How can self-employed workers supplement their pension

How self-employed workers can increase their state pension

All workers should be giving some thought to their retirement, and they should also find out how much pension they are due to receive when they retire. This is especially important for self-employed workers.

Self-employed workers and those working for a company or public entity share the two critical variables that are applied when calculating a state retirement pension: length of contribution period and contribution bases. However, this similarity ends here as, according to the data provided by the Social Security Institute, the average pension for a self-employed person is €987.69 a month, whereas that of an employee is €1,689.35 a month. What is the reason behind this 41% difference in what some workers receive compared to others? The difference is primarily due to the contribution bases used to calculate their contributions over the span of their working career.

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As mentioned above, the amount of the public pension received by a worker is determined based upon the length of time during which contributions have been made and the assessment base used to calculate these contributions; and this is where the key difference is found: whereas wage earners pay contributions based on an average base of €1,693.08 a month, self-employed persons pay contributions on a average base of €978.94 monthly and this has negative repercussions on their pension calculation. The freedom to choose the payment base leads more than 90% of the self-employed under the age of 47 to pay the minimum base, which for 2016 is €893.10.

There is also a second factor that explains the difference seen in the amount of pension received by self-employed workers compared to other employees: The contribution system used for the first group does not have a formula to incorporate contribution gaps, while the system used for other employees does. This leads to a significant penalty when calculating the pension if there have been periods with no contributions.

Increase the contribution base

There are various ways self-employed workers can increase the amount of their state pension. Firstly, unlike company employees, self-employed workers can freely modify their contribution base. In other words, as self-employed workers, they can choose to make larger contributions, and thereby increase the amount they will receive once they retire. However, in order to significantly increase their pension, this option requires a considerable increase in the contribution base, and furthermore, this freedom to determine the base they use only applies until age 47, when the right for self-employed workers to modify their contribution base upwards is restricted.

Also, self-employed workers can only change their contribution base twice each year, which means that if they decide to increase their contribution base they will be obligated to cover this additional cost even during months when their income has been lower and they cannot afford it.

However, as well as increasing their contribution base, self-employed workers can consider the option of opening a pension plan and contributing a small amount of money into it periodically. Over time, this can add up to a significant amount and can provide a supplement to their future public retirement pension.

Open a pension plan

A pension plan is a product based on saving and investment that is designed primarily to accumulate savings that will become available at the time of retirement, and which, due to its characteristics, provides numerous benefits for self-employed workers.

An interesting feature of this product is that you can deduct contributions from your personal income tax return up to a maximum of €8,000 a year. This reduces the taxable income and can offer significant tax savings.

For example, if a worker earns €24,000 a year, their personal income tax band means they will pay 30% in tax. However, if that same worker contributes €4,000 a year to their pension plan, this will lower their personal income tax band to 24% and reduce their taxable income to less than €20,200, the limit between bands.

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In addition to this tax relief, remember that contributions made to pension plans are flexible.  This means that at any time you can choose how much you want to contribute to the plan (a maximum of €8,000 per year) and when to do it, either periodically (monthly, quarterly, half-yearly) or at certain times. This characteristic makes pension plans a very appropriate form of savings for workers who, like the self-employed, do not earn a fixed amount every month. 

Although the maximum yearly contribution is €8,000, it is important to point out that the maximum annual amount exempt from tax is the lower of the following amounts: €8,000 or 30% of net income from work or economic activities.

Moreover, the contributions made to a pension plan do not stay ‘stranded’ in a checking account, but instead will be invested by experts in pursuit of maximum returns with the lowest risk. This means that the account holder of a pension plan can select the type of pension plan that best fits their risk profile: conservative, moderate or decided. Depending upon the profile selected, it can be expected that when the time comes to redeem the pension plan, these investment returns will have allowed the capital deposited to have increased significantly. 

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