13th August 2020
It is important to consider your living standard when you retire. Many will feel the State Pension will not be enough to meet the standard they are accustomed to. Thankfully there are options available for us to contribute more towards that pension pot to achieve a fulfilling retirement.
Contracting through a limited company will, of course, give you the tax efficiency when it comes to your income, but that does not stop there. Let’s explore what you can do to put money aside for the future and save tax at the same time.
Auto-enrolment (Workplace Pension)
Introduced by the Government to encourage people to save for the future the scheme works through the employer, who sets up a pension scheme and then pay into it together with the employee through automatic deductions.
Operating a limited company, you are an employer, and as such, you need to comply with the auto-enrolment legislation. Even though owner-managed businesses exempt from auto-enrolment you may want to consider joining as auto-enrolment is very easy to manage, there are schemes entirely free for use and very user friendly. To sign up, you need to be over 22, earning more than £6,240 and work in the UK.
From April 2019 the minimum contribution levels are the following: 3% must be paid in by the employer, and 4% by the employee, which is then topped up by the Government who adds a tax relief of 1% totalling 8% of your qualifying earnings.
So what are the benefits to you as a contractor?
Your contributions are essentially doubled with the help of your company and with what the Government puts in.
You can easily track how your savings grow by logging into your pension account, or even calculate what it will look like later down the line.
Once you are retired or reach the age of 55, you can spend the funds built up in your account.
Why is it impractical?
As a limited company contractor, you will likely be receiving a low salary for tax efficiency, so your contributions will be negligible.
You can only contribute up to a £50,000 qualifying amount, so if you want to pay in more, you’ll have to look elsewhere, for example, employer contributions (discussed later in this article).
Personal Contributions (Private Pension)
Basically, a savings product, personal pensions allow you to contribute regular or one-off payments. Your pension fund is usually managed by a professional money manager, who will invest your pension savings.
If you are a UK basic rate taxpayer, you get a 25% tax top up on your pension contribution, so a £100 contribution will attract £25 top-up from the Government. Higher and additional taxpayers can claim a further 25 or 31% through their self-assessment returns.
The maximum annual allowance you can pay in is £40,000 or 100% of your salary or whichever is lower. If you are lucky enough to earn over £250K, the allowance tapers down gradually.
What are the limitations?
As above, if your income consists of a low salary topped up dividends, your pension tax relief will be small. That’s because it will be based on your salary only as dividends are not considered “relevant earnings”.
Making employer contributions to your pension are an excellent way to withdraw funds from your company as pension contributions are allowable business expenses. With contributions made directly into your pension, your company will receive corporation tax relief at 19%, and it won’t have to pay National Insurance, which adds another 13.8% to the saving.
The drawback is that funds would be locked until retirement age (although you currently can access some of the funds at age 55).
Allowances and rules
The amount of pension savings that benefits from tax relief is limited to an annual allowance, the amount including both employee and employer contributions is £40,000 this tax year (The lifetime allowance is £1,055,000).
For contributions to qualify for corporation tax relief, they must be paid wholly and exclusively for business. As long as your company, as a director and main earner of the company, you could pay the maximum amount if you wish to do so since you have earned the income and the level of remuneration that you pay yourself is entirely your decision.
How to set up
You may set up a new pension fund or use a personal pension fund already in place and make contributions either monthly or just lump sums at your convenience. To start making pension contributions from your limited company, you need to let the pension provider know that they are employer contributions, so they process the payments correctly. The contributions need to be made directly from the business bank account – you cannot pay personally and then reimburse.
While the above guide is intended to be a general introduction of your options we hope you have found it useful. Before you start contributing to a pension fund, we recommend consulting with your accountant or financial advisor who can help decide which option is best suited to your circumstances.
If you have any questions or would you like to know more, feel free to contact us at 0800 917 9100 or e-mail firstname.lastname@example.org