Umbrella Company Pensions
Navigating the intricate landscape of UK tax legislation is no easy feat, especially for contractors. Amidst the myriad of regulations, one term stands out prominently: Umbrella Companies. But what how do umbrella company pensions work?
In this comprehensive guide, we delve deep into the heart of umbrella companies. Whether you’re an aspiring contractor or a seasoned veteran seeking clarity, this guide aims to empower you with the knowledge to make informed decisions and remain compliant.
When considering umbrella company pensions, contractors have three options: workplace pensions, salary sacrifice and contributions from net pay.
Workplace Pensions (Auto-Enrolment)
A workplace pension, also known as an auto-enrolment pension, is set up by an employer for its employees. Employees typically pay a percentage of their monthly salary into the scheme, with employers also contributing.
As your employer, umbrella companies must legally enrol you into a workplace pension. When you register with an umbrella company, they’ll send you information regarding pension auto-enrollment and their preferred pension provider. This is usually NEST, the Government’s workplace pension scheme.
The minimum contribution set by the Government that you can pay into your pension is 8%, split into 5% employee and 3% employer. It’s important to note that both the employee’s 5% and the employer’s 3% are deducted from assignment income. They are not an additional uplift, and the umbrella company does not contribute from its own funds.
Both employee and employer workplace pension contributions reduce taxable income, thereby reducing income tax owed. The employer element also reduces gross pay, thereby reducing both employer and employee National Insurance contributions.
However, no National Insurance relief is given on the employee element. This makes workplace pensions less tax-efficient than salary sacrifice.
In addition, workplace pension schemes often come with high charges. Take the Government’s scheme, NEST, as an example. They charge 1.8% on every contribution and a 0.3% annual management fee. While the 0.3% fee is broadly in line with the industry average, the 1.8% contribution fee is steep. Plenty of Target Retirement Funds charge nothing to contribute and lower ongoing costs. See Vanguard’s Target Retirement as an example.
Note: The Vanguard Target Retirement merely illustrates the high fees charged by workplace pensions; it is not advice or a recommendation to invest.
Salary Sacrifice Pension
A self-invested pension plan (‘SIPP‘) is a type of personal pension that allows you to manage your investments or pay a chosen financial adviser to support you. Most contractors opt out of workplace pensions in favour of salary sacrifice as it offers more control and greater tax relief.
Umbrella companies deduct salary sacrifice contributions from your gross pay; there is no additional burden for the contractor. Contributions also reduce both income tax and national insurance, unlike a workplace pension, for which only the employer element reduces NI. It is, therefore, the best option for those seeking to minimise their tax liabilities.
Not all umbrellas offer salary sacrifice due to the challenges of implementing it into their existing payroll software. If it interests you, always double-check before you register that your chosen provider can accommodate salary sacrifice. As this is an extra administrative burden for an umbrella company, it often comes with supplementary fees.
Contributions From Net Pay
Many contractors contribute to their SIPP from their net take-home pay; the income received after all taxes and contributions have been paid.
If you contribute to a SIPP from your net take-home pay, you will receive an automatic basic rate tax relief (20%) upon contribution. Your SIPP provider will obtain this 20% relief directly from HMRC; you don’t have to do anything.
You can then apply for higher rate (40%) and additional rate (45%) tax relief via your self-assessment at the end of the year. This is less tax efficient than contributing via salary sacrifice, as you can’t claim national insurance back via a tax return.