Thinking about how to save for your retirement and your pension plan is not conditioned only to be done at the end of your contracting career. You may just be starting out or you could be a seasoned contractor, but it will still be an important consideration in your career.
Searching for contracts and skill developing may be forefront of many contractors’ minds, meaning they have not set up their pension scheme. In other scenarios, some contractors have in fact settled on a pension scheme but they are not aware of the significant tax relief that is possible through forward planning.
A contractor running a limited company can receive major tax savings when paying into a pension scheme. There are two ways to go about this: personal contributions or through employer contributions. Each scheme has different structures but both certainly offer the potential for higher tax savings.
Limited Company: How To Process Employer Contributions?
Through directly paying into your chosen retirement scheme via your limited company bank account, a reduction on your tax burden is created in pension contributions. Employer contribution therefore means that contributing to your retirement from your own business bank account allows the money contributed to be paid as gross. Essentially, you are making a Corporation Tax saving of 20%.
Personal Pension Schemes: How Do They Work?
By paying directly from your salary into your pension pot, your National Insurance and income tax will already be paid. HMRC gross the payment when you make this contribution and pay your pension scheme immediately. For example, by making a payment into your pension of £800, an added £200 would be paid by HMRC. This makes the overall contribution £1,000 as a result of the 20% tax saving. Making the decision to go with a personal retirement scheme means you must record the total contributions you have made in your end of year Personal Tax Return.
Paying Into Your Pension Pot Tax Free: What’s The Limit?
Employer contributions – It is set that you must pay tax on top of your contribution via your limited company if that contribution is greater than your total annual allowance in one year. Currently, the annual allowance is £40,000, as well as there being a £1 million lifetime tax-free allowance. If you do not make any contributions to your pension in three years, unused annual allowances are able to be carried forward which will mean a larger contribution is made in total in the year you begin contributing. However, you are only able to do this if during the tax year from which you wish to carry forward unused allowance, you were registered as a member of a pension scheme.
Personal contributions – there is a maximum level that you are able to contribute personally to your pension tax-free; 100% of your annual salary. Technically you are allowed to pay more than this (up to £40,000) but you will not be granted tax relief on any amount that is paid above 100% of your annual salary.
However, if per year you are earning over £110,000, advice should be sought from a Financial Advisor. This is because HMRC may decrease your allowance for your annual pension as you are considered a higher rate taxpayer. This all depends on how much you would like to put in your pension.
Withdrawing Your Pension: Will You Be Taxed?
It is completely dependent on the type of scheme you choose, but it is possible for a maximum figure of 25% of your pension to be withdrawn tax-free. The 75% of the fund that is remaining is then taxed before you can receive it. Consulting with your chosen provider on the details of your pension withdrawal is crucial. Keep in mind that the money you put into the pension scheme cannot be taken out before you are 55.
Is There A Specific Pension Type That You Should Choose?
Choosing which type of scheme to go for will depend on your personal situation and ultimately what suits you best. A great percentage of contractors choose flexible pension schemes due to the nature of contracting, as this allows you to change the monthly contribution level as well as pause contributions if you want to allocate finances elsewhere or are not working. Also, ad hoc contributions are made easier through a flexible scheme.
You may intend to be in contracting for the rest of your career or you may make the decision to move to permanent employment. Regardless, an important part of the process is seeking advice from a Financial Advisor in order to prepare for your pension whilst contracting.
By using a contractor accountant, you will be able to develop a reliable tax strategy which will undoubtedly maximise your take home pay throughout your work as a contractor.