The Tax Savings…
If you’re a higher rate tax payer contributing to a pension, you can receive 40% tax relief when you make a payment into the scheme, and pay 20% when it comes out, assuming you pay a lower rate of income tax in retirement. You can also take a 25% tax-free lump sum from your pension once you stop work.
Impact of Pension Tax Relief
If you are a contractor who has set up a limited liability company, you can use your company to pay into a pension on your behalf and take full advantage of tax relief on your contributions.
For example, if you’re looking to take an additional £2,000 of income from your company, you can either take this as a dividend, or you can pay it into a pension.
- If you take this sum as a dividend payment, you’ll pay £400 in corporation tax at 20%, leaving you with £1,600.
- If you’re a higher rate taxpayer, you’ll then pay 25% personal income tax on the remaining dividend, which removes a further £400, leaving you with a total amount of £1,200.
- Alternatively, the same £2,000 could be paid directly into a pension fund, rather than you taking £1,200. The tax saving is therefore 40%, or £800, as this is the amount you would have had to hand to the taxman.
- If you’re a basic rate taxpayer, the 10% tax credit cancels out the 10% dividend ordinary rate you’d pay, but you’d still benefit from a tax saving of £400 by paying the £2,000 into your pension rather than taking it as a dividend.
Pension Tax Relief Calculator
Your Pension Tax Relief Result
Pension tax relief means only a proportion of your desired pension contribution will have to come out of your own pocket ('Net Pension Contribution'). The remainder is topped up by the government in the form of tax relief to form your total 'gross' pension contribution. Below we've calculated how much you'll have to pay into your pension to receive a government top-up that will equal your desired total gross contribution this tax year.
20% Tax Relief Added at Source
The government automatically adds 20% tax relief to pension contributions within your annual allowance.
Get More For Your Money Through Your Tax Return
As you're a higher rate (40%) taxpayer, you can reclaim additional pension tax relief through your tax return. The government automatically adds basic rate (20%) tax relief to all pension contributions at the source. The remaining tax relief is reclaimed through your tax return.
As you're an additional (45%) taxpayer, you can reclaim additional pension tax relief through your tax return. The government automatically adds basic rate (20%) tax relief to all pension contributions at the source. The remaining tax relief is reclaimed through your tax return and may be made up of a combination of additional rate tax relief and reclaimed income tax personal allowance.
How this calculator works...
Drewberry has calculated the tax relief you may be able to receive based on you being a 0% taxpayer, a basic rate (20%) taxpayer, a higher (40%) taxpayer or an additional (45%) taxpayer in the 2017/18 tax year.
We've also calculated the benefit to you based on the fact that you may regain some of your lost income tax personal allowance by making pension contributions if you earn between £100,000 and £123,000. However, there are many other factors that may affect your eligibility for tax relief on your pension contributions, including your age – for example, tax relief on pension contributions stops once you reach the age of 75.
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Head of Pensions Advice at Drewberry
IR35 and Pension Contributions
The above examples assume you are outside IR35. IR35 was introduced in April 2000 as a way of preventing contractors from financially benefiting from the tax advantages of being a contractor, when they are actually doing the same work they would if they were directly employed by the company they are working for.
If you are caught by IR35, then the tax benefits of contributing to a pension through your limited company are even greater, as you not only save income tax that you’d normally pay, but also employers and employees National Insurance Contributions.
Once in your pension, your money will be invested so it can grow and be used provide you with an income when you stop work. When you reach retirement, you’ll be able to take 25% of your pension tax-free.
Pension contributions made by your employer
Employer contributions are treated as an ‘allowable business expense’ therefore, it is best to check with your accountant that the proposed contributions are acceptable. There is no maximum amount that can be paid into a pension. However, HMRC impose a tax charge for annual contributions in excess of £40,000 (for the 2015/16 tax year). There is a lifetime allowance of £1.25m currently but this will fall to £1m in April 2016.
Remember that the amount you contribute to your pension from your company cannot be greater than the corporate income you’ve received that year, or that could trigger an investigation by HMRC.
Pensions versus ISAs
Many contractors believe that individual savings accounts (ISAs) are the best way to save tax-efficiently. However, while you don’t have to pay income tax or capital gains tax on returns from ISAs, you don’t receive tax relief on the payments you make into an ISA.
One major downside of paying into a pension is that you can’t access these savings until you reach the age of 55.
It’s therefore usually a good idea to saving into both pensions and tax-free individual savings accounts (ISAs.) That way you can use your ISA savings in the run up to retirement, and your pension when you eventually stop work.
How Can I Take My Money at Retirement?
Once you do reach the age of 55, changes to pension legislation in April 2015 mean that you’ll have much more flexibility over how you use your retirement savings.
Previously, the only option for most people was to buy an annuity, or income for life, from an insurance company. Annuity rates are currently low, and when you die, the income from them usually dies too.
Now, however, you can take money out of your pension gradually.
For example, you can opt for ‘flexi-access drawdown’ where your money is invested into one or more funds, and you then take a regular taxable income. Alternatively, you can simply take money out of your pension whenever you need to.
No More ‘Pension Death Tax’
One of the biggest benefits of the pension reforms is that contractors can now pass their pension assets to beneficiaries without any tax charge if they die under the age of 75.
Prior to the changes, you would have had to pay a 55% death tax charge on a pension left to you by someone else if they’d already started taking an income from it, or had received any tax-free cash.
If you die after the age of 75, you can still pass your pension on to your loved ones, but they will have to pay tax at their marginal rate of tax (from April 2016) on any income they receive from it.
Seeking pensions advice
If you’re a contractor and want to find out more about the benefits of paying into a pension through your limited company, it’s a good idea to seek regulated pension advice.
An adviser will be able to explain how much tax relief you can claim on your contributions, and what to do if you have several other pensions which you are looking to consolidate (your adviser will compare the investment performance, risk and charges to see if your old pensions are competitive or should be transferred).
We are here to talk you through the best investment options for your pension, so your money works as hard as possible for you in funds which suit your objectives and your attitude to risk.
Please don’t hesitate to call us on 0208 432 7333 and we will be happy to help.
Pension & Investment Specialist