Flexible workers need flexible pensions

Self-employment: how do you build a nest-egg if the state won't help and there's no company funding?

It is no secret that the state has been doing less to provide for decent pensions for both those working and those already retired. The link between the basic state pension and average earnings was broken in the 1980s, and the value of the State Earnings-Related Pension (Serps), is being steadily eroded. But while employed individuals can, in many cases, look to their company for a pension top-up, the self-employed are neither eligible for Serps nor do they have the company safety net. All this makes personal planning even more important for people who work for themselves.

A time-honoured way for the self-employed to pay for retirement is to sell the business. If the business has assets, such as property or "goodwill", that others will pay for, this can work. A garage, shop or pub might sell as a going concern, but someone who sells their time, such as a computer programmer or management consultant, will find it harder to realise a lump sum.

A personal pension plan is a more reliable option. Flexibility, however, is vital. The self-employed in particular should be on the look-out for pension plans that allow holders to vary or stop payments without penalties and make additional payments without extra fees.

A conventional pension levies the bulk of its charges, including commission, in the first few years. This means that if a policyholder stops payments, or needs to surrender or transfer the plan, its value is lower than they might expect. An alternative, the "level-charge" plan, spreads the costs across the lifetime of the savings period. "With a level-charge plan you can stop and start the plan whenever you want to," explains Paul Gauntlet of Moores Marr Bradley, independent financial advisers. "There may be a minimum of pounds 30 a month, but beyond that you can vary the premiums. If you hit hard times, it allows you to reduce your premiums or stop altogether."

Pension companies are moving towards this form of plan. Two years ago, Scottish Widows repriced its pensions to reduce the upfront costs. "If, for some reason, you have to stop paying, the value of your plan will be broadly what you have invested," says Kevin Ward, marketing manager.

The personal pension market is becoming more competitive, and the self- employed can also pursue a number of radical options, including a self- invested personal pension (Sipp) that in effect owns the business premises. Alternatively, if you are more than a sole trader, you could set up a company scheme and negotiate a block discount.

One advantage of having the business premises as part of your pension fund is that growth in the value of the property is not liable for capital gains tax (CGT). But Lee Coates, of Ethical Investors Group, says there can be problems with this approach. "One drawback is that a lot of self- employed people rely on being able to sell the business as part of their retirement planning. If the premises are part of your pension fund, that might make it more difficult."

Most self-employed people will be more comfortable with off-the-shelf personal pensions. These score over other investments because of their favourable tax treatment. But this might change: the Government is rumoured to be considering reducing pension tax breaks, perhaps by restricting upfront tax relief to the standard rate of income tax or reducing the ability to reclaim tax paid on dividends. Changes could be announced on 2 July, when Gordon Brown presents his Budget.

Financial advisers suggest that pensions should be just a part of an individual's retirement planning. Mr Coates goes further. He believes that high charges make pensions an expensive way to save, especially for people who have either a low income, or an income that varies. He suggests tax-free PEPs as an initial, highly flexible way to save. As the business grows and an individual pays more tax, then is the time to look at a pension. Pensions are better value, in terms of charges, the more you pay in, and for higher-rate taxpayers the 40 per cent upfront tax relief is a significant boost.