So you want to save tax using an umbrella company pension?

Curiosity about umbrella companies must be on the up thanks to the April 6^th off-payroll rules, because it is not every day that ContractorUK Forum users ask me to write about pension provision via a payroll company, writes Lucy Smith of Contractor Umbrella.

Indeed, over the last few months, with the new IR35 legislation looming, we have received a steady stream of enquiries about operating through an umbrella based on an ‘inside IR35’ verdict and how tax-saving using a pension can come into play.

Tax perks

It should be recognised by contractors that, at the time of writing, pensions are about the only tax-saving opportunity when working via an umbrella company. Even more important to stress is that, in order to gain the tax benefits I outline, below, the pension contributions must be made into your chosen umbrella company’s group pension scheme. Payments via salary sacrifice cannot be made into a personal pension, and so would lose the additional relief from National Insurance Contributions (NIC).

The savings are best illustrated with an example. Let’s take a contractor on a daily rate of £500. This equates to a gross figure, based on a calendar month, of £10,833.33.

If a contractor wishes to sacrifice as much of their salary as possible into the company group pension scheme, they can do so subject to the umbrella ensuring a minimum wage payment is received for the pay period in question. They must also ensure that the total amount contributed into the pension scheme does not go above the annual allowance, currently £40,000 per annum.

Relief cap

It is important to note that more than this can be contributed; it’s just that the contractor wouldn’t receive any further tax relief on contributions over £40,000 per annum.

It’s also worth noting that for very high earners, for every £2 of income above £150,000 per annum, £1 of the annual allowance will be lost. The maximum reduction will be £30,000, meaning that anyone earning over £210,000 will have their annual allowance capped at £10,000. In this scenario, a £500 per day contractor will earn just shy of £130,000 per annum.

So focusing on this £500 per day contractor, based on a normal tax code of 1100L, the take-home pay will be £6,076.66 per month (56% take-home). As their earnings are above £43,000 per annum, some of the earnings will be subject to the 40% tax rate.

If the contractor decides to salary-sacrifice the maximum pension amount allowed towards their pension, they would be able to make contributions of £9,450 per month for the first four months. It would then reduce for the fifth month as they approach the annual allowance.

Virtually zero-rate

In those first four months, take-home pay would be £1,011.16 (9% take-home), gross for tax earnings would only be £1,098.72, and the 1100L tax code would reduce the tax liability to virtually nothing (in this case, £36.20 per month -- 0.3% of their take-home), falling within the 20% tax rate band.

So if you are thinking about using an umbrella company and considering making payments into a pension, as more and more contractors contacting us seem to imply, then it may be worth working out how much you need to net in your monthly pay packet, and what impact the pension contribution will have. An IFA commented some time ago that the “old faithful pension is the last bastion of tax relief for many contractors.” With so many sweeping and taxing changes to brollies and limited companies since then, that rings true today more than ever.