You may never have considered investing in a pension or may have put off the urge to find out more about saving for your retirement for a rainy day. However, pensions represent one of a dwindling number of ways to minimise your exposure to tax as a contractor, which could benefit you right away.
Contractor pensions – an introduction
If you don’t have an existing pension or don’t make the most of the current allowances, you could be paying significantly more tax than you need to.
Pensions are an important weapon in a contractor’s armoury whether or not your work is caught by IR35 or not, as they represent one of just a few remaining tax breaks for the self-employed.
There are two ways to invest; personally (from your own post-tax income), or via your limited company.
If you transfer funds directly from your limited company directly to your personal pension, this is a legitimate business expense. This sum will be free of income tax, and will also avoid the 19% Corporation Tax liability which would otherwise apply to profits.
Most contractors contribute via their own companies, as there is an earnings-related limit for personal contributions. As this limit is based on your salary, and contractors typically have low salaries, company contributions make much more sense.
What about pensions if you’re caught by IR35?
Pensions represent an excellent way to keep your hard-earned funds away from the grasp of the taxman. If your contract work is caught by IR35, you can still transfer funds directly to your pension scheme before any IR35-related taxes are calculated.
Pension tax-free allowances
This annual allowance for pension tax relief is currently £40,000 (2020/21). You may be able to contribute more, due to the ‘carry forward’ rules, which allow you to make use of the 3 previous tax years’ allowances, assuming you haven’t already used them up, and have been a member of an authorised pension scheme throughout that time.
The lifetime allowance for pension contributions is currently £1.073m. Make sure you look at this table for the latest threshold, as it changes fairly often.
How to choose a pension provider
If you have decided to make the most of the tax benefits offered by pension investments, you need to ensure that you choose the right pension provider to look after your investment.
You would be wise to steer clear of firms that levy set-up costs at the start. This ensures that your entire contribution goes into your pension – for contractors and freelancers, funding for what could be the relative short-term is a prudent move, as you won’t have burdened your investment with upfront charges and other fees.
Ideally, you will find a provider who is familiar with the way contractors operate. The scheme needs to be flexible enough so you can increase, decrease, temporarily suspend, or even stop contributions entirely – even on a monthly basis.
As contractors may also change the business structure they operate under, the scheme also needs to be versatile enough to allow you to contribute whether you’re working via your own limited company, an umbrella scheme, or even if you decide to become a ‘permie’ for whatever reason.
Your scheme should also be hosted with a financially strong and trusted institution. As new entrants to the pensions market come and go, it is important that your provider has a solid track record, based on a long-term commitment to pension investment.
Please use this article as a guide only. You should seek professional advice while evaluating your pension options.
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