A contractor’s guide to pensions

As a contractor no one is going to be planning for your retirement except you, so it is definitely a good idea to put some of your contracting salary away for your later years. Pension contributions are one of the few remaining tax breaks available to contractors, so it is a good idea to take advantage. This guide will discuss on how how pension contributions can allow you to be more tax-efficient as a contractor, how to make pension contributions and how much to put away.

How much can I contribute to my pension?

You can pay as much into your pension as you would like, and your contributions will be tax-free as long as they do not exceed the annual allowance, which is currently capped at £40,000 (Financial Year 2016-17). Although you can invest as much as you like into a pension the amount that you invest must not exceed your company’s income for the year as this could raise questions from HM Revenue and Customs as to whether the amount has actually come from your company’s activities.

If you have a large sum that you would like to put into your pension then you may be able to take advantage of the carry forward rule. This allows you to make use of annual allowances that you have not used in the three years previous, provided that you were a member of a registered pension scheme. If you would like to carry forward you must first use your annual allowance for the current tax year before using any unused allowances from the previous three years.   

You should also take into account your lifetime allowance, which is a limit on the amount that can be withdrawn from your pension through either lump sums or through retirement income without incurring extra tax. The lifetime allowance is currently £1 million (FY 2016/17).

How do I make a pension contribution?

As a contractor you can either make pension contributions from your own personal funds or directly from your company’s income. Most Limited company contractors will make their pension contributions through their company as this is more tax efficient.

To make a pension contribution from your personal funds the amount that you invest will attract personal tax relief, which means that the pension provider will top up your contributions by 20%. Please note that there is a limit on the amount of tax relief available to personal pension contributions, this is currently 100% of your income and it is the topped up figure that is taken into account.

Pension contributions that are made directly from your company’s income are invested before-tax, which means that you will save the amount that you would have paid in both income and corporation tax on the contribution. Unlike personal pension contributions the amount that can be invested directly from your company income is in no way linked to the amount that you personally earn as a salary.  

How much will I save in tax on my pension contributions?

Please note that this is a basic example based on a Limited company contractor who is working outside of IR35 and in the higher rate tax bracket. It does not take into account all of the factors that will affect the amount of tax you could save.

As a Limited company contractor working outside of IR35 for every £100 that your company earns you must pay 20% corporation tax, which brings the amount down to £80. You will then need to take this money out of your company, to do this most contractors take their income through a mixture of salary and dividends. If you were to take this £80 as a dividend you will incur dividend tax of 32.5% (FY 2016/17) which brings the amount down to £54.

However, if you were to invest the £100 in a pension you can contribute the whole amount and once in the pension this amount could grow. 

When I can I start withdrawing from my pension?

In most cases you can start withdrawing from your pension at the age of 55. This can be used to help you retire early or to top up your income if you are still working.

How will the automatic pension enrolment scheme affect me?

The automatic pension enrolment scheme has made it compulsory for employers to enrol their employees into a pension scheme. If you are the only director of your Limited company – which most contractors are – then the pension automatic enrolment scheme will not apply to you, but you will need to contact The Pension Regulator to inform them that you are exempt from the scheme. Visit our guide to pension auto enrolment for more information and to find out what it means for Limited company contractors.

If you would like more information or to discuss your pension options further please contact your accountant at SJD who will put you in touch with an independent financial advisor. If you're not yet an SJD Accountancy client, please get in contact with our new business team on 01442 275789 or email newbusiness@sjdaccountancy.com.  

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SJD Accountancy are the UK's largest specialist provider of fixed fee, Limited company accountancy services to contractors; we've been acting for contractors across the UK since 1992 and have more than 15,000 clients.

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