Benjamin Franklin once said that the only two certainties in life are death and taxes. As much as we wish he was wrong, Mr Franklin was certainly onto something writes Tony Harris, MD of ClearSky Wealth.
Particularly in today’s economic climate, it is crucial that contractors and freelancers remain proactive in order to minimise their tax liability. Whilst an effective retirement plan may not be a priority for many self-employed professionals, pension funds do in fact provide one of the most lucrative tax relief opportunities available.
Extracting wealth from your company helps to reduce the amount of corporate and personal income that goes to HMRC. For example, say you were to earn £1,000 in company income. More often than not, a Limited company contractor would declare this as company profit and take a dividend payment. However, this would incur:
- 20% in corporation tax: £1,000 x 20% = £200
- and then a further 25% in personal income tax: £800 x 25% = £200
This leaves a total dividend payment of just £600. However, choosing to invest the full amount into a pension scheme means you would attract 0% in tax.
How much can I invest?
The rules governing pension investments currently state that contractors and freelancers can extract up to £50,000 a year from their company. This ‘annual allowance’ reduces to £40,000 a year as of 2014/15.
HMRC also imposes a single lifetime limit on the amount of pension savings that qualify for tax relief. This currently stands at £1.5 million, but reduces to £1.25 million in 2014/15.
In order to build up a significant amount of capital, a sufficient amount of income must be invested into a pension over the long term. It really is simple – the bigger your pension, the better financial position you will be in during retirement.
What are my retirement options?
Contractors and freelancers can begin withdrawing from their pension fund at the age of 55. Some of the most popular financial options include:
- Drawdown: This extracts income from your pension fund and is based on a set annual limit that is relative to the overall sum.
- Annuities: By purchasing an annuity policy you receive a regular income for life.
ISAs
Another popular choice for long-term investments is to use an individual savings account (ISA). Unlike pensions, ISAs do not attract the same upfront tax break, yet provide more flexibility when extracting money. ISAs are funded by post-tax income and allow an annual investment of up to £11,520.
With such a wide range of ISAs on the market, it is crucial that self-employed professionals identify the best solution that suits their current and future circumstances.
Equity
Despite an increasing number of Brits tapping into any wealth that they have built up in their homes, individuals should also establish a pension scheme in order to fund their retirement. With such an unpredictable housing market, it is crucial that contractors and freelancers guarantee their financial stability and security when it comes to retiring.
Seek professional help
Calculating how much pension income you will require is a difficult task. With a range of variables at play, such as inflation and investment returns, it is crucial that contractors and freelancers seek advice from a wealth management specialist. This helps to ensure that they choose the right pension scheme for them.
The author is Tony Harris, managing director for ClearSky Wealth, part of specialist contractor and freelancer accountant ClearSky Accounting.
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