What Is A Contractor Pension? Should I Have One?

Do Contractors Get a Pension?

In most cases no — if you’re a contractor working through your own limited company you won’t get a company or workplace pension automatically. You can’t rely on anyone else to arrange your pension so it’s vital that you start planning for your retirement as soon as possible.

This will usually involve setting up a personal pension plan, into which you’ll make regular contributions throughout your working life. As a contractor, both you and your company can make tax-efficient contributions into a pension.

You have a number of different pension options for a one person limited company, from a simple stakeholder pension to the more complex self-invested personal pension (SIPP). A SIPP allows you to hold a wider array of investments but tends to come with higher associated fees and charges.

You could even join the government’s pension scheme NEST if you’re the sole employee in your limited company if you want to. Read more on your pension options below.

Can Contractors Get the State Pension?

The New State Pension is paid to men born on or after 6 April 1951 and women born on or after 6 April 1953. It’s worth £168.60 per week in the 2019/20 tax year.

To get the full New State Pension, you need to have 35 years of qualifying National Insurance contributions. If you have fewer than 35 years but more than 10 years, you’ll be paid the New State Pension on a sliding scale. If you have fewer than 10 years of contributions, you won’t get the New State Pension at all.

Sometimes contractors have a spotty work history, or have years where they weren’t making National Insurance contributions due to low earnings. As such, you may not be entitled to the full New State Pension.

Fortunately, if that’s the case you can make voluntary National Insurance contributions to make up for a patchy National Insurance record.

Save Tax on Contractor Pension Contributions

When you make personal pension contributions, you receive tax relief at your highest marginal rate. So if you’re a basic rate taxpayer and you want to make a £100 pension contribution, you’d only have to commit £80 yourself and the government will automatically top this up to £100 with £20 tax relief at source.

If you’re a higher or additional rate taxpayer, paying tax at 40% or 45%, respectively, then the tax savings on contractor pension contributions are even greater. For that £100 pension contribution, you’d only need to pay in £60 yourself as a higher rate taxpayer and £55 as an additional rate taxpayer.

However, whereas the government automatically adds the 20% tax relief to pension contributions, you need to claim back the remaining 20% or 25% tax relief on your self-assessment tax return at the end of the tax year. Don’t forget to do this — after all, it’s free money!

Can My Limited Company Pay Into My Pension?

Yes, your limited company can contribute to your pension, just as your employer would contribute to your pension were you an employee rather than a contractor.

In fact, it’s likely to be better from a tax perspective for your company to make pension contributions on your behalf. This is for a number of reasons, including the fact that personal pension contributions are limited to £40,000 per year or 100% of qualifying earnings, whichever is lower.

For contractors, who typically pay themselves a fairly small salary and top the rest up with dividends for the best tax efficiency on their income, this can be problematic because dividends don’t count as qualifying earnings when it comes to the amount you can pay personally into a pension contribution.

Only the salary proportion of your income counts, so if you’re being paid a low salary then you have a low cap on what you can pay into a pension personally.

How Much Can Contractors Put in a Pension?

Through your limited company, you can pay in up to £40,000 into a pension each tax year, and potentially carry forward unused contributions from previous tax years providing your company’s profits are at least equal to the carried forward contributions you want to make in that tax year.

This is providing employer contribution passes the ‘wholly and exclusively’ test, meaning the employer pension contribution must be deemed ‘wholly and exclusively’ for the purposes of the employer’s trade or profession.

The first step HMRC will take to decide whether the company contributions pass this rule will be to establish whether the level of total remuneration — i.e. salary, dividends, bonuses, benefits in kind, pension contributions etc. — is commercially ‘reasonable’ for the work being done.

HMRC will also take into account other factors before allowing pension contributions via your limited company, including:

• Checking that pension contributions don’t exceed the company’s annual profits
• Ensuring you’re making similar pension contributions to others in your company who are doing work of similar value. For example, if you’re one of two directors each putting in 50% of the hours and effort to drive a company, you should each be rewarded with similar pension contributions in any given tax year.

Utilising Pension Carry Forward

As mentioned, you can also carry forward previous years’ unused allowances and receive tax relief on these contributions too. You are able to carry forward any unused allowances from the previous 3 tax years providing your company was registered in a UK-based pension during those 3 years and made at least as much profit as you want to contribute in the current tax year.

