Contractor / Freelancer Pensions

[JimSims]

Hello experts,

I have a question regarding pensions and I'm sure one of you intelligent people can shed some light on a rather annoying issue that just won't go away.

By way of background, I currently run my own limited company and the turnover is, on average, about £100K a year.

Can someone please tell me, just for the record, once and for all, no more BS, what is the exact amount of money PER YEAR that I can invest in a person pension without any unnecessary grief from the Inland Revenue.

You see, I'm loathed to pay more tax than I have to so i'm keen to set out an annual schedule where I pay myself just enough salary not to incur huge amounts of income tax and employee's / employer's national insurance. I'll then settle the rest in dividends up to the higher earnings threshold.

Although I could leave the rest of the money in the company, I don't want to accumulate a large surplus which I'll then have to draw out and take a tax hit at some future point.

I guess what I'm really saying is:-

* I know the annual (tax efficient) threshold for my Salary
* I know the annual (tax efficient) threshold for my Dividends

* What is the annual (tax efficient) threshold for paying into a pension?

Got there in the end. I hope this makes sense

Thanks
Jim

[John Yerou]

Hello Jim,

It sounds like you've been round the block! We get asked this question daily.

There are no longer any limits to contributions you can make from your limited company income into pension funds; the amounts must simply not be very much larger than your actual declared corporate income. In your case £100k per annum.

HMRC have accepted that employer contributions by Contractor's one-man limited companies should be universally eligible for tax relief. This means that, unless you are planning on contributing very large amounts which are totally out of character with your business you can be safe in the knowledge that your contributions will not be questioned by HMRC.

There is a general overriding rule that a companies expenses must be incurred “wholly and exclusively” for the benefit of the trade and there was until recently significant uncertainty as to how large employer contributions could be for this condition to be met. Recent guidance from HM Revenue & Customs, BIM446001 confirms that except for very limited circumstances, the payment of a pension contribution will be treated as part of the normal cost of employment and therefore will satisfy the “wholly and exclusively” requirement.

This guidance is excellent news for one-man limited contractors and it should now be acceptable for a company to make employer contribution to a contractor’s pension, up to the level of profits made by the company.

In most cases the level of contribution that can be made and that will benefit from tax relief will exceed the amount that a contractor is likely to wish to contribute on an annual basis in any given year.

HM Revenue & Customs guidance indicated that particular care will need to be taken with employer contributions to connected people i.e. the contractors spouse, here the level of contribution should be limited to the level of contribution that would be paid to an unconnected employee. It was also thought to be problematic if contributions where paid by a party other than the former employer, after a trade is sold or otherwise ceased.

Pension contributions are undoubtedly tax efficient but if you do not wish to utilise all the company’s profits in this way you may wish to also consider other tax effective strategies for withdrawing the retained profit from your company. Under the correct circumstances you can distribute funds on dissolution of a company by way of a capital distribution [extra statutory concession C16]. Combined with entrepreneur relief profits withdrawn in this way attract 10% personal tax rate. The effective rate of tax is even less if annual capital gains tax allowances are otherwise unused.

I hope this clarifies and simplifies "Contractor Pensions".

All the best.

[Whiskychaser]

That’s great advice – thanks John.

I’m in a similar situation to Jim (though not quite as wealthy LOL!). Can you tell me what difference it would make paying into a SIPP via either company or personal contributions?

Whilst contributions direct from the company bank account would be made with no deductions at all (i.e. not liable for PAYE, N.I. Corporation tax etc), I don’t understand what advantage this gives over a contractor who pays dividends from the company to himself, and then invests these in a SIPP. As far as I can tell, such ‘personal’ contributions would attract tax relief exactly equivalent to the tax paid on them by the company or individual (i.e. the corporation tax plus any higher rate top-up tax that would otherwise be payable via your own personal tax return). So, as far as I can see, everything ends up equal, no matter how you arrange things.


I’m left wondering what I’ve missed here though – can you give any pointers?

Many thanks!

[Tony Harris]

Hi Jim, what youre proposing really does represent a very effective means of transferring funds from company into personal hands.

I think that John has simply made a typo when he writes 'it should now be acceptable for a company to make employer contribution to a contractor’s pension, up to the level of profits made by the company'.

Please rest assurred that the level of profit made by the company is academic. The pension contribution will, of course, reduce the level of those profits in any case.

