Contractor Pensions

6As a contractor, you are solely responsible for planning for your own retirement. It is definitely a good idea to put some of your income away for your later years. Pension contributions are one of the few remaining tax breaks available to contractors, and our guide will discuss how pension contributions can allow you to be more tax-efficient as a contractor, how to make pension contributions and how much to put away.

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What is the maximum pension contribution I can make?

You can pay as much into your pension as you would like, and your contributions will be tax-free as long as they do not exceed the annual allowance (currently capped at £60,000).

Although you can invest as much as you like into a pension, you cannot contribute more than your retained profits. This could raise questions from HM Revenue and Customs as to whether the amount has actually come from your company’s activities.

If you have a large sum that you would like to put into your pension, you may be able to take advantage of the carry-forward rule. This allows you to make use of annual allowances that you have not used in the three years previous, provided that you were a member of a registered pension scheme. If you would like to carry forward, you must first use your annual allowance for the current tax year before using any unused allowances from the previous three years.

The lifetime allowance was abolished 6th April 2024 and instead, the Lump Sum Allowance (LSA) and Lump Sum Death Benefit Allowance (LSDBA) were introduced, which may have significant implications when planning your pension withdrawals and estate strategies.

What is the Lump Sum Allowance?

The LSA allows you to take a portion of your pension tax-free. You will be able to withdraw a 25% lump sum from your pension savings without tax, up to the LSA limit. After the abolition of the lifetime allowance, the LSA continues to provide a limit on how much can be taken tax-free. Beyond this limit, additional withdrawals will be taxed at your marginal income tax rate.

What's the Lump Sum Death Benefit Allowance?

The LSDBA is in place to ensure that death benefits are paid from the pension, tax-free up to the LSDBA limit, dependent on the person being 75 or under. Any excess beyond the LSDBA will be taxed at the beneficiary's marginal rate. This means it's important to plan pension contributions and drawdowns to maximise tax efficiency.

How to make a pension contribution as a contractor

As a contractor, you can either make pension contributions from your own personal funds or directly from your company’s income. Most limited company contractors will make their pension contributions through their company as this is more tax efficient.

To make a pension contribution from your personal funds, the amount that you invest will attract personal tax relief, which means that the pension provider will top up your contributions by 20%. Please note that there is a limit on the amount of tax relief available to personal pension contributions, which is currently 100% of your income and it is the topped up figure that is taken into account.

Pension contributions that are made directly from your company’s income are invested before-tax, which means that you will save the amount that you would have paid in both income and corporation tax on the contribution. Unlike personal pension contributions, the amount that can be invested directly from your company income is in no way linked to the amount that you personally earn as a salary.

Tax savings on pension contributions as a contractor

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 does not take into account all of the factors that will affect the amount of tax you could save.

As a limited company contractor working outside of IR35 – for every £100 that your company earns you must pay corporation tax, ranging from between 19%-25%, dependent on profits, which would have to be taken out of the company.

To do this, most contractors take their income through a mixture of salary and dividends. If you were to do this, you will incur a dividend tax of 33.75% (2024/25 rate).

However, if you were to invest in a pension you can contribute the whole amount and once in the pension, this amount could grow.

When can I start withdrawing from my pension?

In most cases, you can start withdrawing from your pension at the age of 55. This can be used to help you retire early or to top up your income if you are still working.

How does the automatic pension enrolment scheme affect contractors?

The automatic pension enrolment scheme has made it compulsory for employers to enrol their employees into a pension scheme. If you are the only director of your limited company – which most contractors are – then the pension automatic enrolment scheme will not apply to you, but you will need to contact The Pension Regulator to inform them that you are exempt from the scheme.