Introduction   

If you are a contractor who runs your own company, one thing to consider is a contractor pension scheme.

Taking the right steps before the end of the tax year can provide a financial boost for you and your business.

You may also have pension schemes in place from former employments and if you would like to consolidate these there are steps to consider.

If you are a director of your own company, what is the best way for you to take profits from the business for your benefit? The answer here will vary, and it depends on your tax position and your business. Usually, though, it will come down to finding a tax-efficient blend of income. When you decide on this, it will be in the form of salary, bonuses, and dividends.

When you decide on the level of salary from your business, you will need to think about various factors. These will include the current Tax and NI thresholds. It is often a good idea to keep your salary just above the threshold for NI. This level of pay is enough to qualify for the State Pension, while this also keeps you within a minimum tax band. This threshold stands at £9,564 for the current 2021/22 tax year.

On the other hand, your Personal Allowance will cover a salary of up to £12,570. This level of salary will be free of Income Tax if you have the box standard personal allowance and no adjustments in your tax code. There will, though, be a small amount of NI that will be due. 

Paying dividends 

When we are thinking about a contractor pension scheme, historically, directors of profitable companies have preferred to receive a larger portion of their pay in the form of a dividend. They do so because it can help to reduce their tax bills. The annual tax-free dividend allowance was previously £5,000, but this came down to £2,000 on 6 April 2018. 

Therefore, dividends are now a slightly less attractive option for directors than was the case in prior tax years.

Even so, dividend payments will often be a more tax-efficient choice when you compare this to paying a salary. Dividends are not subject to NI. They also attract lower rates of Income Tax. Any dividend income above the £2,000 threshold and within the basic rate band, attracts tax at 7.5%. 

Dividends falling within the higher rate band or the additional rate band are taxable at 32.5% and 38.1%, respectively.

Using the £2,000 dividend allowance by 5 April may make good sense. Beyond that limit, how much should you choose to pay yourself in dividends? Your decision will depend on weighing up the relative tax bill.

Tax matters 

Aside from salary and dividend payments, there are some other tax-efficient options. Therefore, this is well worth taking a look into these. For instance, if you can look past immediate income needs, it may be a good idea to pay some of your business profits into a contractor pension scheme. If you are a contractor you could set up a contractor pension scheme.

Many business owners overlook the fact that they can make a pension payment from their business for their benefit. What’s more, HMRC treats an employer pension payment as an allowable business expense. Therefore, you can set payments into your contractor pension scheme off against the business’ Corporation Tax (CT) bill.

By moving the cash into your pension, you can reduce the profits of the company. When you do this, it can, in turn, lower or eliminate the liability to CT.

If your company paid £10,000 into a contractor pension scheme, it would save CT at 19%, which is a saving of £1,900.

Please be aware that pension payments into a contractor pension scheme must abide by the rules for allowable deductions. You can find more info on the HMRC website.

Personal preference? 

Depending on your financial position, when you pay into a contractor pension scheme from the business, this may or may not be more beneficial to you. Indeed, this will come when you compare it to paying into a personal pension payment. These can attract personal tax relief at your highest marginal rate of tax. Your financial adviser will be able to help you decide which method is more tax-efficient.

In both cases, you can draw the money in a pension flexibly from the age of 55.

If you have passed your 55th birthday, you will be able to take the whole fund back and use the cash as you wish. A quarter of this will be tax-free, while the rest will be subject to Income Tax.

You can add up to £40,000 to your contractor pension scheme this tax year using pre-tax profits from your business. You may not have made pension payments this tax year or in the previous three. If this is so, you could use the carry forward rules to add notably more to your pot.

Please note your company needs to pay the employer pension payments before its financial year-end. If you do this, your payments will qualify for the deduction during that accounting year or period.

The value of an investment will link directly to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.

The levels and bases of taxation and reliefs from taxation can change at any time. They are also dependent on individual circumstances.

Advice 

As a final note. You may like to talk to a financial expert about the prospect of starting up a contractor pension scheme. What’s more, you may like to know how this could be of benefit to you and your business. Therefore, if you would like to know more about a pension for contractors, please feel free to contact Joe Willcox. You can reach him by e-mail at [email protected].

Link to Contractor Advice UK group on 

LinkedIn    https://www.linkedin.com/groups/4660081/

Published On: March 25th, 2021 / Categories: Contractor Tips, Pensions, Tax Saving Guides / Tags: /

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