What’s stopping the self-employed save?
We explore some of the barriers to retirement saving for the self-employed
By Benedict Dellot, Associate Director, and Fabian Wallace-Stephens, Data Researcher for Economy, Enterprise and Manufacturing at the RSA
Barriers to saving
That the self-employed are under saving for retirement is rarely contested. But the evidence documented in the last chapter revealed the extent of the challenge, as well as the acute danger facing certain groups like the lifetime self-employed. In this chapter, we turn away from the question of whether the self-employed are under saving to look at why this is the case. Many of the barriers will be familiar, such as low incomes and the absence of an employer to nudge, cajole and manage the administration of pension enrolment. But others hurdles are less obvious, for example the widespread myths about the rules surrounding pensions, and the underlying confusion caused by frequent policy changes. Here we explore these issues under three banners:
· Do the self-employed earn enough to save?
· Do the self-employed know enough to save?
· Are the self-employed hardwired to save?
Do the self-employed earn enough to save?
It is well known that the self-employed earn considerably less than employees. But the scale of the gap is worth repeating. According to the Family Resources Survey, the median wage for full-timers who work for themselves is close to a third less than their counterparts in salaried employment — a gap of £157 a week, or £8,164 a year. Moreover, the earnings gap between employees and the self-employed has widened over the last decade. Analysis by the Social Market Foundation shows half of the self-employed earn below the equivalent of the National Living Wage. Low wages in turn make it difficult if not impossible to save for the long-term. Thirty-eight percent of the self-employed with no employees say a main reason they choose not to contribute to a pension is because they cannot afford to (see Figure 8).
Top line figures can be misleading. The self-employed enjoy a lower rate of National Insurance contributions than employees, are able to claim back the cost of various expenses via tax relief, and in a minority of cases may under report their income to HMRC in order to lower their tax liabilities. Indeed, government surveys show that the self-employed are only marginally less likely to be satisfied with their income than employees. However, averages can hide a multitude of circumstances, and as we have already seen there are a large contingent of the self-employed who are poor on multiple dimensions — individual, household, income and wealth.
Figure 8: Most commonly cited reasons workers give for not contributing to a pension (Source: RSA analysis of Wealth and 4)
In addition to having low incomes, the self-employed are discouraged from saving due to fluctuations in earnings. The nature of having multiple clients and customers rather than a single employer means the self-employed are exposed to greater volatility. A taxi driver may have 100 fares one week and 50 the next, just as a farmer may have a bad harvest following a bountiful one. An RSA / Populus survey found that more than one in three (36 percent) of self-employed workers experience detrimental income volatility, which makes it difficult for them to make ends meet. Late payments make matters worse. According to FSB, 30 percent of its members’ bills are paid late, and nearly nine in 10 of these payments are delayed by a month or more. Under these circumstances it is difficult for the self-employed to know how much they can reasonably afford to save for the future.
Even where the self-employed do earn a reasonable sum and this is received in a predictable pattern, they may have other priorities for allocating that money. As with employees, many would prefer to use it to pay for a house deposit, or a family expense such as a wedding. Others have it in mind to pay off debts incurred during the launch of their business. These objectives are not necessarily incompatible with saving for the long-term, however popular products like pensions and the Lifetime ISA do not allow for early access of funds to cover such expenses (an issue we explore in the next chapter).
The UK’s obscure tax system further complicates matters. Since the self-employed pay their tax bills in arrears, many are left in doubt as to how much they owe the government and how much therefore they can afford to save. For example, tax liabilities accrued during the financial year April 2016 — March 2017 would have been paid by most of the self-employed at the end of January 2018, nearly 10 months after their money had been earned. What is more, recent research by Citizens Advice shows that many of the self-employed do not separate out household and business spending, with all money flowing into personal accounts. This in turn makes it difficult for people to understand the state of their finances and whether money can be diverted towards personal saving goals.
Case study: Sally, 59 — Black cab driver in London
Sally is 59 years old and has been a black cab driver in London for almost 20 years. She lives at home with her mum and youngest son. She has seven grandchildren and is always busy supporting her family when not working. Sally gets a buzz from visiting new places in London, and initially chose her job for the flexibility it afforded her when taking care of her then young children. She gets frustrated when business is slow and she ends up hanging around on taxi ranks, and has also noticed things becoming tougher for cab drivers with the rise of Uber.
Money has been a real worry for a couple of years, but she is generally able to make ends meet. Caring for her elderly mother and the rest of the family, she finds it difficult to be organised with her finances. Card payments in cabs make it harder to juggle things as there is a delay before money gets to her account. However, taxi apps have been helping her get more jobs and she feels they are “the way to go.” Her partner has a regular pay check and pays her a certain amount regularly for bills, but she is the one who manages the finances. She has been focused on paying off a £6,000 bill on a credit card for the past few years, and also has an overdraft.
