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Pensions for Contractors

Pensions for contractors and freelancers offer one of the few tax breaks left available if you don't already have one. Money can be invested from both your personal and business bank accounts with the opportunity to benefit from as much as 48% tax relief on money invested.

How much can we invest?

Since pension simplification came into force in April 2006 an enormous degree of flexibility has been added to retirement planning, which suits your needs as a Freelancer perfectly.

Almost anyone can invest personally and parents or grandparents can even invest for children and still gain tax relief on the contributions. Where Freelancers really get to exploit the tax rules is when looking at employer funded contributions via their 'one man limited company' or Umbrella Company. Investment via the 'employer' is, in nearly all cases, limited only up to the annual allowance which currently stands at £245,000.

One Man Limited opportunities

For Freelancers who operate One Man Ltd companies there is a real incentive to utilise this greater freedom - any money that is diverted into a pension will avoid personal taxes normally levied against salary or dividends. The pension contributions can be offset as a business expense thus avoiding corporation tax.

In a post MSC, IR35 and income sharing world it could be argued that pension investment represents one of the few remaining areas of tax planning actually encouraged by the authorities and is a very effective means for a Freelancer to cut the tax take he/she suffers.

Umbrella Company opportunities

It's not just Ltd company set-ups, which typically operate outside IR35, who can benefit. Any Freelancers who use an umbrella company for PAYE may well be able to take advantage of a salary sacrifice arrangement to massively reduce their tax bill.

Your Umbrella Company may put in place a salary sacrifice scheme which allows the 'employer' to transfer funds directly from your contract income into a pension scheme. Crucially this transfer occurs before the Employers or Employees National Insurance and Income Taxes have been deducted which, even for a basic rate taxpayer, could save a 38% tax take. Higher rate taxpayers save even more.

Choosing the best Pensions for Contractors Provider

Pensions for contractors need to be flexible, with the ability to adapt payment schedules and contributions to match varying contracts and level of income on a monthly basis.

You should also choose carefully when deciding on your pension provider, choosing a firm that has a good reputation and is a big player in the pensions market should minimise the risk of takeovers and mergers and ensure that you get the long-term commitment needed for your investment.

Now more than ever, choosing a safe provider for your pension is crucial to avoid you losing out if the credit crunch continues. An Independent Financial Adviser should be able to help you choose the correct pension and provider to suit your needs as a Freelancer, using their expertise to ensure that your money is in safe hands and making the best possible returns.

New restrictions for high earners

From April 2011, tax relief for Contractors that earn over £180,000 will be capped at the basic rate of 20% and those earning between £150,000 and £180,000 will be judged on a sliding scale of between 40 and 20%.

To prevent higher rate tax payers from investing large sums now before the new pensions cap comes into play, anti-forestalling rules have introduced. This means that Contractors who have already earned £150,000 or more this year or over the past 2 years, will be restricted to 20% tax relief on pension contributions above a 'special annual allowance' of £30,000.

Unfortunately, this extends to both employer and employee contributions which impacts on your ability to contribute through salary sacrifice arrangements if you operate under an Umbrella company. It also stops you using unlimited company contributions if you contract via a limited company.
Whilst it is still unclear how the new pensions restrictions will work in practice, any Contractor earning up to £149,999 per year is entitled to invest almost all of it in a pension without incurring income tax, corporation tax, National Insurance deductions or being liable as for benefit in kind. However, if you earn just £1 more than that you are only able to invest up to the special annual allowance of £30,000.

If you fall into the category of a higher earner then it is worth investing up to this £30,000 limit each year as this will still represent a significant tax break and it is important to maximise any opportunity that you get to keep some of your hard earned cash out of the tax mans grasp.

Tax saved today and an income for tomorrow

The importance of having an income in retirement has really climbed up the agenda in recent years and is now one of the key concerns for the Government and public alike. The state pension is going to be under immense pressure in years to come as the realities of an ageing population and shrinking workforce begin to bite.

Politicians of all parties support the notion of personal responsibility for provision of income in retirement and this is the reason why, when all other tax breaks come under pressure, the pension planning route has been left open. Indeed since simplification in 2006 it has even been enhanced with these new higher limits on investment and far greater flexibility at retirement.

In these uncertain times, it can be tempting to neglect your pension contributions in favour of keeping the cash in your pocket. However, it is worth remembering that paying the money into a tax efficient pension or ISA will eventually provide an income in your retirement, whereas taking home the money now leaves it pray to the tax man's cut.

Tony Harris is Managing Director of ContractorFinancials, an Independent Financial Advisers specialising in offering timely, jargon free financial advice to Freelancers.

If you would like know more about pensions for contractors please call 0845 062 8888, fill out the online enquiry form or email tonyh@contractorfinancials.com quoting 'Freestyle Financials'.