If you are caught by IR35 and currently do not have a pension you are missing out on huge tax savings.
Why? Because you can avoid paying all that extra IR35 tax simply by diverting money from the tax man into a pension. Here's how...
What can be saved?
Contractors caught by IR35 pay significantly higher taxes due to employers NI, employees NI, and Income Tax (PAYE) being applied to all of their income. For example, a contractor on £40 per hour has an increased tax burden of 44%.
Tax paid into a pension comes from your income before any of those taxes are applied. So you get 'tax relief' on it.
An example
For a contractor inside IR35 earning £40 per hour, each £100 earned attracts £48 tax with only £52 ending up in their pocket.
Instead of drawing £100 as salary the whole £100 could be contributed to a pension. This reduces net income by £52, but increases a pension by almost double, attracting tax relief of 48%.
Tax relief for some earners can be as high as 68%, due to the changes in the April 2010 Budget. In April 2010 the new additional rate of income tax of 50% was introduced for those earning over £150,000. For those contractors earning more than £150,00 per year the tax relief will be 58%. But for those earning just over £100,000 per year the effective tax rate is 60% due to the reduction in personal allowances introduced, resulting in tax relief at 68%. For high earners pensions are now an even more attractive option as a tax saving device for contractors than before.
You can calculate your own potential savings using the Contractor Pension Calculator.
Some quick facts about Pensions
- Pensions aren't all about saving money to buy an annuity. You can withdraw 25% of your pension funds tax-free from age 55. And rather than buying an annuity, you can continue to draw from the funds each year to maximum limits.
- Your savings can be passed on to your family if you die before age 75 - provided you've not bought an annuity. The money will not be subject to inheritance tax.
- You no longer pay large portions of your payments in commissions to an IFA - charges are negligible - comparable to buying a tracker fund.
- Your funds are perfectly safe as pensions funds cannot become insolvent. A private pension fund is carefully protected by law.
- If you're risk adverse and concerned about funds invested in the stock market you can option for keeping the pot in cash - just like an ISA.
Stakeholder pensions are very flexible. Contributions altered on a month by month basis without any penalties or additional fees.
You can find out more by reading Pensions for Contractors - an Overview.
Pension Quotation
Updated: Monday, May 16, 2011
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