Contractors nearing retirement or seeking to save are the main beneficiaries of Chancellor George Osborne’s 2014 Budget. There are also a range of minor changes to rates and allowances that also work in most contractors’ favour.
The changes with the most impact on contractors will be sweeping pension and savings reforms, as an expert independent financial adviser (IFA) explains: “Older contractors approaching retirement face a real game changer as a result of the Chancellors announcements, whereas younger contractors now have greater incentive to save because there are going to be far fewer restrictions on accessing their money in later life.”
On the tax front, Abbott Moore’s James Abbott notes that higher rate taxpayers will gain for once, as will limited company contractors: “The basic rate and higher rate allowances have increased, and the new £2,000 National Insurance Contributions (NICs) allowance will leave contractors marginally better off.”
Changes to tax rates and allowances
Whilst the budget holds mainly good news for contractors, there are some ‘pain points’. According to Abbott, the key changes to rates and allowances in this year’s Budget are as follows:
- The personal allowance increases to £10,000 from April 2014, and then to £10,500 from April 2015. For once, the higher rate tax allowance has not been reduced in kind. This means that the allowance for higher rate taxpayers during 2014/15 will be £41,865, increasing from £41,450 in 2013/14. When the personal allowance increases to £10,500, the higher rate band will increase to £42,285
- What has not changed is the reduction of the personal allowance at £100,000. In fact, due to the increase in other allowances, contractors earning in this range will find the current marginal rate of 60% between £100,000 and £118,880 even more painful, because it will now apply up to £120,000. The £150,000 limit has not changed
- The increase of the Annual Investment Allowance (AIA) to £500,000 means contractors will qualify for 100% corporation tax relief on pretty much any non-property/non-car equipment or plant purchase during the purchase year
- The childcare proposals have been updated, and confirm that any employed and self-employed (sole trader) contractors will benefit from tax relief of 20% per child up to a maximum of £10,000 per child each year. The scheme will take effect in the autumn 2015. Contractors will pay 80% of childcare costs into a government ‘pot’, and the government will add the 20% and pay the childcare costs directly. Contractors can remain with the existing voucher-based scheme or switch to the new scheme
- The main corporation tax rate most contractors pay remains at 20%. The large company profits rate will be 21% from April 2014. This is calculated on profits over £300,000, so only likely to impact on contractors if they have exceptional earnings, or have several close companies having to share allowances.
Limited company contractors can benefit from £2,000 NIC allowance
“Limited company contractors may also be able to benefit marginally from the new £2,000 Employment Allowance, effectively a contribution towards employer’s National Insurance Contribution (NIC),” says Abbott. “Assuming a contractor has no other earnings, income or benefit in kind, they can pay themselves up to the full £10,000 personal allowance during 2014/15 and be £164 better off.”
Limited company contractors may also be able to benefit marginally from the new £2,000 Employment Allowance, effectively a contribution towards employer's National Insurance Contribution (NIC)
James Abbott, Abbott Moore
However, Abbott warns that any complexities such as personal bank interest or rental income rapidly remove any benefit to using the allowance: “All of a sudden, the employer’s NI benefit falls away, and contractors have to pay employees NICs at 12% on earnings above the lower earnings limit of £7,956 and the personal allowance of £10,000.”
Fortunately, contractors are under no obligation to use the allowance, and Abbott recommends that contractors who have any income other than just their salary and dividends from their limited company seek professional advice and a calculation from their accountant.
False Self-Employment and tax avoidance measures
Abbott highlights that despite the Offshore Intermediaries legislation, the Onshore Intermediaries legislation, better known as the False Self-Employment laws, and other anti-avoidance legislation becoming law from April 2014, few mainstream contractors are likely to be affected.
However, he warns that the new anti-avoidance proposals potentially provide HMRC with sweeping and dangerous new powers: “HMRC can demand the money for tax-avoidance schemes be paid by taxpayers in advance under Disclosure of Tax Avoidance Schemes (DOTAS) and General Anti Abuse Rules (GAAR). If the taxpayer wins the inevitable tax tribunal or court case that follows, HMRC will repay the money.
“In addition, if someone has been litigated against and defeated and who is using the same scheme as you are, then HMRC can ask you to pay up and settle the tax outstanding. If you don’t and later lose, HMRC can charge a penalty. Introducing a penalty is a new approach by HMRC. These rule changes place dangerous powers in the hands of HMRC and make the assumption of the taxpayer being guilty.”
HMRC will also be given powers to deduct money directly from taxpayers’ bank accounts for unpaid tax bills, but only when there have been repeated attempts to secure the money.
Pensions and reform – what it means for contractors
The IFA expert is delighted with the 2014 Budget’s pension reforms. He believes they will revolutionise financial planning for all contractors, and not just older savers and those nearing retirement: “Despite the significant tax advantages for contractors to invest in pensions from early on in their careers, many have been put off by the restrictions over what they can do with their cash when they reach 55, or decide to retire.
“In practical terms the reforms mean that contractors can decide to draw out all or part of their fund and yet avoid paying punitive tax charges for doing so. This freedom will apply from 55, although the government is consulting on moving this age to 57, and we expect to see clients choosing to phase the encashment of their fund because many contractors have alternative sources of income and investments, and continue to work flexibly or part-time into retirement.”
It also means that contractors are no longer forced to invest in annuities, which are currently delivering poorer returns, having faced the twin challenges of low gilt yields and people living longer.
The IFA expert believes that the annuity market must also reinvent itself to take into account the smaller pool of annuity purchasers. Those that do still go down the annuity route will only be those likely to have a family history of long lives. That means the current process whereby people who die early subsidise the incomes of those that live longer will cease.
In practical terms the reforms mean that contractors can decide to draw out all or part of their fund and yet avoid paying punitive tax charges for doing so
“We’re likely to see a revolution in the financial sector, providing alternatives to annuities. Contractors will be able to stagger drawing out from their pension pot, buy short-term annuities if seeking a regular income for a period of time to suit a lifestyle choice. They can also draw out part of their fund to supplement fee income if they prefer to continue working, or buy other revenue-generating products or assets like buy-to-let properties.”
Sweeping changes to tax-free savings rules: Pensioner Bonds, ISAs and Junior ISAs
The IFA expert explains that the tax-efficient savings landscape has also changed significantly, and again for the better for contractors: “From 1 July 2014, there will be a single ISA product with an annual tax-free investment allowance of £15,000 that can be held as cash or as equities. The Junior ISA limit will increase to £4,000 a year, encouraging contractors to build up a nest egg for their children, and grandchildren.
“I can see situation where ISAs become an even more effective weapon in the contractor saver’s armoury. The ability to switch from equities into cash provides contractors with additional flexibility. If saving for a specific need, they can choose higher-risk but higher return equities if they have the appetite for it and then simply transfer to cash as the time to draw the funds out approaches.”
The Chancellor also announced the launch of Pensioner Bonds, which are a new National Savings product aimed at pensioners and designed to deliver a return in excess of current market rates, to provide savers with a better return than the market currently offers.
Making provision for the unexpected
The proposed cap on benefits brings into sharp focus the need for contractors to make provision for not only their retirement, but also sickness and untimely death.
The IFA expert explains: “Most permanent employees take for granted sick pay, death in service and pension benefits. Contractors don’t have this safety net unless they make provisions themselves, and it looks like the proposed cap on benefits is a strong message that the state won’t pick up the bill in the future.
“This shows that contractors should invest in protection in the event that something untoward happens, such as critical illness cover, death in service and life insurances, plus pensions. Most of these financial products can be paid for tax efficiently by a contractor’s limited company.”