A limited company director’s guide to pension contributions

It’s difficult if not impossible to financially make the most out of your contractor limited company if you’re a director not making pensions contributions because you don’t know the tax allowances, rates, relief and rules when it comes to retirement saving, writes Angela James of Yolowealth.

Pensions for limited company contractors: introduction

If you start to contribute to a pension as a limited company director, you’ll be ahead of the crowd. In fact, an alarming number of people are “sleepwalking” into their retirement without adequate preparations and savings provision, according to financial product compare site Unbiased.

And just to give you a sense of how much of a pension you will likely need, the supposed secret to a ‘financially-happy’ retirement is an income of £26,000 a year for a couple, or £19,000 for a single household, the Guardian has reported. But with the UK government’s state pension not even providing half of this amount, when are you going to start building a nest egg, and how?

The rub for contractors is that, as a company director, you fall through the cracks of the UK government’s auto enrolment pension scheme – you’re simply ineligible. This exclusion from auto enrolment means that many contractors running their own limited company NEVER get around to putting money aside for themselves. In short, too many contractors are missing out on saving for a rainy day at the end of their working lives.

Tax relief

In some ways, that’s surprising. Pensions remain and will most likely remain the single most tax-efficient investment that any one person could save into. Pensions are the only investment that provides full relief on the amount that you place into the pension. In simple terms, the money is simply not taxed on the way in.

As a company director, you can save into a pension for yourself through an employer contribution. This money will be paid pre-corporation tax; is not subject to national insurance, incurs no personal income tax and it’s not a benefit-in-kind. It’s straight ‘off the top line,’ as us financial advisers like to say!

The perks of pensions

My strong suggestion is that you choose to utilise your allowance, if the full allowance is available to you, which is up to £40,000 each year. Fail to use this you and you are giving away an annual corporation tax saving of £7,600!. That’s a lot of additional money each 12 months that would be better off in your pocket for the future.

Even better – consider that once in the pension, the growth you achieve on the monies is also tax-free, there is no capital gains tax to pay.

So before we get into the nitty gritty of pension rules, be under no illusion that pensions are a great way to:

• save for the future,
• defer your company profits for when you need them (in retirement) and;
• reduce your effective rate of tax downwards, when you will likely be a lower rate taxpayer in retirement.

Need another incentive to start building your nest egg? Well, you can even have a quarter of your total pension savings tax-free!

Rules

Each year, contractors and all other individuals in the UK have an ‘allowance’ to save into a pension. At present, this allowance is up to a maximum of £40,000 per tax year. Crucially, the amount of this that is available to each individual depends on individual circumstances and the way you make the contribution. Allowances in the majority of cases are lost each year, so if you don’t use the allowance by April 5th, then more often than not it’s gone forever!

For some contractors, you may have the option to use what is called a “carry forward allowance.” Again, this depends on individual circumstances and qualifying criteria so check with your adviser. But in general, ‘carry forward’ affords you the option to go back up to THREE previous tax years and use up some of the allowances not previously taken advantage of! Important to note here that its only THREE years and once you start to use some or all of your allowances, the ability to take advantage of this diminishes as the years pass. It’s also not available to everyone so don’t delay saving on the assumption this is a backup.

Be aware, pension rules can change quite quickly, so do act and take advantage ‘while stocks last.’ In other words, every year that passes means that you lose out on tax relief; time in the market, and allowances. Ultimately this will lead to a smaller pot and less income when you do eventually retire.

IHT sweetener

Something that many of us don’t consider when we think about pensions is there efficiency when it comes to inheritance tax (IHT). If you are fortunate enough (or unfortunate enough as the case may be), to have assets after you shuffle off your mortal coil, to leave to loved ones, there is tax to pay (IHT), at a whopping 40% on the estate we leave for them. So then pensions are a great planning tool to consider, as funds held inside a personal pension do NOT form part of the estate you’d leave behind. We can pass the money onto our loved ones -- it doesn’t die with us, and the tax treatment could be tax free if we pass before the age of 75.

The bigger the pot, the more you will have

Today is always a good day to start saving! Moreover, it’s never too late to start. The beauty of pension reforms in 2015 means that we all have so much more freedom over the way we access our money, in our personal pension, when we retire.

Think of your pension a savings account that you can access from age 55 and use in any way you wish; this means that even if you haven’t quite got to where you would have always hoped for (in financial terms), you at least will have capital over and above the state pension.

Also keep in mind -- flexibility is key when it comes to being a contractor or company director, and it’s no different with retirement saving. There is a lot of choice out their when it comes to pensions and choosing the right one for you is vital. A key goal I’d suggest you have is to ensure you ‘build-in’ the flexibility to contribute what you can; when you have it. Don’t be afraid to AVOID committing to a regular contribution -- if having a set amount you put in is not going to be the best way for you. The right pension can offer a wide variety of options on how to take the income when you are ready to retire, alongside some offering a huge variety of investment options to suit any type of investor. 

Please note, tax treatment varies according to individual circumstances.This article is based on current tax rates and regulations and they may change in the future.

Finally, this is what the limited company pension-contributing contractors who I assist say…

Most of the company directors I advise appear to treat their private pension arrangement as their savings for 'nice to haves' in retirement. So what will be your ‘nice to haves’ and how will you acquire the funds to even consider them? Good luck, and happy retirement saving.

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