Operating as a contractor through a limited company gets a bad rap nowadays. With the British media synonymising it with tax avoidance (think: the use of PSCs in relation to IR35) and many industry professionals warning the self-employed away from such arrangements, it’s easy to forget that limited companies do come with some considerable tax benefits. Amongst these benefits is being able to add to your pension pot via your company.
Part and parcel of working for yourself is having to take responsibility for things like your retirement funds. Pension contributions are one of the few tax breaks left available to contractors and can allow you to be far more tax efficient. As the saying goes, make hay while the sun shines.
Are there any laws restricting contributing to a pension through a limited company?
When you provide services through a limited company, HMRC considers you an employee of that company; essentially, you are employed by yourself, and you are a separate legal entity to your company. If your salary exceeds the personal allowance (in 2019 - 2020, this is £12,500) your company has to deduct income tax via PAYE. If your salary is over the lower earnings limit (currently this is £8,632) you and your company have to pay National Insurance Contributions, or NICs.
However, as an ‘employer’, you have to take part in automatic enrolment. As a contractor working through a limited company, you can apply to the Pensions Regulator for an exemption but if you don’t apply for the exemption, your company will have to set up a workplace pension. This will have to deduct pension contributions from your ‘qualifying earnings’ and make contributions on your behalf. You can land a hefty fine if you’re not exempt and haven’t set up automatic enrolment, so make sure you’ve done your due diligence.
You can apply to the Pensions Regulator for an exemption from automatic enrolment if:
- you’re your company’s only director and employee (this is often the case for professional contractors); or
- your company has two or more directors, but none (or only one) have an employment contract and there are no other staff members.
To apply for the exemption, you’ll need your letter code. This is a 10-digit code the Pensions Regulator will send you by post when you register your limited company. When exempt, you’re free to set up and pay into a pension of your choosing; usually, this will be a Company Director Pension.
How much can I contribute to a Company Director Pension?
As the boss of your own limited company, you can contribute to a Company Directors Pension both as an individual and as a business. These are known as employee and employer pension contributions, respectively. You can pay as much into your pension as you’d like, but it’ll only benefit from tax relief up to an annual allowance threshold.
The absolute maximum a company director can contribute to a pension and still get tax relief, including both employer and employee contributions, is £40,000 per year or 100% of your salaried earnings, whichever is lower. However, this figure starts to taper down for those earning more than £150,000 by £1 for every £2 they earn above this threshold. This is subject to a maximum tapering of £30,000, leaving anyone with an income of £210,000 or more with an annual allowance of just £10,000.
Andy Vessey ATT, Head of Tax at Larsen Howie, adds that it’s important to remember the below:
- Tax relief is given to individuals aged 75 or under who have earnings subject to UK tax or are generally UK resident.
- Tax relief is given by reference to relevant earnings. For employees, this not only includes their salary but also BIK’s + other employment income.
- Pensions tax relief is restricted for those with adjusted income > £150K. Adjusted income includes an add-back of their own & their employer’s pension contributions.
As an individual, you can only contribute 100% of your salaried earnings, which for company directors is often only a small proportion of their remuneration for tax purposes.
How much can I save on tax when contributing to a Company Director Pension?
Please note that this is a basic example based on a limited company contractor who is working outside of IR35 and in the higher rate tax bracket. It doesn’t take into account all of the factors that may affect the amount of tax you could save.
As a limited company contractor working outside of IR35, you must pay 20% corporation tax for every £100 that your company earns, thus bringing the amount down to £80. You’ll then need to take this money out of your company; to do this, most contractors take their income through a mixture of salary and dividends. However, if you were to invest the £100 in a pension, you can contribute the whole amount and once in the pension, this amount could grow.
Of course, we always recommend you speak to a pensions specialist before making your decision on how best to take control of your retirement fund. Every limited company contractor’s circumstance is unique and should be treated as such.