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How self-employed pensions work (and how to get the most for your money)

Being self-employed is great. Nothing quite beats the freedom and flexibility of being your own boss. Don’t fancy working Fridays?…

Author Photo by Kingsbridge

Being self-employed is great. Nothing quite beats the freedom and flexibility of being your own boss. Don’t fancy working Fridays? Then don’t. Want a day off next week to spend with your children? Go right ahead. However, as with most things, there are downsides and the big one to self-employment is a lack of in-work benefits, including paid annual leave, sick pay, and pensions.

Ultimately, employees get these protections by default, whereas the self-employed need to work out safety nets and failsafes should they need them.

It’s estimated that less than 20% of self-employed people in the UK pay into a pension. This can be for a number of reasons. Some will be saving or investing for their retirement in other ways, while for others the variable monthly income could put them off the idea of making a regular contribution.

However, this lack of investment could leave self-employed people vulnerable when they retire, with only their state pension to rely on.  For this reason, we’ve taken a look at pensions for limited company directors so you can make an informed choice for your future.

What restrictions are there on pensions for limited company directors?

As a limited company director, you have the ability to contribute to your company director’s pension both personally (employee contributions) and through your business (employer contributions).

Now, the maximum you can contribute and still get tax relief is 100% of your salaried earnings up to a maximum of £40,000. This is your pension annual allowance. This figure drops down for those who earn more than £150,000, reducing by £1 for every £2 they earn above the threshold.

This reduces down by up to £30,000 so anyone earning £210,000 or more has an allowance of just £10,000.

However, as a limited company director, chances are you pay yourself a lower salary and draw down the rest in dividends. This means your employee contributions will be capped at a comparatively small amount, meaning the bulk of your annual pension contributions will need to come from employer contributions.

How much can I contribute to a company director pension?

As mentioned, your personal (employee) contributions are capped at 100% of your salary up to a maximum of £40,000. However, what you contribute through your business (your employer contributions) is not subject to the 100% cap, which means you can contribute up to £40,000 no matter what you draw down as salary.

However, there are checks in place to ensure that your contributions don’t exceed your annual profits. So, if you were to turn a profit of £30,000 in a tax year, that would be the maximum amount your business could pass on in pension contributions, replacing the aforementioned cap.

How much could I save on tax by contributing to a company director pension?

On personal contributions, you receive tax relief at your highest tax rate. So, a basic rate taxpayer will see £20 added by the government for every contribution of £80. A higher rate taxpayer would get £40 from the government for every contribution of £60, although this would be made up pf £20 paid at source, and £20 claimed back through your Self-Assessment.

On your employer’s pension contributions, you would typically get corporation tax relief, which is set at 19%. There is also no National Insurance to pay on pension contributions made through your business, saving you a further 13.8%.

In addition to this tax relief, company director pension contributions are also seen as an allowable business expense, thus reducing your overall tax bill. However, the contributions must pass what is known as the ‘wholly and exclusively’ test. This means that the employer’s pension contribution must be deemed ‘wholly and exclusively’ for the purposes of the employer’s trade or profession.

As a sole company director, you would almost certainly pass this test, but it’s still worth checking in with your accountant – as is anything pension related.

All in all, making pension contributions through your business could be more tax efficient than making personal contributions, especially if you fall foul of the 100% of your salary rule.

However, you should always discuss any potential changes with your pension in  detail with your accountant or financial advisor – this is a guide for general research and information only and shouldn’t be used to make a final decision on your financial arrangements.

Another thing to discuss with your accountant is your business insurances and to check if you have all the cover you need. It’s worth making sure you have all the basic insurances you need – these are included in Kingsbridge’s standard business insurance package – but also whether or not you would benefit from IR35 Protect cover to ensure you’re protected from risk both now and when the IR35 reforms take place.

Our friendly team can take you through the details of both products if you give us a call on 01242 808740, or if you already know what you need, you can get a quote online.

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