Whether you’re a seasoned contractor or have just started contracting, you have probably thought about pensions and how you can save for your retirement.
Many contractors who are focused on finding contracts and developing their skills may not yet have committed to a pension scheme. On the other hand, many contractors may have a pension scheme but aren’t aware of the tax relief they can receive with careful planning.
Regardless of your circumstance, we can give you tips to help you plan for a comfortable retirement whilst minimising your tax burden now.
Paying into a scheme as a contractor with a limited company can result in high tax savings. There are two ways of doing this: via employer contributions or personal contributions. Both types of schemes are structured in different ways but offer high tax savings.
How can I make employer contributions through my limited company?
One way to reduce your tax burden via pension contributions is by paying directly into your retirement scheme from your limited company bank account.
When you contribute to your retirement directly from your business bank account as an employer contribution, the amount you contribute is paid as a gross amount, allowing you to make a 20% Corporation Tax saving.
How do personal pension schemes work?
If you choose to pay into your pension fund from your salary, this would be done after income tax and National Insurance is paid. When you make the contribution, HMRC will gross your payment and pay into your pension scheme directly.
For example, if you made a payment of £800 into your pension, HMRC would add an additional £200, making the total contribution £1,000. This gives you a tax savings of 20%.
If you decide to choose a personal retirement fund scheme, you will need to record your contributions in your end of year Personal Tax Return.
Is there a limit to how much I can pay tax-free into my pension?
- Employer contributions - You pay tax on your contributions if the amount you contribute through your limited company in one year is higher than your annual allowance. The current annual allowance is £40,000 per year, and there is also a lifetime tax-free allowance of £1 million.
You can carry forward unused annual allowances if you have not made any pension contributions in the last three years, to make a larger total contribution in the current year. However, you can only do this if you were a member of a registered scheme in the tax year from which the unused allowance is being carried forward.
- Personal contributions – The maximum amount you can personally contribute to your pension tax-free is 100% of your yearly salary. You can pay more than this - up to £40,000 - however you would not receive tax relief on the amount paid that is above 100% of your yearly salary.
If you earn over £110,000 per year, you should seek additional advice from a Financial Adviser, as HMRC could reduce your annual pension allowance as a higher rate taxpayer depending on how much you wish to pay into your pension.
Will I be taxed when I withdraw my pension?
Depending on the scheme you have chosen, you may be able to withdraw a maximum lump sum of 25% of your pension pot tax-free. The remaining 75% would be taxed before you receive it. You should consult with your provider to find out how you can withdraw your pension.
Remember when planning for your retirement that the money you pay into your pension scheme cannot be withdrawn until at least age 55.
What type of pension should I choose?
The type of scheme you should choose depends on your situation and what is best for you. Because of the nature of contracting, many contractors opt for flexible pension schemes, which allow you to make ad hoc contributions, change your monthly contribution amounts and pause contributions when you are not working or wish to allocate your finances elsewhere.
Whether you see yourself contracting for the rest of your working life or think you’ll switch back to permanent employment, it’s important to seek the advice of a Financial Adviser to make arrangements for your pension as a contractor.
As contractor accountants, we can work with you to develop a tax strategy that will help you maximise your pay throughout your contracting career. As part of our bespoke contractor accounting service, we will provide you with unlimited tax advice and support.
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