Why a Contractor Pension?
If you work as a contractor, 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.
There are plenty of ways you can maximise the amount that you save, depending on which way you choose to invest in a pension. Importantly, you are entitled to valuable tax relief on anything you pay into your pension, making this one of the most tax-efficient ways to save for the future.
Naturally what is provided below is only general information and a lot will depend on your specific situation and requirements. Please don’t hesitate to call us on 02084327333 to speak with a regulated pension adviser for a tailored recommendation.
Here’s our ultimate guide to pensions for contractors, setting out everything contractors should know.
Is it better to make pension contributions via my limited company?
If you contract through a limited company, then the biggest benefit of paying into a pension is that your company can make payments into your pension on your behalf. This means that you can keep your salary as low as you can afford, therefore reducing your national insurance bill and your corporation tax bill.
Rather than declaring income your company has received as a profit, and taking this income as a dividend, you can instead contribute this income into a pension. For example, if you are a higher rate taxpayer and your company received £1,000 in income, and you took this as a dividend, you’d have to pay £200 in corporate tax.
Tax efficient pension contributions
You’d also have to pay income tax at 32.5% on the dividend (rate from April 2016), removing another £260, leaving you with a total of £540. If, however, you paid the £1,000 straight into a pension, there would be no deductions, so the full amount can be invested to grow for your retirement.
If you are in IR35, then there are even greater tax advantages from contributing to a pension through your limited company. You’ll not only save on income tax that you’d normally pay, but also on employers’ and employees’ National Insurance Contributions, so you’ll be keeping as much as possible out of the taxman’s grasp.
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Tax relief on pension contributions will boost your contractor pension
If you make pension contributions yourself, rather than having your limited company make them for you, there are direct tax benefits of contributing to a pension for a contractor. If you’re a basic rate taxpayer, you will receive 20p in tax relief for every pound you make in pension contributions. This means for every 80p you contribute to your pension, you’ll receive 20p in tax relief. As a result, a £1,000 pension contribution will only cost you £800.
If you’re a higher rate taxpayer this increases to 40p in tax for every pound you pay in. You automatically receive basic rate tax relief, but you’ll need to claim back any extra through your tax return. If you pay tax at the 45% rate, you receive 45p in tax relief.
If you pay yourself a small salary and the remainder if dividends these rates will differ but you may decide alternatively for your pension to be paid for by your business (see below).
How much can I invest into my pension?
You can personally pay in as much as 100% of your income into a pension if you want to, and benefit from income tax relief on these payments, subject to the annual pension allowance.
The annual pension allowance for the 2018/19 tax year is £40,000, so you can invest up to this amount each year and you’ll receive tax relief on your contributions at your highest marginal rate (please note, from April 2016 restrictions apply for those with taxable earnings plus pensions contributions that exceed £150,000 per annum).
Utilising your carry forward allowance
You can also “carry forward” previous years’ allowances and receive tax relief on these contributions too. You are able to carry forward any unused allowances from the previous three tax years.
From April 2016 you are able to receive up to £1m in payouts from pension schemes (this figure was previously £1.25m) without triggering a tax charge. This ‘lifetime allowance’ applies to all pensions you have but excludes the State pension.
Consolidate your existing pensions
If one of the reasons you have yet to start paying into a pension as a contractor is that you’ve left a large number of company pension schemes in your wake and you don’t want to have to deal with any more paperwork, you might want to think about consolidating these pensions.
Where appropriate, you could set up a new pension to pay in regular premiums and transfer old pensions into the new one. You should always seek professional financial advice before you do this, as some older pension schemes have valuable guarantees which you shouldn’t give up. Your pension adviser will be able to do the following for you:
- Obtain a valuation of what your pensions are worth
- Evaluate the investment fund(s) performance relative to your attitude to risk
- Determine if the management charges are competitive
- Discuss whether it’s worth consolidating to a new arrangement
- Liaise with pension providers to arrange any transfers on your behalf
I meet many contractors who have worked at half a dozen different companies and have no idea where their pensions are or how much they are worth. I help by consolidating these contracts into a single arrangement which can be accessed online 24/7.
