What is the best pension via an umbrella company?

If you’re working through an umbrella company, then you should have been offered the chance to join their own ‘occupational’ pension scheme. But is there a better choice?

Here, exclusively for ContractorUK, I’ll outline your pension options as an umbrella company contractor, explain some of the basic principles about modern pension schemes including how they work and why they’re so tax-efficient. Plus I’ll throw in some lesser-known considerations about umbrella pensions, which could make a significant difference to your financial security now, and in the future, writes former contractor Paul Mayhew, associate partner practice of St. James’s Place Wealth Management.

Which pensions are on offer to umbrella company employees?

Let’s start with the umbrella’s occupational scheme.

As the umbrella company is your employer, the umbrella is obliged under government auto-enrolment regulations to offer eligible employees access to an employer-sponsored pension scheme. This legislation was set up to encourage pension saving, and it requires contributions to be made by both employer and employee. The idea here is that it encourages both parties to share the cost of funding an employee’s pension.

For umbrella company employees, it’s not quite this simple, however. In practice, all deductions have to be deducted from the sums invoiced to the end-client. Conceptually therefore, this is similar to National Insurance -- and the sense that you’re effectively paying both employer and employee NI.

Be aware, you can choose to opt-out of the scheme being offered to you by your umbrella, if you wish. And you may choose to do so, perhaps in favour of using a personal pension instead. Or indeed if you simply don’t want to make any pension contributions at all! Not something we’d advise of course.

It’s also worth remembering that providing you have a sufficient National Insurance record, you may qualify for a State Pension as well as your other pension arrangements. The state pension is a valuable benefit, and it is definitely worth taking full advantage of it wherever possible.

Why save into a pension at all?

This is a fair question. Pensions can sometimes be seen as complicated and opaque – or even fairly tedious!

But pensions have changed significantly across recent decades. The traditional ‘Defined Benefit’ schemes (which provided an income for life) have mostly been replaced now by ‘Defined Contribution’ schemes now (based upon an investment pot). These latter schemes are more flexible, but also present some risks – including investment risk, and the possibility of running out of funds too early. Pensions usually have a minimum access age too – currently 55-years-old, but soon increasing to 57.

That said, there are significant tax advantages to funding a pension. In particular:

• You can claim tax relief on money that you put into them, subject to limitations.
• Investment growth on the funds within your pension will be largely free of tax.
• In retirement, up to 25% of the pension funds can be withdrawn tax-free.

This tax relief on pension contributions applies to income tax. But if the right arrangements are made, it is also possible to avoid some National Insurance – both employer and employee NI. These arrangements are called ‘Salary Sacrifice’. It’s an approach which can, theoretically, be applied to both the umbrella’s occupational scheme and also to your own personal pension.

So which should I choose, the umbrella’s scheme or a personal pension?

The answer to this central question depends on a range of factors and circumstances. Unfortunately, there is no one single, correct answer applicable to all contractors.

A good starting point is to ask a second question - Can my umbrella company facilitate Salary Sacrifice into both their own scheme and my personal pension?

If they can only do it for one of these, then that option has a significant advantage for you, and which is probably enough to base the decision upon. Or, if you’re currently choosing an umbrella company, this is a great question to ask during the selection process.

Otherwise though, I recommend considering whether the umbrella’s occupational scheme suits your needs. Queries to pose to yourself include:

• Does the scheme offer a range of investments for my pension which are right for me?
• Do I know how to choose, monitor and adjust these investments? (Or have the time and inclination to do so?!)
• Am I confident that my contributions are the right amounts – in the immediate term, but also to suit my future retirement plans?
• Am I happy with the level of service offered by the scheme provider?

If the answer to all of these is ‘yes,’ then the umbrella’s scheme may be just fine for you.  If not, then it’s worth considering a personal pension as an alternative.

Go personal, and you’ll get access to a wider range of investment choices. You could also choose to consult a financial adviser to assist you, when you’re setting up your personal pension and managing it thereafter.

Why would I choose to consult an adviser?

Again this is a fair question. Financial advice isn’t free. But good advice aims to more-than pay for itself. Research undertaken by the International Longevity Centre UK has shown that those who take advice are on average £47,706 better off in retirement than those who don’t. That’s a sum even well-heeled contractors wouldn’t sniff at!

Some important factors that an adviser will help you with include:

1. Choosing the right investments for your pension funds, usually taking account of:
   • Your attitude to investment risk
   • The time horizon for your investments
   • The benefits of broad investment diversification
   • Ethical investing considerations, if these are important to you.

2. Discussing investment performance, and the massive difference this can make to your retirement plans. Investment returns can never be guaranteed, and investment decisions must be made carefully. But in principle it is easy to illustrate the significance of investment returns on your pension savings. Consider for example that you contributed £500 per month into your pension for 30 years - £180,000 in total:

• Assuming consistent 2% annual growth, these funds would be worth £246,000 after those 30 years.
• If that growth was 5% instead of 2%, they’d be worth £416,000.
• At 8% growth they’d be worth £745,000 – three times the 2% outcome.

These figures are examples only and they aren’t guaranteed. They are not minimum and maximum amounts. What you get back depends on how your investment grows and the tax treatment of the investment. You could get back more or less than this, in practice.

3. Helping you to optimise your tax relief by evaluating your wider circumstances and needs, using pensions (and other suitable HMRC-approved solutions too, such as Venture Capital Trusts).
4. Explaining the different types of personal pensions, stakeholder schemes; Self-Invested Personal Pensions (SIPPs), and maybe some older schemes that you hold from earlier working life.
5. Explaining some limitations of pensions -- for instance the minimum pension access age, the maximum annual contribution allowance, and the pension lifetime allowance.
6. Also talking you through the risks associated with pensions -- including investment risk, risk of depleting your pension funds too quickly, and potential future changes in legislation.
7. Regularly reviewing all of the above, to make sure you remain tax-efficient in the present, compliant now and in the future, and on track for your future retirement goals.

If you’d like to get started with your retirement saving as an umbrella contractor, or would just like to learn more, we recommend you consult a wealth advisory which, like us, offers a no-obligation consultation. Good luck contractors!

Editor’s Note: Please note, the value of an investment with St. James’s Place will be directly linked to the performance of the funds you select, and the value may therefore fall as well as rise. You may get back less than you invested.

The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.

St. James’s Place guarantees the suitability of the advice given by members of the St. James’s Place Partnership when recommending any of the wealth management products and services available from companies in the Group, more details of which are set out on the Group’s website at www.sjp.co.uk/products.

Paul Mayhew Wealth Management is an Appointed Representative of and represents only St. James's Place Wealth Management plc (which is authorised and regulated by the Financial Conduct Authority) for the purpose of advising solely on the Group’s wealth management products and services, more details of which are set out on the Group’s website www.sjp.co.uk/products.