Freelance Finance: Are you ready for retirement?

You may not be thinking of retirement just yet, but it’s always worth being aware of rule changes that could impact on your pension. Paul Cleworth, Financial Planner and Director of Wealth Matters shows us freelancers and contractors how we can tee up our options…

Are you ready for retirement?

As a contractor with no company pension available, it is important that you make your own arrangements to ensure a comfortable retirement. In 2006, HMRC has changed their view on company contributions to pensions. Th˙ is news may have fallen outside the radar of many contractors, but their decision could have far reaching consequences for all contractors. And, for once, HMRC have provided contractors with some good news.

Employer contributions:

Since April 2006 (A-day or Appointed Day in the world of pensions) employer contributions to pensions are unlimited and are not restricted by the earnings of the individual concerned. There is no restriction on the number of employer schemes that can be set up for an individual. Employer’s contributions are normally an allowable expense against corporation tax and hence reduce the companies’ tax bill.

However, until updated guidance in February 2007, the extent to which an employer’s contribution would benefit from tax relief after A Day would depend on whether the contribution is deemed to be “wholly and exclusively” for the benefit of the trade (section 74 ICTA 1988). This created uncertainty about how much a contractor could contribute into a pension via their company. Fortunately, HMRC have now confirmed the ‘wholly and exclusively’ rule will only be applied in limited circumstances. In the new guidance (BIM46001), HMRC confirms the payment of a pension contribution is part of the normal costs of employing staff and as a result the “wholly and exclusively” rules will generally only be considered in limited circumstances. It says: “It [the contribution] will only be disallowable where there is an identifiable non-business purpose for the employer’s decision to make the contribution to a registered scheme, or for the size of the contribution.”

The two main areas concentrated on by HMRC are:

If there is a non-trade purpose for the size of the contribution paid in respect of a controlling director or an employee who is a close friend or relative of the controlling director or proprietor of the business.

Where contributions are paid by a party other than the former employer after a trade has ceased or been sold, as such contributions are not allowed because they are not paid by the employer, although it points out they may be allowable as a deduction under general tax principles.

As a result, the new guidance, which is effective for all accounting periods ending on or after 6 April 2006, will particularly affect owners and directors of companies and any connected employees such as a spouse or child who may work for them.

This guidance allows contractors and advisers to plan pension contributions with more confidence, as it is clear the vast majority of pension contributions will receive full tax relief. It should now be acceptable for owners of companies to take a remuneration package up to the level of profits made by the company, as the profit usually reflects the value added by that individual.

For connected people such as spouses, pension contributions comparable with unconnected employees are acceptable, but if there is no comparable employee, a contribution which aims to provide a reasonable benefit at retirement – say two-thirds of salary – shouldn’t give HMRC any cause for concern.

A-day Pension Rule Changes:

There was a massive overhaul in pension rules in April 2006. A few of the rules have been subsequently changed or tweaked. Some of the key rule changes are as follows:

• Since A-day there has been no limit on the amount of personal contribution that can be paid into a registered scheme, although there is a limit on the amount that can benefit from tax relief.
• This will be the higher of £3,600 (gross) and 100 per cent of “Relevant UK Earnings” up to a maximum of £245,000 in tax year 2009/10, rising to £255,000 in 2010/11. This is called the Annual Allowance.
• For contractors with ‘relevant’ income above £150,000, full higher rate tax relief will only be available on the first £20,000 per annum. The anti- forestalling rules are complicated and so you should seek advice if affected.
• Individuals can pay contributions in to as many different pension plans as they like.
• The maximum size of your pension (Single Lifetime Allowance) is £1.75 million in tax year 2009/10, rising to £1.8 million in 2010/11. Any surplus will be heavily taxed.
• Tax Free cash will become 25 per cent for all types of registered pension schemes and therefore includes personal pensions, retirement annuity contracts, money purchase and final salary occupational schemes.
• Normal minimum retirement age moves from 50 in April 2006 to 55 in April 2010.

Taking your income in retirement:

One of the downsides of pensions in the past has been the need to take an annuity. The rate available is based on gilt and interest rates. As these are very low at the moment, annuities have become poor value for money. In addition, annuities can be inflexible, with poor death benefits. Prior to 6 April 2006, on retirement, when you take your tax free cash you had to either buy an annuity straight away, or go into what is called ‘income draw-down.’

Draw-down is a popular option for people with larger pots, as it allows them to take an income from their pension, while leaving the rest of the fund invested.

Death benefits are also often better for partners and dependents. Since A-day, you can take your tax free cash without the need to take your pension from the balance. In addition, draw-down limits have become far more flexible.

At age 75, you have the option of taking an annuity, or taking a form of draw-down known as an Alternatively Secured Pension (ASP). The rules on ASP were significantly changed in the pre-budget report in December 2006.

Certainly, an option worth considering is a Self Invested Personal Pension (SIPP). These contracts allow you very wide investment opportunities and are extremely flexible.

A-day and the new clarification from HMRC represent a golden opportunity for contractors to tackle their pension requirements. But the new pension rules are technical and require expert guidance. Your best option is to seek advice from an Independent Financial Adviser.

If you have any questions on this topic please feel free to leave a comment below and I’ll do my best to answer any questions you might have.

For clarification of the new rules and to see how you may be able to benefit from making pension contributions you can contact me directly.

By Paul Cleworth,

Financial Planner and Director of Wealth Matters Ltd

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