With the State Pension age edging higher and higher, the idea of living comfortably off a state pension when you reach retirement age increasingly seems like a thing of the past. It is now more important than ever before to make sure you have your own plans to save for retirement.

However, building up a good private pension as a freelancer or contractor comes with its own set of unique challenges. The government’s Taylor Review into working practices found that self-employed people are less likely to be saving for their retirement than regular employees and that only 23 per cent intend to rely on a personal pension in retirement.

With the number of self-employed people rising rapidly in the UK (from 3.3 million in 2001 to 4.8 million in 2017), more and more people risk setting themselves up for difficulties in retirement.

With that in mind, here are the key things that freelancers need to know about pensions.

You have to do it yourself

The government is taking steps to ensure that regular employees build up an adequate workplace pension through auto-enrolment, requiring your employer to match your pension contributions up to a certain percentage of your salary.

But what if you are your own employer? Auto-enrolment does not apply to sole traders, contractors or company directors working through a personal service company. If you fall into this group, you’ll need to make your own provisions for a pension.

There are several different types of pension – personal pensions, self-invested personal pensions and stakeholder pensions, which have various features and are available from various different providers. If this seems daunting, don’t worry. A good financial adviser can help you to work out which option is best for you.

You should start now

It pays – quite literally – to start saving for a pension early, because investments in a pension can benefit from compound growth – in other words, any returns from your investments can be reinvested to potentially grow further.

For example, if your investments pay interest, as you earn interest on your money, your overall pension pot grows. When you earn interest on this larger pot, you earn interest on both the amount you first put in and the interest you’ve already earned. This means that you gradually earn interest on a larger and larger amount of money. Over time, your savings and investments will grow at a faster and faster rate.

An investment that gives a 5% annual return on an investment over 30 years will more than quadruple your money. A higher rate of return or saving over a longer period will grow your savings even more.

And yet young self-employed people who are most able to make the most of compound interest are least likely to be saving for a pension. Only 4.2% of 15-34 year old self-employed people were participating in a pension in 2014/15. This group is missing out on potentially huge gains. For young freelancers, putting money away may be difficult and retirement may seem a long way away, but anything you can contribute now will pay dividends further down the line.

You can reduce your tax bill

If you work as a contractor through your own limited company, you can treat pension contributions as an allowable business expense. This means that it gets taken from pre-corporation tax income, allowing your limited company to save on its tax bill. Employers also don’t have to pay National Insurance on pension contributions. This means you can save even more by contributing directly into your pension rather than paying yourself through a salary.

Even if you’re a contractor and you pay into your pension through your salary, there are still valuable tax savings to make. Contributions to a personal pension are taken from pre-tax income, so any amount you contribute to your pension will instantly avoid being taxed at the marginal rate of tax you pay.

You benefit even more from this if you’re a high earner. If you’re a higher rate taxpayer, you save even more by putting money into a pension rather than paying tax on it. For each pound you earn over £50,000 (2019/20 tax rates), you could receive 40% tax relief by putting it into your pension.

Whether you save more by paying into your pension directly through your limited company or paying from your salary will depend on a number of factors, including your own earnings. It can therefore be helpful to speak to an accountant who specialises in freelancers and contractors to help ensure you’re making the most of tax relief on pension contributions.

Tax and pension rules are constantly shifting, and it can be difficult to keep track of the best way to manage your finances, especially if you’re a busy freelancer or contractor and you have to put time into finding – and maintaining – your clients.  There are several considerations to take into account before making pension contributions, such as annual limits, and we would advise consulting a regulated and qualified financial planner to discuss your options.