A complete overview of Pension for Contractors
Details of pension for contractors and its working
If you are employed in an established firm or serving as a government employee in the UK, then there is not a lot to worry about in relation to your taxes and pensions as they are sorted out at source. However, if you are providing contracting services as a contractor in the UK, you will have to fulfil most of the obligations yourself.
Though contractors have the benefit of additional flexibility and higher levels of income compared to an employee within a similar role, they do have added stress due to the extra tax and compliance responsibilities.
Whilst many contractors focus on their current earnings and work out their taxes accordingly, few pay attention to the prospects of investing in a pension fund. Pension, not only does it have the potential to provide substantial tax relief, but also has the potential to leave the contractors with more money to spend after retirement. Contractors have the opportunity to contribute to a pension fund to reduce the amount of tax they have to pay.
Facts about pension savings for Contractors:
- Contractors have access to a lifetime allowance of about £ 1 million which they can use by simply investing up to £ 40,000 annually with no additional tax implications
- 25% of your pension pot can be extracted without paying any tax, the remaining 75% is taxed under the income tax regulations.
- Family members of the contractors can get access to their pension on their death before the age of 75, given that no annuity has been bought.
- Pension funds are protected from insolvency by law, hence your pension savings will be secure
- If the contractor is a risk-averse individual they can keep their pension pot in cash, similar to an ISA.
Contractors, business owners and employees are required to pay tax on the income earned. However, if they decide to invest a certain proportion of their total income into a pension fund, they can save money in the form of tax relief.
There are two ways through which contractors can invest their funds into a pension fund, either by investing personally or through their business. Contractors who don’t have any pension set up and are not paying much attention towards the contributions and available tax reliefs are potentially losing money through potential high amounts of taxation.
Speak to your Contractor Accountant to see the potential savings you can achieve by contributing to a pension scheme.
What if you are within IR-35
If you are picked as being within IR-35 you are liable for tax on 95% of your income with 5% allowances for expenses. Pension contributions are not within this 5%, therefore contractors can contribute up to 40,000 pounds to a pension pot to reduce their tax liability by a significant amount.
How does tax relief work?
Let us consider an example of a contractor working through a limited company, the individual takes a small tax-free salary and remaining in the form of dividends. This contractor falls outside the scope of IR-35 and is a higher rate taxpayer based on the total earnings. Let us consider two scenarios to understand how the tax relief for pension contributions would work.
In the first scenario, the contractor decides to take the income instead of contributing to a pension fund. For every £100 generated as profits, the contractor has to pay a 20% corporation tax. If the contractor contributed to a pension fund the amount would be a tax allowable cost, reducing the corporation tax payable.
In the second scenario, the contractor gets a contribution made on their behalf to a pension fund from their limited company, the contribution amount is tax allowable which means lower corporation tax, the amount contributed also grows with time.
Tax relief is basically the percentage of tax saved- in this case, the amount of cash deposited into the pension fund instead of paying out as tax to the concerned authorities. It’s safe to conclude that the contractor was successfully able to enjoy a huge tax relief when contributing to a pension fund. This also provides him with security for the future when he retires.
Selecting a Pension Provider
Contractors have the flexibility to control the amounts of their contributions, they need a provider who can cope with these requirements, furthermore, the provider needs to be a well-recognized one so as to make sure the provider does not disappear. It might be a good idea to ask your contractor accountants to refer a financial adviser who can help you set up the most lucrative pension scheme.
Clear House Accountants are specialist Accountants in London, who have been working with contractors from a variety of industries, helping them save money and reduce the amount of tax they pay.
Jibran Qureshi FCCA is the Managing Director of Clear House Accountants, and has over 10+ years of experience in practice and across multiple industries. Jibran’s educational background includes a Master’s in Financial Strategy from Oxford University and an Executive MBA from Hult International Business School. His experience in Financial Strategy, Tax Planning, Operational Consultancy and Performance Reporting guide his cognizant approach to leading Clear House and its clients to the future. It was this dexterity that led him to be Enterprise Nation’s Top 50 Advisors.
Jibran is fueled by his passion for helping businesses. He unequivocally believes that as business advisors and accountants for our clients, it is our responsibility to work with them as business partners. As specialists, it is our duty to help our clients navigate through the complexities of constant change and the implications that come with it.
Over the past decade, innovative disruptions have changed the way businesses work, everything from cloud software, innovative business models, to AI and machine learning, have impacted how businesses operate, grow, and expand.
Jibran recognized the need to manage these disruptions sustainably, early on and shaped Clear House Accountants to not just be compliance specialists, but advisors who help build complex ecosystems around cloud accounting software, provide advice on funding support, help manage innovative tax schemes, set up and implement complex strategic plans, and much more. So, his clients can thrive, not just survive.
Jibran developed his prime role as the Managing Director to build Clear House’s capabilities so it can add value for their clients. He is of firm belief that this can be done through consistent high-level training, building the right tools, and creating roadmaps to help businesses cope with prospective disruptions. He envisages that every client that comes on board, is provided maximum value through onboarding, ongoing services and the right mix of tools to help them become the best in the world.