It’s always best to compare existing pensions to the rest of the market – what you’ve been contributing to historically may be better than what you could get on the market today, so it may be better to go back and restart contributions into an older scheme rather than starting another new pension.
Pension & Investment Specialist
Umbrella companies and auto-enrolment
Even though you are working for yourself, if you work for an umbrella company, then under the auto-enrolment system, which was introduced to encourage more people to save for the future, you may be enrolled into that company’s pension scheme.
This usually applies if you operate via Pay As You Earn (PAYE) when you pay tax on your earnings. You don’t have to stick with the scheme you’ve been auto-enrolled in – you can opt out if you want to. However, this will mean you won’t receive valuable contributions from your employer.
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.
Making your own pension arrangements as a contractor
You’ll need to make your own pension provision if you haven’t got an umbrella company to do it for you. This will usually involve setting up a personal pension plan, into which you make monthly contributions. If you are self-employed, you can then make payments into the plan, or, if you’ve set up a limited company, the company can make contributions on your behalf into an approved scheme.
There are lots of different contractor pension schemes to choose from, and charges can vary widely, as can the investments offered, so if you aren’t certain which plan to go for, always seek pension financial advice first.
Building your pension portfolio..
Remember too that you can choose investments depending on your approach to risk. For example, if you are very close to retirement, you might want to stick with less risky investments, such as cash and government or corporate bonds.
If, however, you are young with 20 or 30 years to go before retirement, and you may be prepared to accept a higher level of risk in return for potentially higher rewards, so you might want to stick to stock market linked investments.
You can’t take your pension benefits until you reach the age of 55
While there are significant advantages of paying into your contractors pension, remember that you won’t be able to touch these retirement savings until you reach the age of 55. At that point, you can take up to 25% of your pension as tax-free cash, and use the remainder to provide yourself with an income.
It’s therefore a good idea to build up some savings alongside your pension so that you have some emergency funds available prior to retirement.
One of the most tax-efficient ways to save outside a pension is into an individual savings account (ISA) as returns are free from income tax and capital gains tax.
In both the 2015/16 and 2016/17 tax years you can save up £15,240 into ISAs, either into cash, stocks and shares, or a combination of both.
You can pass your contractor pension onto your loved ones
New pension freedoms which came into effect in April 2015 mean that if you die before the age of 75, you can pass your contractors pension to your beneficiaries without them having to pay any tax. Before the new rules came into effect, your loved ones could have had to pay a 55% death tax charge on a pension left to them but you if you’d already started taking an income from it, or if you had received any tax-free cash.
If you die after the age of 75, you can still pass your pension on to your beneficiaries, but they will have to pay tax at their marginal rate of income tax on any income they receive from it.
You don’t have to buy an annuity at retirement
Prior to the introduction of April 2015 pension freedom legislation, the vast majority of contractors had to use their pension to buy an annuity, or income for life, from an insurance company.
While annuities can still be useful if you want a guaranteed income, contractors now also have the option to use ‘flexible drawdown’ which involves drawing any level of income that you need.
Previously you had to have pension income of at least £12,000 a year to be eligible for flexible pension drawdown, but this requirement no longer applies.
If you haven’t saved much into your pension, you can take the whole of your pension as what’s known as a ‘trivial commutation’ if all your pension benefits added together don’t exceed £30,000. You can only take the whole of your pension if you’ve reached the age of 55.
Pensions Advice for Contractors
If you’re considering a pension for contractors and are not sure about which route to take, you should seek professional financial advice. An advisor will be able to talk you through all the available options, so that you can choose the right one to suit your needs. Being regulated advisers we can help, so call us on 0208 432 7333 to find out more.
Contractors may also be interested in…
In addition to contractor pensions, many contractors are also interested in contractor income protection, which pays a monthly income to you if you are unable to work due to illness or injury, and relevant life insurance, which pays out a lump-sum to your loved ones if you pass away. These policies have the benefit of being owned and paid for by your business.