Sally wants to work for as long as possible: “I wouldn’t want to end up totally on my own and not working, it terrifies me.” She knows she can’t drive a taxi forever, and hopes to get an ‘easier’ job such as working in Marks and Spencer’s. She has not been able to put any savings aside, as any extra income goes on supporting her children and grandchildren. She has never looked into pension options and knows little about how they differ from normal savings. She would like to start saving soon, but does not see how she could do this apart from by earning more money.
Do the self-employed know enough to save?
Just as financial circumstances present a barrier to long-term saving, so too does a lack of knowledge. Polling undertaken by the Association of British Insurers found that 50 percent of pension savers (enrolled through automatic enrolment) find pensions confusing, 22 percent are unaware of their contribution level, and only one in four recognise the benefits of tax relief. Other research by Prudential shows that more than two out of three people over the age of 55 are still confused about the new rules on pension freedoms, which for example mean they no longer have to purchase an annuity. The knowledge barrier is arguably greater for the self-employed who lack the guidance of a trusted HR department. Citizens Advice polling found that a quarter (27 percent) have never received information or advice about pensions from anyone.
A related problem is the perpetuation of myths and misperceptions. The same Citizens Advice research — this time based on qualitative interviews undertaken with the self-employed — identified several points of confusion about pensions in particular. Among widely held beliefs are that pensions need to be paid at a flat rate with no flexibility, that the state pension would be reduced if people had a personal pension, and that people would not be able to pass on their pension savings as an inheritance to loved ones. A further quarter (26 percent) wrongly believe that regularly paying money into an ISA will offer them better tax breaks than paying the same amount into a pension.
What accounts for this confusion? One factor is frequent changes made to government policy. In the last five years alone, a raft of measures have been announced including the introduction of auto enrolment (the terms of which will soon be revised), the creation of new pension freedoms (including the termination of a compulsory annuity purchase), the formation of the new Single Tier state pension (which directly affects the self-employed), and the launch of the Lifetime ISA, seen by some as a potential replacement for pensions. Even before these changes, the landscape of long-term savings products was difficult to navigate. Consider the tax treatment of pensions, where there are several bands of tax relief, a yearly tax allowance, an annual tax allowance, and a 25 percent tax free lump sum accessible at age 55.
The dense language used by the financial services industry adds another layer of confusion. Terms like annuity, SIPP, defined benefit, defined contribution, accumulation, decumulation and master trust are bewildering to many savers — not least the time-poor self-employed. While pension providers have tried to use simpler language, statements and other communication to savers remain complicated and verbose. A qualitative study by the Citizens Advice found the statements of their participants ranged from a concise two pages to a longwinded 46. One saver they spoke to in his early 50s thought he would not be able to access his private pension until he was 70 because he misunderstood his statement. Poor communication is a barrier both to building savings and to accessing them.
A lack of clarity on how pensions work may be reinforcing the view of the financial services industry as distant and untrustworthy. Research undertaken by NEST in 2014 indicated that consumers associated the industry with ‘corruption and incompetence’.[7] Last year, a survey by Which? found that less than a quarter of consumers — 23 percent — said they trusted long-term financial products, including pensions. This is considerably lower than the 40 percent who said they trusted day-to-day banking services. While the pensions, banking and insurance industry is more honourable than some media headlines would have us believe, people’s unease is understandable. Many are old enough to remember pension fiascos such as Robert Maxwell’s plundering of the Mirror Group pension scheme and the near collapse of Equitable Life in 2000.
Case study: Rebecca, 25 — Beauty therapist in Manchester
Rebecca is 25 and lives at home in Manchester with her mum. She has owned her beauty salon for three years, where she offers hair, nails, massages, tanning and other treatments. Prior to this she worked as a beautician at other salons and spa hotels. She likes the convenience and flexibility of having her own business, however sometimes finds it to be stressful and expensive. She hopes to be doing beauty work for as long as possible, however the industry is very competitive and so she has to make sure to keep up with training herself in the latest beauty techniques.
Rebecca prides herself on being very organised and knows exactly when and how much regular outgoings leave her business account. Her income, by contrast, is irregular and varied, although December is typically her busiest time and January the quietest. She has a partner but they live separately and so do not pool their resources. She makes ends meet each month but there isn’t much left over. She would like to save money but says it’s too difficult at the moment. Her biggest financial concern at present is the cost of her business rent.
Rebecca thinks about the future a lot and mainly hopes to be able to move out of her mum’s house and buy a place with her partner. She would love to retire when she is about 50, but doesn’t feel she has done anything to prepare for retirement yet. Her mum doesn’t have a pension either — she thinks that perhaps if her mum had, she would have done this too. She is worried that at 25 she might be too old to start a pension and also that “…what if I died when I’m 50? Would I not get it? Would my next of kin not get it?” She feels she does not know enough about pensions at present, particularly for self-employed people, and would not want to pick the wrong one. Trust in the pension provider is very important to Rebecca; she approves of HMRC and so likes the idea of raising the National Insurance rate. By
contrast, she thinks there’s a good chance of not living until aged 60, so would be wary of a Lifetime ISA.
Are the self-employed hard-wired to save?
