Summary
There have been widespread concerns about the patterns of retirement saving amongst self-employed workers, who now make up just over one in eight of the whole labour force. Most strikingly, the fraction of self-employed workers earning over £10,000 who are making contributions to a private pension has been around 20% since the early 2010s. That compares with over 80% among employees. Self-employed workers who want to save in a pension must arrange their own personal pension, in contrast to most employees who will be automatically enrolled into a workplace pension by their employer. However, many self-employed workers have private pensions from previous employment, save in other forms of wealth, or are married to or cohabiting with someone who does have a workplace pension. The state pension system has also become more generous for the self-employed since the introduction of the new state pension in 2016. This report summarises the patterns of saving and wealth among the self-employed, including new modelling on the potential adequacy of saving for the self-employed compared with standard benchmarks. From the concerning trends we uncover, it is clear that reform is overdue; we therefore also set out some policy options for policymakers to choose between.
Key findings
1. The distribution of total wealth of the self-employed is similar to that of employees who are not currently saving into a defined benefit (DB) pension, while both of these groups have accumulated much less wealth than employees currently saving into a DB pension. A key difference is that the self-employed hold less of their wealth in private pensions and more of it in property wealth, financial wealth and, towards the top of the wealth distribution, business wealth. As with employees, there is substantial variation in the amount of wealth that self-employed workers have accumulated to date, with around a quarter of self-employed workers having no more than £10,000 in total wealth.
2. It is of particular concern that the direction of travel for the self-employed is quite different from that for employees. Among self-employed workers making annual profits of more than £10,000, only one in five is saving into a pension, down from three in five in 1998. Meanwhile, automatic enrolment has boosted workplace pension participation among employees earning more than £10,000 a year to over four in five. Many of the self-employed who do save in a pension make the same cash-terms contributions for many successive years, rather than increasing them as earnings grow, as typically happens with employees.
3. If the self-employed were to continue building up private pension wealth at their current rate, we project that around 55% of the self-employed would not have any pension savings to supplement their state pension entitlement in retirement. Consequently, in the absence of other private resources to fund retirement, two-thirds would not reach their Pensions Commission replacement rate benchmark (a percentage of pre-retirement income that is thought to approximate ‘smoothing’ of living standards from working life into retirement) and three-quarters would not achieve the ‘minimum income’ standard produced by the Pensions and Lifetime Savings Association. An important caveat to these results is that they assume that all today’s self-employed workers continue to save the same proportion of earnings into a pension as today for the rest of their career. This is unlikely to be the case for self-employed people spending significant time in future working as employees, for whom pension saving rates are higher.
4. These inadequacy rates are markedly higher for the younger self-employed than for those at older ages, with only one-fifth of 25- to 34-year-olds projected to reach their target replacement rate, compared with almost half of those in their 50s. This partly reflects the falling rate of pension participation over time among the self-employed. Adequacy in terms of replacement rates is lower for higher earners, reflecting the fact that the state pension replaces a lower share of their earnings and that private pension saving is not sufficient to bridge the remaining gap for most.
5. Although a larger proportion of younger age groups are currently not on track to hit adequacy benchmarks, the saving rates required to get back to those benchmarks typically appear to be more achievable for the young than for older people because they have a longer period over which to make up any saving shortfall. On average, self-employed workers not currently saving into a pension, aged 25–34 and in the third quartile of earnings (annual earnings of £22,200 to £39,000) would need to save 9% of their income to hit their replacement rate target. That compares with 18% for those in their 50s and in the same quartile.
6. An important point to bear in mind alongside these results is that the self-employed accumulate wealth in forms other than pensions. For those in their 50s, we find that including non-main-property wealth, financial wealth and business assets as sources of retirement income leads to 20% more of the self-employed being on track to hit their target replacement rate. Much of this increase comes from people higher up the wealth distribution who hold larger amounts of this other wealth. This means that the outlook for higher earners in younger age groups is in all likelihood better than the outlook in our central projections because they may subsequently accumulate these other types of wealth and use them to fund their retirement.
7. Once the resources of the partners, and the potential future inheritances, of the self-employed are taken into account, a larger proportion reach adequacy benchmarks, particularly among those with lower earnings. While individuals – and for that matter policymakers – may not want to rely on these resources being available and shared with the self-employed once they reach retirement, it does indicate that for a substantial proportion the outlook may not be as stark as individual-level modelling implies.
8. Together, this provides some concerning and some more reassuring evidence on the prospects for the retirement incomes of the self-employed. Reasonable people can differ on how much policy action is needed to make it easier for the self-employed to save for retirement. Nevertheless, in our judgement the status quo, in which self-employed people have to arrange their own pension plans without assistance, is no longer fit for purpose, particularly given the effort the state has put into making pension saving easy for employees and the extent to which the self-employed are no longer engaging with personal pensions.
9. We suggest policymakers choose between one of two options. One is to require all self-employed individuals filling out a self-assessment tax return to make an active choice about the level of pension contributions to make at that point (with zero being an option). Any contributions made would then go into either a nominated private pension plan, a government-chosen default pension plan or a Lifetime ISA. Evidence suggests this would boost pension participation, though there is some uncertainty about how much. While the increase would be expected to be smaller than under automatic enrolment, this might be considered appropriate given that for some – or indeed many – self-employed individuals, private pensions might not be the right saving option.
10. A second option would be a form of automatic enrolment, again operationalised through the self-assessment tax return, with HMRC selecting a pension provider if no decision was made by the individual. As defaults can be powerful, this should be limited to those with self-employment income above a certain trigger, perhaps set at the level of the equivalent trigger for employees or at the level of the new state pension. Default contributions could be introduced at a moderate level and increase over time to equal the default total contributions for an employee with the equivalent level of earnings. A straightforward way to opt out should be available for those who do not wish to make a pension contribution. Those declaring to be already making pension contributions on their self-assessment form could either be not enrolled or be enrolled with contributions equal to the default level minus their declared contributions. An option to instead divert savings to a Lifetime ISA could also be introduced.
11. To help self-employed people who are saving in a private pension save a more appropriate amount, the defaults on direct debit contributions should be changed. At the moment, contributions typically remain fixed in cash terms. A range of options for automatically increasing contributions each year should be provided, perhaps with a default of rising in line with the Consumer Prices Index.
Further reading