In conjunction with PCG, Wealth Matters have been running a number of Contractor Seminars this year. When it comes to investing they’ve found quite a few questions keep repeating themselves among the 250-strong contractors in the audience. Today Wealth Matters’ Director Paul Cleworth answers these questions for a wider contractor audience.

The Economic Environment

It is no secret that the Government is currently short of funds and we already know that taxes are going to rise in 2010. Many of these taxes will directly affect contractors:

• Corporation Tax rises from 21% to 22%
• Employer’s National Insurance to increase by ½%
• Employee’s National Insurance to increase by ½%

For top earners, there will be additional taxes:

• Incomes over £100,000 will gradually lose their annual allowance
• Incomes over £150,000 will pay an income tax rate of 50%
• Incomes over £150,000 will lose their right to full tax relief on pension contributions

Fortunately for contractors, the flexibility of working through a limited company and using their professional advisers (accountant and financial planner) should usually avoid the issues affecting top earners, but there will definitely be more tax to pay.

ISA Top-up Time

In his April Budget, the Chancellor announced an increase in the contribution limits for individual savings accounts (ISAs). The lateness of the Budget and, probably, the tightness of government finances, meant that the increase was staggered:

From 2010/11 the maximum overall contribution will rise from £7,200 to £10,200 of which £5,100 (previously £3,600) may be invested in a cash ISA.

If you were born before 6 April 1960, these higher limits will apply for 2009/10, but only for contributions made after 5 October 2009.

If you are ‘mature’ enough to benefit from October, then do take advice before investing. For example, if you have already contributed to an ISA in this tax year, your options may be constrained by rules which say you can only contribute to one cash ISA and one stocks and shares ISA during the tax year.

You can transfer cash ISAs to other cash ISAs or into equity ISAs, but you cannot transfer equity ISAs into a cash ISA.

2009 Budget – Pension Rules

Many contractors are concerned about the new pension rules that came into affect from April this year. Fortunately, most contractors should fall out of their scope, but it is important that the rules are understood.

New pension legislation will come into force from April 2011 reducing full tax relief on pension contributions for people earning more than £150,000. However ‘anti-forestalling’ rules have been brought in from April 2009 to prevent large pension contributions before 2011. The details on Anti-forestalling can been summed up as follows:

• People with income of £150,000 or more can continue existing regular contributions and/or increase contributions up to £20,000 a year.
• If they are already paying in more than £20,000 on a quarterly or more frequent basis then they can continue to do so, and higher rate tax relief will be given on these payments. If they are already paying single or annual payments, then they will continue to get higher rate tax relief on the lesser of £20,000 and the average of the last three year’s payments (with a minimum of £20,000). Take care if someone is paying both as the limits interact.
• Pre-determined increases where total contributions are above £20,000 are also exempt – for example, payments linked to salary or which go up in line with national average earnings will continue to receive higher rate relief.
• Contributions (for people with income of £150,000 or more) which exceed these limits will attract only basic rate relief.
• An amendment has been added increasing the allowance to £30,000 for people contributing up to or over £30,000 in the last 3 tax years.

However, the measure of earning £150,000 relates not just to the 2009/10 tax year but also the 2007/08 and 2008/09 tax years. Therefore, if you were in permanent employment in 2007/08 and earned in excess of £150,000, but are now contracting and drawing far less than £150,000 in salary and dividends, you are still affected by the legislation. Our suggestion is that if you are concerned about whether you fall under the anti-forestalling rules, seek advice. The legislation is very complex and income that you may not believe to be relevant, might have to be included.

Will it be the same if the Tories get in?

This question has been asked many a time in the last six months. Our view is that the answer is yes. Many of the new tax and pension rules will be around for many a year. Whichever party is successful at the General Election, they will have to re-balance the public finances, so tax cuts are unlikely to happen. Furthermore, it is unlikely that if the Tories are successful, they can cut top earner taxes, whilst at the same time freeze public sector pay. Politically this would be seen as unacceptable, especially with all the talk of “fat cats” and banking bonuses.

Should I get my Limited Company to invest its spare money?

With bank deposit rates paying such derisory interest rates at the moment, many contractors are looking for a better rate of return for the cash sitting in their business. As a rule we would suggest that most contractors increase cash in their business account from three months expenditure to six, due to the volatile job market.

So should this short term money be invested, into a potentially rising stock market? We would argue against this. Although your company can invest in a Unit Trust in it’s own name, tax and liquidity reasons usually make this bad advice. Firstly, any equity based investment should be viewed as medium to long term i.e. a minimum of five years. If you need money quickly or for your end of year tax bill, this is a non-starter.

Your company cannot own it’s own ISA or Self Invested Personal Pension (SIPP), so it cannot take advantage of these tax efficient investment wrappers. Furthermore, if your company Unit Trust did have an impressive growth rate, you could be deferring a much larger tax bill down the line. Eventually, your will want to access this money. In order to get the money out of your business, you are either going to have to take a salary or dividend or close the business down. All of these scenarios will create a tax charge.

It is usually best to invest into your pension or ISA initially (the pension investment should reduce your Corporation Tax bill if set up correctly) and then your investment can grow within a tax efficient wrapper. Both these tax wrappers also allow you to avoid or minimise tax when you withdraw the money to create an income.

In limited cases, where cash is going to sit idle for many years, there may be a case for the company making an investment. Even here, care should be taken; if too much of a company’s cash is invested, the Revenue may view the organisation as an investment company rather than a limited company for a contractor. However the legislation is somewhat vague and open to interpretation.

Get tailored advice

Although many contractors share the same financial issues, every individual contractor’s financial position is unique. Furthermore, individual family and personal circumstances will affect your needs. The right answer for one contractor, may be entirely inappropriate for the next. The most important thing to do, is to obtain advice from someone that truly understands the tax issues and demands that affect contractors.

Wealth Matters have been working with contractors and freelancers for over eight years and offer a free face-to-face meeting at their offices or within a 60 mile radius. For more information call 01582 720511 or email info@wealth-matters.co.uk

By Paul Cleworth, Wealth Matters

Image by scottwills