A final set of barriers relate to behavioural heuristics and biases. The self-employed are ‘hard wired’ in just the same way as employees, of course. But what is different is how human biases interact with environmental decision-making contexts, which are different for the self-employed. One such bias is myopia, or the propensity to discount the future more heavily than the present. People are more likely to choose to be given £100 today than wait for £105 tomorrow, but would probably be happy to wait the extra day if the gift was offered in a year’s time. The psychologist Dan Gilbert believes this is because we view the near future through a concrete lens but the distant future through an abstract one. This can dampen long term saving, with earners (including the self-employed) more inclined to spend for today than save for tomorrow.
An understanding of bias can also shed light on why messages and adverts that extol the virtues of saving often fail to land. Availability bias, for example, captures the human inclination to remember information that is more salient, and therefore more alarming in nature. A single headline of a pension fund crashing or story of a couple losing their savings due to reckless actions in the banking industry are more likely to be recalled than a mountain of leaflets and emails that contain information about how most pension funds offer good returns. As the psychologist Paul Slovic puts it, humans have an innate tendency to focus on the ‘numerator’ rather than the ‘denominator’ when judging risks. The fear of an event often has little correlation with the probability of it happening.
Another hindrance to saving is confirmation bias, which refers to our tendency to ignore information that runs counter to pre-existing beliefs. In short, people can be locked into a state of mind, even when the available evidence indicates their viewpoint to be wrong. Cognitive bias also influences how people search for information, such that they use particular terms and questions to arrive at answers that confirm their opinions. Again, this may have a bearing on people’s financial behaviours. Once lodged in people’s minds, for example, the belief that property is as safe as houses or that pensions are highly risky is not easy to budge. One study suggests many business owners are susceptible to ‘post-decisional reinforcing’, whereby they exaggerate the attractiveness of a decision once it has been made.
The effects of these biases may be harder felt among the self-employed due to cognitive overload. A study by McKinsey found the average person is confronted with more than 100,000 words in daily communication. But the drains on attention are likely to be greater for the self-employed, who are often fighting multiple fires across their business and jumping from one job to the next. With so much time spent on creating a product or service, winning over new customers and managing accounts, the self-employed have little spare cognitive bandwidth to think about their future selves. More to the point, the self-employed often have less time on their hands. Many work excessive hours, with 27 percent clocking over 45 hours per week, compared to 18 percent of employees.
All of these biases should be seen in the context of a self-employed workforce that operates in isolation. Unlike employees, the self-employed do not have an employer who can mitigate these behavioural frailties. The power of inertia is often cited as one of the main reasons why auto enrolment has been so successful. People exhibit a status quo bias, meaning they often prefer to do nothing if they can stick with a decision that has already been made. Changing the default option therefore has significant effects on people’s behaviour. And in this context employees must now make an active choice to opt-out, which has made the option of continuing to make pension contributions more attractive. Self-employed people, on the other hand, must make an active decision to start saving for retirement — a decision made more difficult by loss aversion. Unlike employees, whose contributions are deducted from their payslip before it reaches their bank account, self-employed people do not have an employer with oversight of their finances. It is possible that they frame the diversion of their profits into a financial vehicle that offers no liquidity as a short-term loss, which creates an additional cognitive barrier.
Case study: Johnny, 30 — Personal trainer in Manchester
Johnny is 30 and lives in Manchester. He spends 20 hours a week as a personal trainer, doing a mix of work for the local gym and with his own clients. He has recently started working as a fitness instructor at a local school and also does food delivery for Uber and Deliveroo for around 5 hours per week. He loves the variety of his work, the sense of “creativity and flow” and has also got to know the streets of Manchester extremely well through his delivery work. He hopes to build his personal training business, and eventually he would like to open his own specialist martial arts gym.
There is some regularity to Johnny’s financial month, especially with outgoings. These are relatively few as he lives with his friend and his friend’s dad, and pays them £35 rent a week, which he sees as a “very sweet deal”. He is careful with his money and keeps track of what he has. He won’t buy things without checking he has enough money for them. Overall, he doesn’t feel he is short of money but thinks it’s good to be frugal: “It’s good to keep a bit of an impoverished mind-set.” His biggest financial concern is that he feels he may have all his “eggs in one basket”, in that all his work relies on him being physically fit. If he injured himself he is not sure what he would do.
Johnny knows that he won’t be able to rely on his physical fitness to make a living into his 50s, 60s and 70s. He is, however, keen to keep working for himself and also wants to invest his savings in something that will grow over time — he thinks that property and index funds are two good bets. He likes the idea of “accumulating wealth, having a set-up or a business that can be managed less and less by me over time.” Pensions do not appeal to him, primarily because he wants control of his own money and values “liberty”.
Having looked at the various barriers to pension saving, the next chapter spells out thirteen interventions that could begin to overcome them — from new products like the ‘sidecar’ pension model to the use of nudge techniques like auto escalation.
- Read more from the RSA on retirement security for the self-employed: Tax relief for the many
- Download the RSA Venturing to Retire report (.pdf)
- Follow the RSA on Twitter @theRSAorg
