If you are using a contractor umbrella company to manage your contracting income, you can get very significant tax advantages through pensions while at the same time building up a fund which you can start withdrawing from starting at age 50 (55 for younger investors).
Pensions Are Liberalised
Everything has changed for pensions funding since the so-called 'A Day' in April 2006 when the regime was vastly liberalised.
No Limits
''In effect there is now virtually unlimited scope to contribute funds from your gross contract, into a pension fund. If Freelancers have the scope to cover bills etc by other means, they could avoid paying tax and NI on almost all of their contract income, " explains Tony Harris, director of the Richmond, Surrey-based ContractorFinancials, which offers independent financial advice and specialises in contractor affairs.
In effect there is now virtually unlimited scope to contribute funds from your gross contract, into a pension fund.
Tony Harris - ContractorFinancials
'Pre-Taxed' Income
Provided your umbrella company has a pension scheme in place you can use 'salary sacrifice' to contribute 'pre-taxed' income to a pension. Most do have a scheme in place, and if they don't they can get one set up fairly quickly. So, instead of paying employers NI, employees NI and Income Tax you can put the whole sum straight into your pension.
Salary Versus Pensions
Here's an example:
You have £100 worth of income, and you are a higher rate tax payer. You can either put the £100 into a pension, or you can take it as salary via your umbrella company.
But if you choose the latter option and take a salary, you pay:
- £12 employers and employees NI, leaving £88.
- A further £36 is paid as higher rate PAYE tax (Income Tax).
- Your total take home is £52.
Choosing the pensions option means that the whole £100 goes into a pension fund and then has the opportunity to grow in a tax efficient environment. In reality £25 of your contribution represents the part of the pension fund which you can then draw out tax free when you are retire. £27 of your own money also go into the pension fund, together with the £48 that would have gone to the taxman (quite a decent initial 'return' on your £27). This £75 can also grow and be used to skim off an income at a later date, or buy an annuity.
Annunities, Skimming, Inheritance
You don't have to buy an annuity until you reach the age of 75. Before that time you can skim a certain amount from your pension as income. Most annuities only pay around a 5% return, but remember you've only invested £36 yourself, but with the £39 from the taxman it is paying off as £75. So even with the choice of an annuity your overall return is much higher because of the initial tax savings.
As a contractor your employment status is inherently changeable and you must have complete freedom to increase, decrease, suspend, restart and cease contributions completely literally on month by month basis
Tony Harris-ContractorFinancials
In the event that you die before you retire, if you've not taken an annuity, the whole of your fund can be passed on as an inheritance completely tax free.
Contractors should not fear that they are 'making a rigid commitment' to pension funding. ''Any contractor pension should be flexible: as a contractor your employment status is inherently changeable and you must have complete freedom to increase, decrease, suspend, restart and cease contributions completely - literally on month by month basis,'' Harris points out.
So whether you choose a pension with an eye to an annuity, or just to taking some tax-efficient income for yourself as you reach a more advanced age, you should not neglect this possibility for an entirely legal and risk-free tax-savings strategy.
Published: Wednesday, July 16, 2008
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