The Pensions Minister is in favour of using self-employed people's tax returns to deduct pension savings in a move intended to help millions save for their retirement, can reveal.

In a recent interview with MSE, Pensions Minister Richard Harrington admitted that his favoured approach to solving the automatic-enrolment conundrum facing the UK's army of self-employed workers would be to adapt the annual tax return system so that pension contributions could also be made.

If you work for an employer and earn more than £10,000 a year, the chances are your company has already signed you up to a workplace pensions scheme via auto-enrolment. This means money will be automatically subtracted from your monthly pay cheque and added to your private pension pot, providing you don't opt out.

The auto-enrolment minimum contribution is initially 2%, of which at least 1% must be paid by your employer. Over time this will increase to a total of 8%, of which at least 3% must be paid by your employer.

However, no such auto-enrolment scheme currently exists for the five million self-employed people around the country. If such a scheme were to become policy it could go some way towards boosting pension provision for the self-employed.

It's not yet clear how it would work in practice and many questions remain about how beneficial the scheme would be. While employees who are auto-enrolled get matching employer contributions, that wouldn't to apply to the self-employed - though the tax implications and possible benefits of the scheme are yet to be thrashed out.

As things stand now, if you're self-employed, you have to actively take out a pension to guarantee you're putting money aside for your retirement. According to figures produced by the Department for Work and Pensions (DWP), just one in seven self-employed people are contributing to a pension.

Check out our Pension need-to-knows guide for full info on how best to plan for your retirement.

'Self-employed auto-enrolment equivalent could be through tax returns'

The DWP launched a review earlier this month to investigate how auto-enrolment can be developed further to encourage more people to put money aside for their old age.

As part of that review the DWP hopes to develop a better understanding of how self-employed people can be included within the wider auto-enrolment regime.

While it's only at discussion stage, Harrington told MSE he's in favour of linking pension saving for the self-employed to their tax returns.

He said: "What do all self-employed people have in common? Tax returns. So seeing as there's that common bond between them it seems to me not too difficult to say that a self-employed person's equivalent of automatic enrolment could be through their annual tax return.

"There could also be some tool that shows how much tax you save if you put in £1,000, or whatever it is. So we're looking at all that kind of thing in terms of new ways to do it."

He added: "I've included a load of things in [the auto-enrolment] review that we didn't have to do; one of them is looking at groups that aren't part of the automatic-enrolment scheme, which are not just self-employed people but also people who have multiple jobs where there is not one income more than £10,000.

"If you're looking at self-employed people then it's obviously more difficult because they don't have an employer, so our review will be looking at how to include these people in an auto-enrolment system."

Pensions Minister: Tax returns could allow self-employed to build up a pension
From 2019 the minimum auto-enrolment will increase to 8%, of which at least 3% must be paid by your employer

How would auto-enrolment for self-employed people work?

The DWP review is still in its 'call for evidence' stage and so it's not yet fully clear how auto-enrolment via the tax return system would work.

Financial services company Hargreaves Lansdown – which has previously championed using self-employed people's tax returns as a way to deduct pension savings – claims the process would be relatively straightforward.

Tom McPhail, Hargreaves Lansdown's head of retirement policy, said using the tax system for self-employed auto-enrolment would essentially involve building in an additional line on a tax return that addressed pension savings.

So for example, if you're self-employed and you earn £20,000/year you pay 20% tax, which works out at £1,800 once the £11,000 tax-free allowance is factored in. Under the auto-enrolment proposals you would pay an additional 5%, which would go towards your pension.

McPhail said: "The idea is still in its early stages, but there's policy interest. However, it's complicated by the fact that it requires buy-in from Treasury, the DWP and [HM Revenue & Customs]."

What other options are being discussed?

Another option for self-employed auto-enrolment mentioned by former Pensions Minister Sir Steve Webb involves exploiting the national insurance (NI) system.

When the self-employed fill in their annual tax return they are assessed for income tax and for class 4 NI, which is a profits tax. Sir Steve's proposal would involve the Government raising class 4 NI contributions – which apply to self-employed people earning more than £8,060/year – from 9% to 12%.

He explained: "Last year I produced a Royal London policy paper, 'Britain's Forgotten Army', about pensions and the self-employed, suggesting that by default their class 4 rate should be raised from 9% to 12% but they could nominate a pension scheme to receive the extra 3% if they wished.

"This would be in effect an 'employer' contribution into a pension scheme. They would then have to put their own 5% gross (as with employed earners once automatic-enrolment is up and running in full) and they would end up with 8% in total.

"They wouldn't have to put their own contribution in, but if they didn't then they would lose the 3% (it would go to the Treasury). This is analogous to the way that an employed earner who opts out of automatic enrolment loses their employer contribution."

Keep an eye on for our full interview with the Pensions Minister...