Pension Carry Forward Example

Imagine you set up your company in 2016 and didn’t make any pension contributions in 2016, 2017 or 2018.

That means that in 2019, your limited company could potentially pay in up to £160,000 into your pension, as long as it makes at least £160,000 of profit in that tax year.

The Pension Lifetime Allowance

As well as annual contribution limits, everyone has a pension lifetime allowance (LTA), which refers to how much they can have in a pension scheme in their lifetime without paying a tax charge.

The pension LTA is currently £1,073,100 — for those with a pension greater than this (unless they’ve applied for lifetime allowance protection), then there’s a 55% charge on the pension if you take the excess as a lump sum or 25% if you take it as income, plus the tax due on that income.

Pensions, Umbrella Companies and Auto-Enrolment

While most of the contractors we work with at Drewberry operate via their own limited company, although we recognise that there are contractors out there working under umbrella companies.

Here the setup is slightly different because, even though you are working for yourself, you’re technically employed by an umbrella company. Under the auto-enrolment system, you may therefore enrolled into that company’s pension scheme.

You don’t have to stay in this scheme if you don’t want to — as with all auto-enrolment schemes you’re free to opt out at any point.

However, it will rarely be appropriate to opt out of a scheme with employer contributions as these will be hard to replicate outside the scheme, regardless of any benefits you may perceive from being outside such a pension.

Limited Company Pension Options

You have three main options when it comes to contractor pensions:

• Stakeholder pensions
• Self-invested personal pensions (SIPPs)
• Joining NEST (if you’re the sole employee of your limited company).

Stakeholder Pensions

Stakeholder pensions are perhaps the simplest form of personal pension available on the market today. They were set up my legislation to offer easy and affordable access to pension savings for the masses.

Stakeholder pensions usually include:

• Capped charges
• Fee-free transfers
• Flexible contributions — allowing you to start and stop contributing as required by your cashflow
• Low minimum contributions — you can typically start a stakeholder pension with no more than £20 and minimum monthly payments are low or non-existent
• A default investment fund to invest your money in if you don’t want to / are unable to choose your own.

Although stakeholder pensions are simple to contribute to, there’s a limit on the types of investments that can be held in a stakeholder pension so you have limited investment choice compared to some of the other types of pension on the market.

However, if you’re looking for a simple pension that you and your company can contribute to with low charges and a default investment fund, a stakeholder pension could be the best option.

Given that these pensions are relatively simple, you can set up a stakeholder pension yourself in a number of ways, including online on what’s known as an execution-only basis, meaning you don’t take advice and therefore bear all of the responsibility for ensuring the pension is suitable. Alternatively, you can use a financial adviser.

Self-Invested Personal Pensions

A self-invested personal pension (SIPP) offers access to a wider array of funds and investments than a stakeholder pension. You also tend to be more ‘hands on’ with a SIPP, choosing where you want to invest your retirement savings.

These pensions are usually for more sophisticated investors who have experience with investing as there’ll be a wide variety of assets and funds you can opt to invest in, such as:

• Unit and investment trusts
• Government securities
• Insurance company funds
• Traded endowment policies
• Some National Savings and Investment products
• Deposit accounts with banks and building societies
• Commercial property (such as offices, shops or factory premises)
• Individual stocks and shares quoted on a recognised UK or overseas stock exchange.

SIPPs usually have higher charges than stakeholder pensions to reflect the fact that they’re more complicated. Higher charges are also due to the fact that you have access to a wider array of investments.

Given that SIPPs are more complex than stakeholder pensions, it’s usually best to use an adviser to set one up.

Multi-Employer Pension Schemes

Since the introduction of auto-enrolment, it’s become mandatory for anyone employing people — even one person — to provide some form of pension for those workers.

This could be a workplace pension, which would be provided for workers by just one employer. However, multi-employer pension schemes exist to make it easier to offer pensions for employees and provide pensions to multiple different employers. The biggest and best-known of these is the National Employment and Savings Trust (NEST).

As a company director, if you employ people you have a duty to provide them with pensions. You can use NEST to provide these pensions if you wish, or you may wish to set up your own occupational scheme.

Your Financial Plan: Build A Better Future

A good financial plan can help you make the right decisions when it comes to your finances. Make the right decisions today to build a more prosperous future.

Good financial planning with clear goals can increase your retirement income by as much as 53%. Old Mutual Redefining Retirement Survey

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