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Contractor pensions

Contractor pensions and related tax savings

contractor pensions and their related tax savings

As a contractor or freelancer have you given any thought to a pension?  Combine government mismanagement of public finances and a generally aging population base, you might be lucky to receive £100 a week by the time you retire.

On top of this there are huge tax savings to be had by investing some of that profit in your limited company into a pension scheme.  Too many limited companies are guilty of not using this basic tax planning tool that will help you later in your life.

The tax savings with contractor pensions

As a limited company contractor or freelancer you might be taking a low salary and the rest of your income as dividend.  This is likely leaving a fair amount of profit in the company, which is taxed at corporation tax rates of 20%.  On top of this, any dividends you take beyond your basic rate are taxed at a further 25%.

The good news is that with a pension you can put that unused company profit into a pension tax free.  You can put up to £50,000 a year (with a lifetime allowance of £1.5million) into the pension regardless of what salary you draw from the company.

The tax savings arise as the pension contribution is completely tax deductible when computing your company’s profit.  This means you may pay very little or no corporation tax that may arise.

Let’s put some figures to the savings

Let’s assume you take a low salary and dividends up to the basic rate tax band, i.e. a salary of £7,696 and a dividend of £30,379 in the tax year 2013/14 .  Now that means your company needs at least £38,075 of profit before salary, tax and dividends.

If you want to take more dividend than this out of your company, you will be a higher rate tax payer.  The additional profit will have first attracted 20% corporation tax and then 25% income tax on the further dividend.  So for each £1,000 extra you want to take out, you have paid £400 in taxes, leaving you with only £600!

Now assume you instead put this £1,000 into a pension, the pension contribution will be tax deductible, so “reduce” your profit and hence your corporation tax bill.  This all happens at the level above corporation tax and dividends.

Doesn’t this mean I will have a lower income?

Yes this does mean your net income will be reduced by £600, but most importantly you will have increased your pension fund by £1,000, not to mention all the tax free growth in the value of the fund.

This means you have saved tax at 40% and grown the value of your pension fund, which you can start to take advantage of at an older age.

When can I take the pension?

You can start to draw down on your pension when you are aged 55, regardless of whether you are still working or not.  You can even decide to take out 25% of your total pension fund value tax free as a lump sum.

Professional advice and help

When looking to help setup a pension scheme, it makes sense to speak to somebody who understands contractors and freelancers.  We only recommend specialist contractor and freelancer Independent Financial Advisors (IFAs).  They have experience of helpings thousands of individuals just like you,  can give you truly independent advice and go through all of your options.

Will I be charged commission by the advisors?

From 1 January 2013, as part of the FSA’s Retail Distribution Review, advisors cannot receive commissions and will instead be charging fees for the work they do.  This was designed to give you greater transparency and to motivate the industry to provide excellent customer service and independence.  Remember that these fees will be completely tax deductible in your limited company.

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About Hardeep Mangat

Hardeep is a down to earth accountant, who loves helping contractors, freelancers and small businesses save tax and make more profit. He also has a particular interest in IR35 . Hardeep attended University College London and is a Chartered Certified Accountant, who previously worked for Credit Suisse Investment bank and at a local accountancy practice.

Hardeep on Linkedin and Google+


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