Reply to: IR35 - offsetting pension contributions

[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!

[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)

[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.

[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!)

[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.

[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.

[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]

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]

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.

[rootsnall]

Or double taxed for very high earners - now that higher rate relief is capped. They will effectively pay 20% tax on the way in, but probably have to pay 40% tax to get it out

I can't see many of us having a pot big enough to pay higher rate tax. It would have to be 500K+.

[rootsnall]

But, the pension is not "tax free" of course (save for the 25% lump sum allowed), it is really just tax deferment since however you eventual take the income it is taxable.

All things considered though it is a good deal for somebody who is within striking distance of 55 and can afford to live off mostly savings for a few years. With the added bonus of you are effectively IR35 proof while not paying any NI.

[centurian]

But, the pension is not "tax free" of course (save for the 25% lump sum allowed), it is really just tax deferment since however you eventual take the income it is taxable.

Or double taxed for very high earners - now that higher rate relief is capped. They will effectively pay 20% tax on the way in, but probably have to pay 40% tax to get it out

[ASB]

They weren't disallowed, it's just that I had large NI/tax bill at the end of the year. It's more a matter of not having a good enough handle on my finances. If I'm in IR35 I'd like to have a better idea of how much I can stick into my pension, how much to set aside for tax/NI and how much to pay myself. I guess an accountant should be able to set up a payroll for me? Mine's just useless. Ok with my annual company accounts and things but useless otherwise. Trouble is, I've had 2 before him and they were awful too. Tempted to set up a payroll and do it myself, can't be that hard.

In IR35 here's my idea of the extreme:-

Bill 100k.
Less legitimate expenses: 0 (for ease)

Salary 6k (to use allowances) Tax NI required NIL

Nominal Gross profit 94k
COMPANY pension contribution 94k.

Then the P+L shows gross taxable profit of 0 and thus no CT.

Personal income is still the 6k net.

If you are of an age where immediate vesting is a possibililty you could take 23.5k as the tax free lump some and leave the balance in fund for drawdown.

But, the pension is not "tax free" of course (save for the 25% lump sum allowed), it is really just tax deferment since however you eventual take the income it is taxable.

[wurzel]

On what basis were the contributions disallowed relief? Yes, personal contributions are limited, however the basis for disallowing company contributions in general is that they were not wholly for the purposes of trade. Provided they were genuine company contributions, not the company making personal contributions on your behalf then there would normally be no reason to disallow them. Recent revenue guidance (which has been posted up several times) seems to make this quite clear.

If your accountant decided to simply disallow them on the basis the exceeded 100% of salary then they may have done you a disservice. You still have the opportunity to correct this.

They weren't disallowed, it's just that I had large NI/tax bill at the end of the year. It's more a matter of not having a good enough handle on my finances. If I'm in IR35 I'd like to have a better idea of how much I can stick into my pension, how much to set aside for tax/NI and how much to pay myself. I guess an accountant should be able to set up a payroll for me? Mine's just useless. Ok with my annual company accounts and things but useless otherwise. Trouble is, I've had 2 before him and they were awful too. Tempted to set up a payroll and do it myself, can't be that hard.

[centurian]

I've not read up on IR35 for ages, wasn't there a 5% limit on expenses !? I guess it's one to ask the accountant ! I don't intend declaring myself inside IR35 but if I am paying the majority of my income into a pension then it would be good to know that any investigation would be virtually a waste of time for the IR. I think I'll only pay about 10K in divi's this year, so I guess they be chasing 2K approx.

Employers pension contributions come out first - before the 5% calculation is applied. If I recall correctly, the rough ordering for working out IR35 is as follows

Company pension contributions
Indemnity insurance
Travel and subsistence (should still allowable under IR35)
= Gross deemed amount
5% cropped off - pays company expenses - anything left can be taken as dividend
= Sub total
Employer's NI
= Deemed payment
Employee pension contributions (if you really, really want to pay as a person)
= Taxable salary
Employee's NI
Income tax
= Net employee salary


HMRC's own IR35 deemed payment calculator has a section for pension contributions...