If the main aim is for you to extract funds from your company as tax efficiently as possible, you could also consider (subject to your needs for a day to day income) reducing or stopping the dividend altogether and could divert this money to boost your pension contribution instead. Whilst you are obviously conscious of the benefits of avoiding the higher rate of tax on dividends there would still be a tax charge incurred, whereas the pension route would mean that the money could be drawn out of the company without the taxman recieving a penny.

[olly]

Originally Posted by Tony Harris

whereas the pension route would mean that the money could be drawn out of the company without the taxman recieving a penny.

perhaps the word "initially" should be added there!

Annnnnnnnyway..hello new forum. Was just waking this up as I'm having a hard time finding the specific advice from HMRC on this one. Please do you have any links to their website that states pension contributions can be many many times larger than salary (other provisos met)?
Would really appreciate it as ClearSky / Quay Accounting are advising a contribution in line with salary.
Thanks
Oliver

[NeilBenson]

Hi Whiskychaser, I have the same question as you: can the company make employer contributions to my SIPP without it touching payroll, or (B) does the employee have to make the contributions from net pay.

However, I don't think the net result of each option is the same. Let's say option A contributes £1,000 to the employee's SIPP. Under option B, ER and EE NICs are deducated as well as income tax, so let's say the employee receives £600 (for the sake of argument). When the employee contributes this £600 to his SIPP, he receives tax relief (but there's no such thing as NIC relief) so the SIPP receives £800. HMRC pockets the £200 of ER and EE NICs.

Happy to be proved wrong -- my new accountant thinks that option A isn't allowed, but I've used it before.

[John Yerou]

Originally Posted by olly

Please do you have any links to their website that states pension contributions can be many many times larger than salary (other provisos met)?
Would really appreciate it as ClearSky / Quay Accounting are advising a contribution in line with salary.
Thanks
Oliver

I think you are confusing a personal pension investment contribution with an employer contribution. Let me try and clarify this for you:

You can now fund your personal pension direct from your limited company income and there are no longer any restrictions to the contributions you make, limited only by the annual tax relief allowance which currently stands at £245,000.

However, when you make a personal pension investment contribution, it is indeed limited to 100% of your salary. However, if you are a one man limited company contractor you should be making an employer contribution. In this case (employer contribution) the salary level has no bearing at all on the investment contribution you make into a pension. So you should be free to invest all this years contract income if you choose to.

I have also contacted one of the senior accountants at Clear Sky/ Quay Accounting (Craig Szeto 01202 753 111) and he confirmed that there are no restrictions to the contributions you make from a limited company except for the annual tax relief allowance which currently stands at £245,000.

[Tony Harris]

Originally Posted by NeilBenson

(a) can the company make employer contributions to my SIPP without it touching payroll, or (B) does the employee have to make the contributions from net pay. However, I don't think the net result of each option is the same. (there's no such thing as NIC relief) Happy to be proved wrong -- my new accountant thinks that option A isn't allowed, but I've used it before.

Hi Neil, youre obviously caught by IR35 (as you pay NI) so option (a) is, without question, the way to go. Youre dead right that theres no such thing as NI relief and so paying the contribution personally would not be anything like as tax efficient as investing via your company.

As for your new accountant, I'm guessing you didnt pick him based on his knowledge of the pension rules. Option A is most definately allowed.

Hope this helps clarify things for you, Tony

Tony Harris
MD, ContractorFinancials

[Tony Harris]

Originally Posted by Whiskychaser

Can you tell me what difference it would make paying into a SIPP via either company or personal contributions? As far as I can tell, such ‘personal’ contributions would attract tax relief exactly equivalent to the tax paid on them by the company or individual (i.e. the corporation tax plus any higher rate top-up tax that would otherwise be payable via your own personal tax return).

As mentioned on previous posts, you'll obviously need to bear in mind that if you invest personally you can only contribute up to 100% of salary (salary being low as you'll obviously prefer to draw money out by way of dividends rather than incur NI costs unnecessarily). So deciding on the personal contribution route will no doubt limit your overall scope to invest.

Whilst I agree that the effective rates of relief are broadly the same you do have the extra admin of claiming the additional higher rate tax relief via self assessment (nb you need to make the personal contribution net of only basic rate income tax relief initially) whereas a company contribution is paid gross and theres no income tax to reclaim.

An additional comfort that could be gained from making these investments direct from your company account would be that in the (admittedly unlikely) event that you are ever deemed to be within IR35, HMRC would ask for the National Insurance to be paid on your drawings whereas pension contributions are allowable in addition to the 5% expenses rule and therefore should never be liable to NI.


Tony Harris
MD, ContractorFinancials