Why paying into a pension could save you a fortune in the long-run

As a limited company contractor, we’re here to help you operate tax-efficiently. In this article, Chris James, Head of Accountancy Services, explains why paying into a pension could save you fortune in the long-run.

When you become a company employee, you will be auto-enrolled into their pension scheme– presenting you with a consistent and structured savings plan that’s designed to support your future.

However, as a contractor, your long-term financial future may not be where your focus lies right now. Taking advantage of the flexibility and freedom that you enjoy on a daily basis, your financial plan may not currently extend beyond your profit levels over the coming months. However, with corporation tax changes on the horizon, now may be the perfect time to consider a pension – not just for its future benefits, but for the money it can save you right now.

Tax changes are coming…

As a limited company contractor, you pay Corporation Tax based on the amount of profit your business makes.

As ever, preparation is fundamental to keeping on top of tax returns and payments – and that couldn’t be more true right now as we approach some fundamental tax increases.

Right now, Corporation Tax is a flat 19% of company profits. In the grand scheme of things, this is a very low percentage compared with many other countries. However, as of 2023, this is set to change, and the effective rates of tax are different at different profit levels:

• Profits up to a total of £50,000 will be taxed at the existing 19%.
• Profits between £50,000 and £250,000 will be taxed at the higher rate of 26.5%.
• Profits above £250,000 will be taxed at 25%.

 

Note this is not an incremental increase, there is an immediate jump to 26.5% once you cross the £50k threshold. And while there are still question marks over whether or not this change will be successfully introduced (following the last-minute alterations to the proposed National Insurance thresholds in 2022), there are things that you can do to keep your profits below the higher tax threshold.

How does this change affect you?

First thing’s first, as the change is implemented there may be some crossover in terms of which bracket you fall into and how much tax you have to pay.

If your financial year straddles the new tax year, then both the old and new rules will apply. If you can prove that a larger proportion of your earnings were made within the timeline of the old rules –you might want to consider preparing an additional set of accounts by shortening or extending your year end to lock these into the lower tax regime. Otherwise, profits are allocated to the different regimes on a pro-rate, systematic basis.

Alternatively, there may be other options to help you extract money from your limited company compliantly. You will want to review again how you run your business to ensure you are not missing opportunities to extract value, such as claiming for justified expenses, although the list of these is not long. You may also like to consider paying into a personal pension.

How opening a pension could help

 

Did you know that within certain limits, any money you pay into a pension is tax deductible in your Corporation Tax return? As a limited company contractor, you can normally pay up to £40,000 per year into a pension pot and not pay a single penny of tax on it – giving you a buffer of up to £40k in profit that is preserved from the taxman.

Of course, as ever there are considerations and drawbacks, the main one being that that money is then untouchable until you are eligible for retirement. In addition, you need to consider how much you can afford to pay into a pension without it impacting the money your business needs in order to continue operating effectively and efficiently.

However, on the plus side, you’ll be saving for your future in a highly tax-efficient way– and the sooner you start, the more thankful you’ll be likely to be when retirement comes around.

What to do

Take a serious look at the forthcoming tax changes and ask your Workwell accountant to look at some scenarios for you so that you can be prepared for the impact and decide what to do. You may also need input from an independent financial adviser. We can put you in touch with our specialist financial services partners, who are used to the particular needs of one-person businesses and SMEs.

NB: Remember the future value of investments is not guaranteed. Workwell is not a financial adviser or wealth management specialist and we recommend you consult a qualified professional before taking action. Workwell can accept no liability for actions taken or not taken having viewed this material.