IR35 - offsetting pension contributions

[Freelancer Financials]

Pensions for contractors

If you work through a limited company the fundamentals are clear and simple. Generally you pay tax on your income. When part of this income is diverted into a pension, you save most of the tax you would generally pay in to it.

For those contractors that are caught be IR35 the tax savings are even greater as you save on the employers and employees national insurance contributions.

Contactors with a limited company are able to contribute “pre-taxed” income into a pension avoiding personal and corporations taxes. And there are no longer any limitations to the contributions you make, apart from the annual tax relief allowance which is currently £245,000 (soon to be £255K).

This would obviously represent a very tax efficient method of transferring funds from company into personal hands.

[ASB]

This would obviously represent a very tax efficient method of transferring funds from company into personal hands.

I'd question the use of the word "obviously". Certainly within an IR35 context it's probably a no brainer - due to the NI savings. Outside IR35 it's far from clear cut, though in a lot of cases I believe it would be the best choice.

There was in fact an item on R4's moneybox recently where an IFA was postulating that in a lot of cases most people would be better off using ISA's etc rather than a personal pension. Whether this may be the case for a company pension I can't be bothered to figure out.

The big problem I personally see with ISA's etc is that from a view of benefits they are going to have to spent whereas the pension fund can't be.

[Freelancer Financials]

There was in fact an item on R4's moneybox recently where an IFA was postulating that in a lot of cases most people would be better off using ISA's etc rather than a personal pension. Whether this may be the case for a company pension I can't be bothered to figure out.

You can only make personal contributions into an ISA hence the term "Individual Savings Account" so your contributions are net of tax (after tax income).

With pensions you get taxed on the way out and ISA's on the way in. However, pensions provide better tax breaks overall (whether inside or outside of IR35).

Check this out with any accountant who specialises in freelancer contractors on this web site.

[ASB]

You can only make personal contributions into an ISA hence the term "Individual Savings Account" so your contributions are net of tax (after tax income).

With pensions you get taxed on the way out and ISA's on the way in. However, pensions provide better tax breaks overall (whether inside or outside of IR35).

Check this out with any accountant who specialises in freelancer contractors on this web site.

I'm not convinced. If you put 800 quid into a pension it gets topped up to 1000 as a BR taxpayer. This then grows at X% for Y years yielding Z.

Under exactly the same charges, growth and duration then the ISA would have a lump sum value of 0.8 * Z.

Now, if one could take the pension as a lump it would yield precisely 0.8 Z. So in this sense all a pension does is defer the tax.

Of course I accept that the pension has to be converted into an annuity. That is taxable at highest marginal rate (and it is likely but not certain that tax allowances are used by the state pension). There is the 25% lump sum tax free. This gives a potential effective saving of 4% of the fund. It may well be that this is eroded by associated charges, trailing commissions etc.

Of course other things go against ISA's - contribution limits for example. But they do gain in flexibility.

I am not saying that a pension will not yield a tax advantage, just that for somebody who is a basic rate taxpayer pre and post retirement it is likely that any tax saving may be outweighed by additional charges. It is all down to the individuals circumstances and attitudes.

There are many potential reasons to choose a pension, but for most people tax saving is not likely to be a valid one.

[Gaz_M]

I'm not convinced. If you put 800 quid into a pension it gets topped up to 1000 as a BR taxpayer. This then grows at X% for Y years yielding Z.

Under exactly the same charges, growth and duration then the ISA would have a lump sum value of 0.8 * Z.

Now, if one could take the pension as a lump it would yield precisely 0.8 Z. So in this sense all a pension does is defer the tax.

Of course I accept that the pension has to be converted into an annuity. That is taxable at highest marginal rate (and it is likely but not certain that tax allowances are used by the state pension). There is the 25% lump sum tax free. This gives a potential effective saving of 4% of the fund. It may well be that this is eroded by associated charges, trailing commissions etc.

Of course other things go against ISA's - contribution limits for example. But they do gain in flexibility.

I am not saying that a pension will not yield a tax advantage, just that for somebody who is a basic rate taxpayer pre and post retirement it is likely that any tax saving may be outweighed by additional charges. It is all down to the individuals circumstances and attitudes.

There are many potential reasons to choose a pension, but for most people tax saving is not likely to be a valid one.

I just have done.

[jetrimby]

Hi ASB you are correct If you are talking smaller sums (ie under ISA limits) the pension route allows growth on the tax saving but apart from the 25% tax free lump this is eventually taxed when withdrawn. Also tends to have higher charges and less flexibility.

Pensions work best if savings are at 40% (if company contributions they are still saving at your top rate as that is what you would pay to withdraw them to go into an ISA etc) And you "retire" as a basic rate tax payer at 20%. You have a 20% return thanks to taxman

They do also stop you spending the money early on a flash car! Fairly bankrupt proof nowerdays and, if you die in the harness a good IHT saver

I think the dicipline of not touching long term savings is enough of a problem for people so small pensions are often still going to be the best option! (Mine would have gone long ago if I could get it!)

[GreenerGrass]

Pensions work best if savings are at 40% (if company contributions they are still saving at your top rate as that is what you would pay to withdraw them to go into an ISA etc) And you "retire" as a basic rate tax payer at 20%. You have a 20% return thanks to taxman

They do also stop you spending the money early on a flash car! Fairly bankrupt proof nowerdays and, if you die in the harness a good IHT saver

I think the dicipline of not touching long term savings is enough of a problem for people so small pensions are often still going to be the best option! (Mine would have gone long ago if I could get it!)

It is a no brainer if you are currently a 40% taxpayer and are going to be a 20% taxpayer in retirement, the IR35 NI thing is just an added bonus.
My only dilemma is whether to bother with Cash ISAs at all apart from for a place to keep emergency fund cash tax free.

Up until the mortgage is paid off an offset mortgage savings account will often beat an ISA in terms of interest rate and is also tax-free. Also no need to faff about changing provider each year to get a better rate.
Most Cash ISAs don't even keep up with inflation anymore.

[Tarquin Farquhar]

Correct me if I'm wrong here (!) but ISTM that comparing the tax advantages of (company-paid) pensions and ISAs:

The pension pays income tax on 75% of (capital + gains), at the rate in retirement.
The ISA pays income tax on capital, at the rate in work; and NICs if applicable

So the pension gains:
-- if working inside IR35
-- if tax rate in work is higher than in retirement
-- if retirement is spread over more years than saving (use more allowances)
-- 25% tax-free in any case

and the ISA gains:
-- if you save for a long time, so the interest/gains are relatively large (because they are taxed in the pension but not in the ISA)

[jetrimby]

Tarquin as a summary not bad! Life is never quite so simple but definately a good generalism Especially for IR35 companies a company pension scheme has huge immediate advantages over private savings due to the NIC savings (as well as the tax).

Its normally worth having some pension (partially for security if other things go wrong) and because spreading funds and products for financial services is normally a good thing as reduces risks. Also I think the disipline thing is the most important once it is in there you can't touch it!

Professinally I cannot advise how someone saves for retirement (not IFA registered) but I can advise them to do so generally and it is always very scary being told how much you will need to have a good retirement With twin toddlers suspect retirement will always be a dream for me!