Pensions and Tax Advice for Contractors

If you choose, you can retire at 55. Sounds very tempting, doesn’t it?

What would you do with your retirement? Spend it travelling? Maybe you would like to learn a new skill? There are so many options.

However, in order to do these things, you need money to finance them. Paying money into a pension scheme enables you to save money now and plan for your future, at the same time.

Save tax through a pension

As a contractor, you pay tax on your income. By putting some of this money into a pension, you pay less tax.  You can either pay money into a pension personally from your own funds or through your company bank account. Paying it via your business account is the most tax efficient way in most cases. This is because, the money goes into the pension before tax has been applied, meaning you save on Income Tax and Corporation Tax.

Example:

N.B: This example is based on a contractor working through a limited company, outside of IR35 and a higher rate tax payer.

For every £100 you earn, Corporation Tax (19%) is charged. This brings the amount down to £82. Most contractors will choose to withdraw this from their limited company by a combination of small salary and dividends. If you take the £82 as dividends, you will incur dividend tax at 32.5%, which makes it £55.35.

However, if you choose to pay into a pension you can contribute the £100 and it should continue to grow inside the pension scheme.  No corporation tax or income tax is paid.

Key facts to consider with pensions

In April 2015, the UK government introduced significant changes to pensions. These changes gave increased flexibility to individuals on when they can draw their pension pots and how they use them.

We’ve outlined the changes that impact on contractors:

• You can invest up to £40,000 per year into a pension through your limited company without incurring any additional tax implications. This is available up to your lifetime allowance of £1 million.
• A tax free lump sum (also known as a Pension Commencement Lump Sum) can be taken from your pension. This is usually limited to 25%. The remaining 75% can be taken as a lump sum or as a regular income, subject to income tax.
• From the age of 55, you can withdraw income from your pension as a lump sum or as a regular income without any restrictions. Please bear in mind though, these withdraws may be subject to income tax.
• If you pass away before the age of 75, any funds left in your pension can be paid out tax free to your beneficiaries as a lump sum or as a drawdown pension.
• If you are not comfortable with your funds being invested in stocks, you can choose to keep your funds in cash.

Choosing a pension provider

Let’s be honest, contractors are a unique breed. The one thing that sets you apart from your employed colleagues, is that you don’t have a steady working agenda.

There will be times where your contracts will be back to back, and there will be times when you find yourself having a break between contracts. When choosing a pension provider, it is important that you look for one that can accommodate for such circumstances. Ask upfront if they offer the options of being able to increase or decrease contributions alongside being able to stop, start contributions without incurring penalties.

Want to take the next step?

If you are interested in setting up a pension scheme or are considering changing your pension provider, we recommend that you seek professional advice from a financial advisor. We are happy to recommend one if you are looking for someone who is experienced in working with contractors.