Q&A with a contractor pension expert
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Q&A with a contractor pension expert

Pensions are a huge benefit of being a contractor. You may have only just started thinking about contractor pensions, or maybe you’ve accumulated lots of pensions in different pots over the years.

Whatever your situation, there will always be questions. We sat down with a pensions expert to give you the definitive answer to the most-asked questions about getting a pension as a contractor.

In our last blog, we brought you a Q&A with one of our contractor mortgages experts. Didn’t see it? Read it here!

 

1. I started building my pension pot as a full-time employee. Over the last couple of years as a contractor, I stopped paying anything in and started using ISAs. Should I restart my pension as a contractor or keep using savings accounts?

Yes! You will receive more tax relief initially on a pension.

Let’s assume you invest £20,000… and you want to draw this out the business.

£20,000 is liable to corporation tax at 19% – £3800. Therefore only £16,200 available to draw out.

Furthermore, this attracts dividend tax at 7.5% (assuming best case scenario) – £1,215.

This means only £14,985 available to draw out and invest in an ISA assuming dividend and personal allowance use.

With a pension, the full £20,000 is available to invest on day one. Over time, this will make a substantial difference with compounded growth.

Pensions allow you to fund directly from your limited company and class this as a business expense. This means that any investments made to a pension effectively receives a 19% corporation tax relief.

What’s more, it means that you do not have to draw out the funds as dividends (as you would need to when investing in an ISA) which has a potential tax saving of 7.5%, 32.5% or 38.1%.

 

2. How do contractor pensions give tax breaks?

It’s exactly the same as above. Any investments made to a pension scheme directly from a ltd company would be classed as a business expense and would come out of the company with no liability to corporation tax. This effectively gives a 19% tax saving.

Furthermore, it means that you do not have to draw out the funds as dividends which has a potential tax saving of 7.5%, 32.5% or 38.1%.

 

3. What’s the difference between a Stakeholder pension and a SIPP? Does it matter?

In short, no!

Stakeholder pensions were introduced in 2001 as a simple pension option which incorporates a set of minimum standards laid down by the government.

These standards are designed to make this type of pension simple, cheap and accessible for those on lower incomes.

As with most other types of defined contribution pension, the money can be drawn from age 55 onwards with a tax-free lump sum of up to 25 per cent taken straight away and the remainder used to buy an annuity.

Anyone aged under 75 can pay into a stakeholder pension and you can invest up to £3,600 each year.

SIPPs offer a much more flexible approach to investments.

That flexibility is the big plus point of this type of pension, but it does mean that the responsibility of picking the right funds is down to you.

You can invest in pretty much anything, from commercial property and gold bullion to more conventional unit trusts and shares.

When considering this as an option you need to ask yourself whether you are prepared to do the homework, and regularly monitor your investments.

You need to be comfortable making and taking responsibility for your own investment choices. If you think that applies to you, then a SIPP is probably a good option.

 

4. How much cash should I build up before I start drawing a pension?

As a general rule of thumb we would recommend 6 month expenditure.

 

5. I’m making my partner a Director in my limited company. Is it better if we both have pensions or have just one between us?

It would be better if you both have a pension, but careful planning needs to be considered as to the amounts to determine if this is wholly and exclusively for the purpose of business.

Any evidence of abuse in this area could lead to the local inspector of taxes concluding that “there is a non-trade purpose for the size of the contribution paid”, which could result in the employer not being allowed to treat some or all of the contribution as a deductible business expense against their corporation tax bill.

 

Was your question not answered?

Get in touch with us – we’d love to help you.

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