Pensions & Tax
Personal pension contributions
We will first explain the difference between contributions made personally and contributions made by your company (also called employer contributions).
As a limited company contractor or freelancer you should ensure you are a director of your company to justify the company pension contributions.
Contributions made by your company are paid directly from your company bank account into your pension fund. The pension provider must be told that these contributions are ‘employer’ contributions, this will ensure they are treated correctly for tax in the pension fund – they are not ‘grossed up’ in your pension fund which means that if £100 is paid by your company then £100 is what goes into your pension, there is no additional tax added like there is usually with personal contributions.
Contributions made personally are from your own personal pocket and when paid into your pension fund are normally grossed up by 20%. So if you pay £80 into your pension fund, £20 of tax is added by the government and your total pension addition is seen to be £100.
With personal contributions, if you are a basic rate tax payer you get no additional benefit through your personal tax return, you just get the 20% tax added into your pension fund ( which you have already paid 20% income tax on), but if you are a higher rate tax payer you usually save an additional effective 20% tax through your personal tax return (depending on how far you are into the higher tax band compared to the total gross pension contributions made). ( Again this is because you have already paid 40% tax before you have made the personal contribution ).
Personal contributions can be very advantageous for Higher Rate tax payers as you can reclaim your 40% and then when you take the benefits from your pension pot you are likely to be a Basic Rate tax payer (as you have retired!) so you will get 20% plus all the growth based on todays tax rates.
Do bear in mind that personal pension contributions are made out of your own pocket so you will have potentially paid income tax on your salary / dividends already, which differs to company contributions.
Personal pension contributions will usually have a lower annual limit than company contributions for limited company contractors and freelancers.
This is because with personal contributions you are limited to your pension contributions not being higher than your earnings, and your earnings include your salary from your company but do not include your dividends, therefore for a typical contractor and freelancer their earnings may only be the £680 per month salary, which is £8,160 for the year.
Company pension contributions
Company pension contributions as they tend to be the most effective structure for limited company contractors and freelancers.
When a company makes employer pension contributions into a pension fund, the company is allowed to treat these contributions as a business expense just like with a directors salary, so the company saves 19% corporation tax on the expense.Not only are you topping up your pension but you're saving tax also!
One thing to be aware of is that HMRC will only allow your company pension contributions the corporation tax savings as long as your salary, any benefits-in-kind and pension combined are not seen to be ‘excessive’ for the role you are performing in the business.
So if you have a salary of £680 per month which is £8,160 for the year, and there are also £20,000 of employer pension contributions, HMRC would look at this total remuneration of £28,160 and make sure it’s not excessive for the role being performed.
In reality for a limited company contractor and freelancer working full time it would usually only be if you are making very large company contributions that you would start to go into dangerous territory and risk a HMRC challenge.
However if you are paying your spouse a salary and also making company pension contributions for them (make sure they are a director or company secretary) this is where things do get riskier if they are not performing a senior and full-time a role in the business, so we would not’t recommend going too high with their contributions.
Things to consider when assessing if your contributions are excessive:
• How much would you have to pay someone to do your role
• How senior is your role
• How many hours do you work
• Is the company making sufficient profits to support the level of contributions
There are some limits to be aware of with pensions.
The total maximum gross pension contribution (company and personal) per person is £40,000 per year for the 17/18 tax year. If your earnings are above £150,000 then new rules came in from 16/17 that will reduce this. There is also a facility called “ Carry Forward” where you can effectively maximise contributions from the 3 previous tax years once you have utilised the 40, 000 in the current tax year. This is proving more popular when planning cash flow and exit strategies for business owners especially now that benefits can be drawn down from age 55 onwards with no limits on how you take the income or 25% currently available tax free cash regardless of other income streams or if you still continue working.
Get in touch with us directly if you would like to speak to one of our partners in regards to pensions. Accountants are not regulated by the Financial Conduct Authority, so we can only advise on the tax impact of pensions.