Limited Company Pensions
Navigating the intricate landscape of self-employment is no easy feat, especially for contractors. Amidst the myriad of regulations, one term stands out prominently: Limited Companies. But how do limited company pensions work?
As a contractor, contributing to your pension is the best way to both reduce the taxes you owe and secure your future. But what are your options? And what is the most tax-efficient way to pay into it if you work via a limited company?
In this comprehensive guide, we delve deep into the heart of limited 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.
Contractors working Outside IR35 via a limited company have two options for contributing to their pension: (i) via a workplace pension scheme and (ii) via a SIPP.
Workplace Pension Scheme
A workplace pension scheme is organised by the employer. All employers must legally enrol eligible candidates in the scheme unless they opt out. Once registered, you will be subject to a minimum contribution of 3% of your monthly gross salary.
As a contractor working through a limited company, you can apply to the Pensions Regulator for an exemption if you’re the company’s only director and employee. If you don’t apply for the exemption, your company must set up a workplace pension and make employee and employer contributions on your behalf.
If the company has two or more directors, none may have an employment contract to qualify for the exemption. Therefore, if you currently employ your spouse via your limited company, you must register them with a workplace pension scheme, although they can opt out.
Due to the inflexible nature of workplace pension schemes, most limited company contractors choose to take the exemption and instead contribute via their SIPP. A much more flexible option.
Self-Invested Personal Pension (SIPP)
A SIPP is a type of pension that gives you more control and flexibility over how much is invested and what it is invested in (funds, shares, ETFs, Investment Trusts, etc). With a SIPP, you manage your own investments and can make changes and additions as often as you want.
There is no minimum contribution; you can increase, decrease, or even stop your contributions altogether if you’re not working. For most contractors, this flexibility and range of choice is why most invest in a SIPP instead of a workplace pension scheme.
How Do I Set Up A SIPP
You can open a SIPP in as little as 15 minutes, either with a bank payment or by transferring an existing pension. Most SIPP providers (such as Hargreaves Lansdowne or AJ Bell) will walk you through the process.
Can I Contribute To My SIPP Via My Limited Company?
Yes, you can contribute to your SIPP via your limited company. Contributing to your SIPP is an excellent way of saving for retirement and a tax-efficient way of using your business’s profits. The company’s contributions to your pension are allowable expenses, meaning you reduce your taxable profits and, therefore, your corporation tax liability.
Another benefit of making employer pension contributions via your limited company is that employer pension contributions are not subject to National Insurance.
How Much Can My Company Contribute?
Your annual allowance limits the pension contributions that can be made to all your pension schemes in a tax year (06 April to 05 April) before you have to pay tax on them. The current annual allowance is £60,000.
Provided the pension contributions meet HMRC’s ‘wholly and exclusively test’, and the amount doesn’t exceed the company’s income for the year, you can contribute the entire £60,000 into your SIPP via your limited company. You can contribute more to your SIPP; however, the contributions would be subject to income tax, negating any benefit.
If you use all your annual allowance for the current tax year, you may be able to carry over any annual allowance you did not use from the previous three tax years. You could contribute up to £240,000 in a single year, £60,000 for this year and £60,000 for the last three years.
You can use HMRC’s calculator to check whether you have any unused allowance to carry forward.
What Is The Reduced (Tapered) Annual Allowance For Pensions?
Similar to the tapering of the personal allowance for incomes above £100,000, you’ll have a reduced annual allowance in the current tax year if your threshold income is over £200,000 and your adjusted income is over £260,000.
Threshold income is broadly defined as an individual’s taxable income for the year (salary, bonus, dividend income, interest distributions, etc). Adjusted income takes threshold income and adds employer pension contributions. This prevents individuals from avoiding restrictions by exchanging salary for employer contributions.
Where both thresholds have been breached, the rate of reduction in the annual allowance is £1 for every £2 the adjusted income exceeds £260,000, down to a minimum allowance of £10,000. HMRC has detailed instructions on calculating whether you are subject to a tapered annual allowance.
Should I Contribute To My Pension Personally Or Through My Limited Company?
As a limited company contractor, you can pay into your SIPP from your after-tax earnings or directly from the company.
If you make payments from your after-tax earnings, you get automatic tax relief at the basic rate of 20%; then you claim back the higher rate (40%) or additional rate (45%) relief via your self-assessment tax return.
If you make payments directly from your limited company, the contributions count as allowable business expenses, reducing the corporation tax you pay. You will also save on Employer’s National Insurance (something you can’t claim back if paying out of after-tax income) and income tax owed on the extra salary/dividend not taken.
Therefore, paying into your SIPP via your limited company is more tax-efficient than paying from your after-tax earnings.
An additional restriction comes with paying into your pension from after-tax earnings. You are restricted to contributing up to 100% of your annual salary into your pension, with dividends not counting to the limit. If you are a limited company contractor paying yourself mainly dividends and taking a small salary of £9,100, the most you can contribute from your after-tax earnings is £9,100.
You could always increase your salary to increase the limit, but this isn’t necessarily tax-efficient.
This salary threshold doesn’t apply to limited company contributions, meaning you can keep taking the £9,100 salary and contribute the total £60,000 into your pension.
What Is The Most Tax Efficient Way To Pay Into My Pension?
To pay into your pension in the most tax-efficient way as a limited company director:
i) Apply For An Auto-Enrolment Exemption
Apply for an auto-enrolment exemption from the Pensions Regulator to avoid contributing to a workplace pension scheme.
ii) Set Up A SIPP
Speak to a financial advisor if unsure which SIPP to go for.
iii) Pay Into The Pension Directly From Your Limited Company
You can pay up to £60,000 and carry over any unused allowance from the previous three years.
If you’re unsure about any of the above, we recommend speaking to a pension specialist so they can provide bespoke advice based on your individual circumstances.