Pensions: It’s never too early to invest

With reducing birth rates and longer living, the strain on the state pension is starting to show. By the time you reach OAP status, the retirement age could be as high as 70 and the state pension minimal, if not extinct. The pressure on the UK’s benefit system means it is essential to take precautions for your retirement and start saving for the golden years as it is likely that you will be living off your own savings in the future.

As a contractor, you do not have the benefit of employer funded schemes so you must take action on your pension. You can pay up to £50,000 per year either as lump sums or regular payments to a pension provider with a total maximum of £1.5 million and can choose between schemes whereby your money is invested on the stock market or you can take the less risky approach of investing into an interest earning scheme such as an ISA. Pension schemes are protected by law making them safe investments and your family can benefit from your savings, inheritance tax free, should you pass before your 75^th birthday.

When it comes to retrieving your pension, you can take it in lump sums as a drawdown pension or you can buy an annuity, whereby an insurance company takes your pension and gives you regular payments.

The government has introduced incentives to make these future savings that little bit more desirable by offering a tax relief. Pension contributions are made prior to tax being paid so any money invested this way escapes the taxman*, essentially increasing your take home pay (you just can’t touch some of it until you’re old).

Besides keeping more of your income for yourself and not the taxman (albeit in the distant future), by investing into a pension fund, you are also reducing a potential IR35 bill. On account of the contributions being deducted before tax, your tax bill relative to your daily rate is reduced. This means that in the event of being caught by IR35, your potential tax liabilities would be less than if you didn’t contribute to a pension.

For example, let’s say you earn a gross income of £100,000 per year but only pay yourself a salary of £20,000 on which you are taxed 20%.Ignoring free allowances and other payments which would otherwise be factored in, this means you would pay an annual income tax bill of £4000.
Now, if you were caught by IR35, you would be expected to fork out a further £16,000 that you missed (20% of £100,000 minus the already paid £4000). However, if you had paid a pension contribution of £100 per week (52 weeks x £100) and thus an annual contribution of £5200, your tax bill if caught by IR35, would be reduced to £14960 (20% x (£100,000 - £5200) - £4000). This is obviously a very simplistic calculation but you get the point.

If you are still not convinced, consider then that all of the money which goes into your pension fund starts earning interest right away. This means that the would-be tax is helping to line your pocket by earning for you instead of disappearing into the hands of the Revenue never to be seen again. Make the most out of your income by investing into a pension fund and remember to find a scheme which is both affordable and flexible.

*You can take 25% of your pension fund tax free but income tax will apply to the remaining sum.