Pension Contributions

[THEPUMA]

At the moment, if you're getting on a bit like me, putting as much as you can into a SIPP is a complete no brainer. Not only does it IR35 proof that money, but if you play about with the numbers on a website like Contractor Calculator you will see that it you can achieve a tax rate of about 15% on your turnover. This is as good as the dodgy off shore schemes we keep hearing about except it is on shore and contributing to a pension is actually (at the moment) positively encouraged by the government. It really doesn't get any better than that, IMO.

I'm not so convinced it is such a no-brainer. Assume you are approaching retirement and can therefore make a pension contribution and get the 25% lump sum back immediately. The alternative, presumably, is to leave the money in the company and draw it out either tax -free (dividend below higher rate tax threshold over a period of time) or net of 10% CGT when the company is closed down. So the 3 options work out as follows:-

Pension contribution:-

Profit before pension contribution - £10,000
Pension contributions - £(10,000)
Therefore taxable profit - £NIL

Cash received:-

25% tax-free - £2,500
Balance (over a period of time) - £7,500
Tax on balance (assume at 20%) - £(1,500)
Net received - £8,500

Retained in company:-

Profit before pension contributions - £10,000
Pension contributions - £NIL
Therefore taxable profit - £10,000
Corporation tax @ 20% - £(2,000)
Net profit available for distribution - £8,000

If you opt for a capital liquidation, it is likely that there will be a further 10% tax to pay so you net £7,200.

If you draw out as tax free dividends (bearing in mind if you are married to a non-earner and neither of you have any income from outside the company, you should be able to draw out circa £76K per annum tax-free between you), then you would net £8,000.

So you are paying £500 (5%) or £1,300 (13%) extra, depending upon your circumstances, in order to have the cash up-front.

Personally, if I could draw it as tax-free dividends, I would definitely be happy to pay 5% in order to have the cash in my pocket rather than in a pension scheme. I would probably be prepared to pay 13% if I had to but obviously that would be a more marginal decision.

This example does not take account of tax-free growth nor of the fact that it is your gross that is being invested in the first place. This is both because the example would become far too complicated but also because I have assumed that the shareholder is close to retirement and therefore these issues are less material.

You would also need to bear in mind any additional accounting fees and administrative burden of continuing to run a company beyond retirement if you opted for the tax-free dividend over a number of years route.

PUMA

[Fred Bloggs]

Thanks for your thought, very valuable. I must admit that I certainly do not regard dividends as tax free, I have already paid 20% corporate tax on that money. But the money goes into my SIPP without that deduction.

[Hex]

Thanks for your thought, very valuable. I must admit that I certainly do not regard dividends as tax free, I have already paid 20% corporate tax on that money. But the money goes into my SIPP without that deduction.

Yes - but when you take income from your SIPP you are taxed on it. The dividends can be spent or put into an ISA all without further tax liability. As THEPUMA's examples show, you are a bit better off going the SIPP route due to the tax free lump sum, but in return for this you are sacrificing flexibility as you are tying your money up in a SIPP where it is subject to government rules on how you take it out.

I don't think that putting money into a SIPP is a "no brainer", but I think there is a good case for doing this with some of your funds for a lot of folks.

[Fred Bloggs]

Yes - but when you take income from your SIPP you are taxed on it. The dividends can be spent or put into an ISA all without further tax liability. As THEPUMA's examples show, you are a bit better off going the SIPP route due to the tax free lump sum, but in return for this you are sacrificing flexibility as you are tying your money up in a SIPP where it is subject to government rules on how you take it out.

I don't think that putting money into a SIPP is a "no brainer", but I think there is a good case for doing this with some of your funds for a lot of folks.

Thanks, in my case, I will be able to draw down as much from the SIPP as I like since under the >April 2011 rules if you have >£20k of other pension income (and I do) you can do an uncapped drawdown. Yes, I'll pay income tax when I draw the money down but in the meantime it has gone into the SIPP free of all taxation, grows in the SIPP free of all taxation and I can take my 25% free of all taxation whenever I want to. As a bonus, it is fully IR35 proof. For me, indeed, now in my mid 50's I do think it is a no brainer. But everyone's circumstances are different.

[THEPUMA]

Thanks, in my case, I will be able to draw down as much from the SIPP as I like since under the >April 2011 rules if you have >£20k of other pension income (and I do) you can do an uncapped drawdown. Yes, I'll pay income tax when I draw the money down but in the meantime it has gone into the SIPP free of all taxation, grows in the SIPP free of all taxation and I can take my 25% free of all taxation whenever I want to. As a bonus, it is fully IR35 proof. For me, indeed, now in my mid 50's I do think it is a no brainer. But everyone's circumstances are different.

I can see why in your circumstances you might consider it to be a no-brainer. However, your circumstances are quite specific and unusual. ie for your position to apply you need other pension income of over £20K but total income including the SIPP pension below £42,475.

This means that the maximum pension you can drawn down from the SIPP without incurring higher rate tax (and thereby pretty much defeating the object of the whole exercise) is £22K per annum.

So you can't build up a substantial pension pot and have immediate access to it without paying higher rate tax.

You also presumably don't need the lump sum particularly.

I think it probably works very well in your case but there are probably better alternatives for most contractors.

PUMA

[Fred Bloggs]

I can see why in your circumstances you might consider it to be a no-brainer. However, your circumstances are quite specific and unusual. ie for your position to apply you need other pension income of over £20K but total income including the SIPP pension below £42,475.

This means that the maximum pension you can drawn down from the SIPP without incurring higher rate tax (and thereby pretty much defeating the object of the whole exercise) is £22K per annum.

So you can't build up a substantial pension pot and have immediate access to it without paying higher rate tax.

You also presumably don't need the lump sum particularly.

I think it probably works very well in your case but there are probably better alternatives for most contractors.

PUMA

Thanks for the comment, that's pretty much spot on actually. Once I decide to start drawing down, it will take me about 10 to 15 years to run down my SIPP via uncapped draw down which after all, is a significant part of the plan. Any surplus money beyond living costs that is drawn down will go into ISAs or will be given to the kids.

[psychocandy]

I think there's 0.5% difference between the two - negligible, I believe you can only pay personal contributions up to your annual salary, which I may want to increase in the future. i also like the comfort of receiving a small basic salary each month, regardless of how much work is coming in

Still confused about the personal contributions thing. Is it limited to your salary or your income (i.e. salary + dividends).

If its salary then it could be as low as £7K for some of us. Is that right?

[psychocandy]

I think there's 0.5% difference between the two - negligible, I believe you can only pay personal contributions up to your annual salary, which I may want to increase in the future. i also like the comfort of receiving a small basic salary each month, regardless of how much work is coming in

Where does the 0.5% come from?