Contractors should befriend pensions this Christmas

Pensions are a form of tax-efficient savings which allow contractors to set aside money for retirement through regular or lump sum contributions. Crucially, tax relief is received on payments made into a pension and where funded by your company for every £80 you contribute, a further £20 will be added by the exchequer. 

The ‘savings’ pot can be accessed from age 55, and up to 25% of your pension value can be drawn tax-free at or after this point – effectively meaning a quarter of the funds you’ve saved will have received no tax on either deposit or withdrawal.

The remainder will be taxed as you make drawings and will be subject to your personal allowance marginal rate of Income Tax at that time.

Can you afford to ignore a windfall like this?

The current state pension offers just £119.30 per week (£6,203.60 per year) in retirement income, providing for only a meagre living standard at best.

Even a relatively modest pension can have a significant impact on your living standards at retirement. A 45-year-old paying £1,000 per month into their pension and who retires at age 67 will have a private pension pot of approximately £376,188, giving an income of £18,809 annually, significantly altering their lifestyle post-retirement.

That same contractor also stands to cut their corporation tax bill by £52,800 over the 22 years they pay into their pension and would save a further £25,392 in tax should they make use of the 25% tax free lump sum drawdown! There would even be further savings in the form of income tax for many in the years to come as well.

The great pensions makeover

This year has seen the implementation of the biggest shakeup in pension history, turning the once drab, restrictive retirement option into a highly flexible and tax-efficient means of providing for the future.

In a nutshell, George Osborne, the chancellor, announced sweeping changes to pensions in the 2014 Budget, removing restrictions on pension drawdowns and giving contractors the flexibility to choose how and, to a degree, when they take their retirement income.

Historically pension savers were restricted to drawing a 25% lump sum from their pension pot after their 55^th birthday, which would be tax free, but the balance would typically need to be used to purchase an annuity – a form of investment which provides a guaranteed income for life. This left contractors at the mercy of the annuity market with limited choice as to their long term investment strategy in retirement.

Under the new pension rules, contractors still benefit from being able to draw 25% of their pension pot tax-free but today benefit from freedom of choice when it comes to the remaining 75%. Well, the new rules allow for the entire pension to be liquidated at age 55, should that be the right financial choice for the contractor.

Reform and the last bastion of tax mitigation…

Dividends face a shake-up in 2016 and buy-to-let may appear less attractive an investment for some savers following a sustained kicking from the chancellor, leaving the old faithful pension as the last bastion of tax relief for many contractors.

Those who have previously overlooked a pension should take this festive holiday to look again – the stuffy rigidness has gone and a pension should become a contractor’s best friend.

For further information on contractor pensions please click here.