving into your pension, aim to have most, if not all, of your pension contributions invested into your pension - as opposed to being gobbled up by charges. This is why you should check allocation rates (the percentage of your pension contribution which is invested in your pension fund) when shopping around.
"In general, allocation rates tend to be better on a personal pension plan but typically early surrender penalties [charged if you cash in an investment early] apply," says O'Neill. "A PRSA on the other hand will have lower allocation rates but will not have early surrender penalties."
The questions to ask
Along with checking the allocation rate, ask if there are ongoing management charges, policy fees - and any other charges.
"Ask how a company's funds have performed relative to its peers," advises Stewart. "Not all funds perform the same way and performance may vary between two funds that look or sound similar. Find out too if there are any early exit penalties - these can be applied if you decide to move your pension to another provider in the first five years. If you plan to manage your pension yourself or change funds regularly, the fund manager may charge a fee known as a fund switch charge. So find out what - if any - are the fund switch charges. Typically, there are a certain number of free fund switches allowed each year and there may be a charge thereafter."
Should you be hiring a financial advisor, find out how they're paid. Do they earn a commission or charge a fee - and if so, does this push up the charges on your pension? Your best bet is to hire an independent financial advisor as he can offer advice on all of the products on the market.
How to boost your pension
One of the biggest advantages which employees have is that their employer will often pay a contribution into the pension on their behalf - which makes it easier for employees to save up a reasonable pension. Self-employed individuals have no such benefit so it is important they do what they can to boost their pension.
"Start your pension as young as you can," advises Stewart. "The effects of compound interest are incredible so the longer you are saving for, the bigger your potential pension The growth you get in a pension is tax-free so your pension savings should grow faster than other savings."
Be sure too to take full advantage of the tax breaks on pensions when saving for your retirement.
You can get tax relief on pension contributions at your highest rate of income tax. This means you can claim back 20pc or 40pc of your pension contributions in tax relief, depending on the rate of tax you pay. There are limits to the amount of tax relief you can get on your pension contributions, depending on your age and earnings. It makes sense not to exceed those limits - but to increase your contributions once you reach an age which entitles you to a greater amount of tax relief.
Remember if you haven't yet filed your tax return, you still have time to make a contribution to your pension ahead of this year's tax deadline - and to chop your tax bill as a result.
Be prepared to take some investment risk with your pension - particularly if you are young. Understand - and be comfortable with - the degree of investment risk which you may be taking on though. As a self-employed individual, you are very much alone when it comes to your pension. Pensions are a complex area - so don't be afraid to pay for independent financial advice if you need help navigating this minefield.
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