I currently have around eight years of corporate pension contributions from my full-time employee days, so my nest egg has been building nicely. However since I’ve been contracting for the last four years, I’ve not been paying anything into the pot, opting instead to put money into paying off debts and using an ISA.
So what is the best way, for me, to go about sorting a pension? When it comes to pensions, is there a ‘norm’ among contractors with my circumstances? Are there efficient pensions options for people who are contract but were ‘perm,’ or is it best to just to keep putting money into savings?
It is a common misconception that pensions are a dying breed. Whilst this may be true for permanent employees, contractors have a lot to gain from pension investment. When it comes to retirement planning we hardly ever speak to contractors about long days on the golf course, instead it’s all about the tax savings that pensions can offer!
As a contractor you can personally invest the lower of your gross income or £40,000 per annum – and back date the payments for up to three years – into a pension and benefit from income tax relief at your highest marginal rate.
However, the real savings come in to play when you invest via your limited company.
Pension contributions are one of the few remaining tax breaks available to limited companies. It makes sense to take advantage of this tax break for you, as a company director.
Making pension contributions through your limited company
Paying pension contributions is tax-efficient because you’ll reduce your company’s taxable profits and therefore your Corporation Tax liability. Making the contribution through your limited company is usually more tax-efficient than making the contribution from your own funds.
How much tax can I save on pension contributions?
For the 2018/19 and the 2019/20 tax years, the Corporation Tax rate is 19%. So for every £100 your company earns as profit, you’ll pay Corporation Tax of £19, reducing the amount you can take from your company as a dividend to £81.
Paying £100 into an employee’s pension fund effectively costs the company only £81 due to the reduction in Corporation Tax payable and, over time, the £100 investment will grow within the pension fund – and remember, the funds are growing in a tax free environment!
When can I start withdrawing from my pension fund?
Generally, you can start withdrawing from your pension fund 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. Again, you should take specialist advice on this, particularly if you plan to keep working while drawing a pension.
How much can I contribute to my pension scheme?
You can pay as much into your pension scheme as you like, subject to HMRC’s contribution limits and rules.
Your contributions will be tax-free as long as they do not exceed the annual allowance, which is currently capped at £40,000 (2019/20 Tax Year). The amount that you pay 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 trading.
If you have a large amount that you would like to put into your pension scheme, then you may be able to take advantage of the carry forward rule. This allows you to make use of annual allowances that have not been used in the previous three years, provided that you were a member of a registered pension scheme. If you would like to carry forward, you must first use your full 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 scheme through either lump sums, or through retirement income, without incurring extra tax. The lifetime allowance is currently £1,055,000 for 2019/20 tax year. Lifetime Allowance? That’s a topic for another blog!
The only argument against pension investment is that you can’t access the funds immediately. However if you have already built up a savings buffer in an ISA, as you have, then this shouldn’t discourage you. If you can afford to continue investing up to the ISA limit each year, and contribute to a pension fund, then this would offer you the safety net of savings to fall back on in the short term, while still benefiting you from the tax savings associated with pensions. Also, subject to minimum age, you can withdraw 25% of your pension straight away without having to stop benefitting from the tax savings available.
To explore your pension options call Aston Leigh on 01793 858211.