Paying into a pension scheme not only helps to secure your future but can be a tax-efficient way to get value from your business.

This is because pension contributions can be made from your gross profits, thereby reducing your Corporation Tax bill. And with Corporation Tax on the rise, it’s worth considering paying in more to an existing pension (if you can) or setting up a pension now if you haven’t already done so.

The contractor pensions dilemma

When you’re an employee, pension planning is relatively straight-forward. Your employer will usually have a pension scheme which you’ll be enrolled into (after a qualifying period) unless you actively opt out.

When you’re contracting through your own PSC/limited company, or running your own small business, you’ll need to make your own arrangements by setting up a personal pension. This can be daunting when you’re starting out as the uncertainty of your contracting income can make it difficult to commit to a pension which you’ll not benefit from until you’re at least 55.

A Fidelity report showed that 62% of self-employed people have no pension savings and 28% of self-employed people are not saving anything. When you consider that we are all living longer, there is inflationary pressure and the cost of living is rising, it’s important to consider your future finances, even if you’re a long way off being able to pay in the full tax-efficient allowance each year.

However, once you’re established in your contracting career and are comfortable that you do not need all of your income for your current lifestyle, a pension is an obvious consideration as it can play a significant role in the tax-efficiency of your business.

If you already have a pension and you’re making contributions from your limited company, it’s worth considering what level of investment you can afford to make if you’re not already putting in the annual limit which rose to £60k in the Spring Budget. It’s also worth looking at whether you can combine pension pots if you have more than one (for example, employer pension schemes you previously paid into).

Pensions – The Basics

• You and your business as your employer can pay up to a total £60,000 per year into your personal pension. Pensions are a tax-deductible expense category and therefore offset company profits for the year.
• Pensions give you a Corporation Tax saving which can be as much as 25% under the new rules (read more about the new tax rules here). Of course, the disadvantage is that you cannot access your pension until you are at least 55, so you need to be comfortable that you can afford to have your money tied up in this way.
• Note the pension allowance runs from 6th April to 5th April. If you have enough reserves, you can carry forward the previous three years of unused contributions and make a lump sum payment now, offsetting company profits for the year. To maximise efficiency and show the consistency of pension payments, the ‘carry forward’ can be carried out over several tax years to significantly reduce Corporation Tax for consecutive company years.

Before taking any action, take personalised advice from your financial adviser, and tax adviser.

Scenarios

(credit: CCFP, one of our approved financial advisory partners)

Case Study 1

Mr and Mrs Smith run a limited company with a turnover of £100,000 and gross profit of £85,000. At the current rate of 19% their Corporation Tax will be £16,150. From April 2023, their new rate for Corporation Tax will be 22.09% or £18,775! Both are directors of the limited company and are on payroll.

If Mr and Mrs Smith invest £25,000 each into a pension, they would reduce their gross profit margin from £85,000 to £35,000. The resultant Corporation Tax bill will be £6,650 now and post-April 2023. That is a £9,500 saving before 2023 and a huge £12,125 saving post the Corporation Tax rise!

Case Study 2

Mr Brown is the sole director of a limited company with a turnover of £150,000 and a gross profit of £100,000. He has not contributed to a pension for several years but does have legacy pensions. He wishes to take advantage of his Corporation Tax savings while also making up for missed contributions into his pension.

Using carry forward allowance, Mr Brown is able to utilise his current pension tax year and previous tax year. This would mean a total contribution of £80,000, reducing his gross profits to £40,000.

If he did nothing, the current Corporation Tax rate would be 19% or £22,800 while the new rate would mean a marginal tax rate of 23.38% or £28,050 corporation tax liability. Paying £80,000 into his pension would mean a resultant corporation tax bill of £7,600 (at 19%) or saving £15,200, or a huge saving of £20,450 post the Corporation Tax rate changes.

As you can see, there can be a significant impact on your Corporation Tax liability if you pay into a pension scheme.

What to do next

Your Workwell accountant can help you review your company finances to ensure you are working tax-efficiently. If you’re not already with Workwell, find out about our ready-made accountancy packages to speak to us about your bespoke needs. If you are with us already, we’ll be proactive in covering tax-efficiency in your quarterly and annual reviews.

It’s important to take specialist advice from a tax and wealth management perspective before making decisions regarding your pension. We have partnered with Contractor Wealth and CCFP who are regulated by the FCA and can provide independent financial advice to suit your individual circumstances.