Why is it important that you consider a pension? After all, you’re healthy, young and making loads of money. Aren’t pensions for elderly folk? Not at all.
Pensions for contractors can reduce your tax bill substantially as well as providing a retirement income for your future. Pensions will not only save you money today, because of the enormous tax breaks, but will also provide you with a lot more money for when you do retire.
Important Facts about Pensions for Contractors:
- Contactors with a limited company are able to contribute “pre-taxed” income into a pension avoiding personal and corporations taxes
- Contractors can now fund their personal pension from limited company income and there are no longer any limitations to the contributions you make, apart from the annual tax relief allowance which is currently £245,000.
- Pensions needn’t be about putting money aside to purchase an annuity. You can take 25% of your pension savings as a tax free lump sum providing you are over 55.
- Since April 2006 (dubbed A-Day), you no longer need to purchase an inflexible low value annuity, instead the funds can be left invested and you need simply draw an income from the pension pot each year.
- Up to the age of 75 your pension savings can be passed on free of inheritance tax to your surviving family provided you’ve not purchased an annuity.
- Pension fee charges have reduced considerably. Stakeholder pensions are ideal for contractors in the UK who are eager to save for retirement, secure in the knowledge that they won’t be charged excessive fees.
- You can choose from over 100 funds to invest in and your pension fund grows free of income tax and capital gains tax.
- Pensions represent the most tax efficient method of transferring money from your limited company into your personal hands.
- This would obviously represent a very tax efficient method of transferring funds from company into personal hands.
- You can now make contributions into as many different pension plans as you like
Pensions for Contractors - Save You Tax
The fundamentals are clear and simple. Generally you pay tax on your income. When part of this income is diverted into a pension, you save most of the tax you would generally pay in to it. So, if you haven’t already considered setting-up a pension, you’re probably paying a considerable amount of tax that you could otherwise be avoiding. And for those contractors that are caught be IR35 the tax savings are even greater as you save on the employers and employees national insurance contributions. Depending on your personal situation the amount of tax relief can be as high as 48%.
How Tax Relief Works
If you are a one man limited company contractor and are a higher rate tax payer working outside of IR35 tax legislation, your accountant would have probably advised you to take a low salary, and the rest of your contract income taken in dividends. If not, you need to look for a new accountant.
Let’s take the following example where you draw £100 of company gross profit. Initially you have to pay corporation tax of 21% leaving you with a dividend payment of £79. This is followed by an extra tax on the dividend of 22.5%, leaving you with exactly £61.22 take home. Putting it simply, you’ve just paid the Inland Revenue £38.78 for the benefit of taking home £61.22.
Now here is how a pension can cut your tax bill substantially. Instead of drawing the £61.22 as dividends, your limited company can contribute £100 towards your personal pension fund. Essentially £25 of your contribution equates to the portion of the pension fund which you can take tax free when you are retire. The £38.78 that would have gone to the HMRC together with the balance of £36.22 (£75 in total) is also added to the pension fund to grow and be worth substantially more.
In other words the tax relief you get by diverting your company pre-taxed profits into a pension is 38.78%. This is the percentage tax saving (38.78%) you can redirect into a personal pension rather than the Inland Revenue.
Tax Savings and Income in Retirement
Pensions are still one of the few remaining areas of tax planning still actively supported by the government. The government are constantly looking at incentive schemes that will encourage individuals to save more money in personal pension schemes. The government knows that on its own, the State Pension scheme is insufficient as a single source of income, and therefore the government does what it can to make personal pension investment as attractive as possible by allowing these substantial tax breaks. The government knows that the key incentives to self-employed workers with a limited company are attractive tax breaks.
New Pension Rules for Higher Earning Contractors
Contractors need to be careful to avoid the new rules that were introduced following the April 2009 Budget. Contractors that now receive over £150,000 per year are unfairly going to have their tax relief gradually reduced. For those earning between £150,000 and £180,000 the tax relief will gradually be reduced from 40% to 20%. The anti-forestalling rules are complicated and we recommend that you seek professional advice from a pension expert if you are one of those contractors affected.
Drawing your pension after 75
Up until April 2006 when you got to age 75 you had to buy an annuity with your pension fund. This is still the rule but there is now an alternative option, Alternative Secured Pension (ASP). An ASP behaves similar to an Income Drawdown that permits you to invest your pension savings from your pension and draw an income stream within laid down limits as agreed in the terms of the ASP.
Although annuities bring a guaranteed income until your death, enabling you to also transfer to a designated spouse or dependant, after your death the fund is lost to the annuity provider. However, an ASP permits you to pass possession of any leftover funds after your death to another person.
Sadly, the government of today made a quick u-turn after April 2006, making ASPs less appealing. ASPs are now subject to taxes; this is because they are classed as part of the estate, meaning that if you pass on any leftover funds on death to other members such as children and grandchildren, they will subject to income tax and possibly inheritance tax too.
Even with the tax implications ASPs can still offer benefits, they still provide investors the flexibility to draw and manage their money in retirement.
Choosing a Provider
Due to your contractor status you need a pension that is completely flexibility to raise, reduce, suspend, restart and freeze contributions. The plan needs to be adaptable taking in to account that one day you could return to permanent employment.
How Can I Get A Contractor Pension?
Talk to Freelancer Financials, who are specialist in the field of providing financial advice to contractors.
For more information you can also read our overview of Contractor pensions
For a pension quote please contact our pension’s specialist Ralitsa Bargazova on 020 8421 7998
Contractor Pension advice by Freelancer Financials
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