Most tax efficient way to turn current into future income Most tax efficient way to turn current into future income
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  1. #1

    Nervous Newbie


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    Default Most tax efficient way to turn current into future income

    Hi there,
    I am a permanent considering moving to contracting with a limited. My "problem" is that I have a very thrifty lifestyle and I would only need 10%-15% of my monthly rate. I don't want to take the money out and pay taxes if I am not needing it. Ideally I would like to save it, invest it and in some years time start working less and less months per year.

    What would be the most tax efficient way to pile-up savings and invest them to withdraw them little by little in the future?

  2. #2

    Nervous Newbie


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    The most tax efficient way is obviously putting up to £40k per year into your pension as you'll avoid the corporation and income/dividend taxes, albeit at the cost of locking your savings away until retirement.

    You'll probably want to take your £8k salary and £34k dividends out of the company each year and save anything you don't need into an ISA.

    You can leave the rest in your company account and build up your warchest, which can then be used to pay your salary when you're not working as much.

  3. #3

    Contractor Among Contractors


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    Bear in mind that anything left in the company will be available to hand over to HMRC if they one day disagree with your IR35 judgements going back several years. Money that's in your pension is definitely safe from that, and money extracted via dividends probably safe.
    My priorities would be:-
    1. Salary up to the NI threshold, or maybe pay a little NI and use up the whole personal allowance
    2. Dividends to take total taxable income up to higher rate threshold.
    3. Up to 40K (whole annual allowance) of any remainder into pension. (Maybe more if I have unused annual allowance I can carry forward from previous years)
    4. Leave anything left over in the company.

  4. #4

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    Quote Originally Posted by IR35 Avoider View Post
    Bear in mind that anything left in the company will be available to hand over to HMRC if they one day disagree with your IR35 judgements going back several years. Money that's in your pension is definitely safe from that, and money extracted via dividends probably safe.
    You sure about that?
    Unless all your contracts are incorrectly declared outside I’m not sure that HMRC will requisition money from your company. What they do is tell you how much you owe and then it’s down to you how you fund it.

    You cannot access your pension until you’re 55. That is different to it being safe from HMRC. If you owe them, you owe them. There are no safe havens, just limits on your ability to access funds.

    Again, money from dividends is not ‘safe’. For a start if you should have been inside then you shouldn’t have declared the dividends. And that money is not safe either.
    See You Next Tuesday

  5. #5

    Still gathering requirements...


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    Quote Originally Posted by IR35 Avoider View Post
    Bear in mind that anything left in the company will be available to hand over to HMRC if they one day disagree with your IR35 judgements going back several years. Money that's in your pension is definitely safe from that, and money extracted via dividends probably safe.
    My priorities would be:-
    1. Salary up to the NI threshold, or maybe pay a little NI and use up the whole personal allowance
    2. Dividends to take total taxable income up to higher rate threshold.
    3. Up to 40K (whole annual allowance) of any remainder into pension. (Maybe more if I have unused annual allowance I can carry forward from previous years)
    4. Leave anything left over in the company.
    The IR35 bill is incurred personally; so whether its in the company, pension or spent (after being issued as dividends) is entirely irrelevant - if you've bilked the taxman he'll get what is owed to him once he finds out

    Where it is or how you (incorrectly) dispersed it will not figure very highly on his radar - in fact he won't give a flying *****

  6. #6

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    Quote Originally Posted by IR35 Avoider View Post
    Bear in mind that anything left in the company will be available to hand over to HMRC if they one day disagree with your IR35 judgements going back several years. Money that's in your pension is definitely safe from that, and money extracted via dividends probably safe.

    My priorities would be:-
    1. Salary up to the NI threshold, or maybe pay a little NI and use up the whole personal allowance
    2. Dividends to take total taxable income up to higher rate threshold.
    3. Up to 40K (whole annual allowance) of any remainder into pension. (Maybe more if I have unused annual allowance I can carry forward from previous years)
    4. Leave anything left over in the company.
    This is dangerously wrong from an IR35 point of view. Money owed under IR35 is owed by you personally as all payments made to your co. under IR35 become "Deemed Payements" and subject to full PAYE, less a 5% allowance for expenses. Your co. may also become liable for Employers NI on the full amount.

    It doesnt matter how you got the money out of the company, if you are caught under IR35 then unless you you paid Income Tax and National Insurance on it you owe them money, along with potential interest and late payment penalties.

    If you can't pay from savings or other sources you would be expected to cash in any assets you have, incuding your pension, to clear the debt. Even if you have money left in the company, the best case scenario is that you have to declare a dividend and then pay Tax and NI on that at the higer rate, as you have already reached the limit, before you can pay HMRC what you owe under IR35.

    There is no way to "protect" money from IR35. The best you can do is either have savings sufficient to cover any potential liability or take out insurance, or both.
    "Being nice costs nothing and sometimes gets you extra bacon" - Pondlife.

  7. #7

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    1. Max out pensions. Pension contributions from your company into a pension plan in your name are exempt from all tax including corporation tax, so you reduce your CT liability and incur no National Insurance or Income Tax liabilities. So open a SIPP if you don't have one already and max out your contributions.

    1A) You can contribute up to £40K each year.
    1B) If you had a pension open in previous years, and it didn't receive a full £40K in any of the last three years, you can use up the full £40K for the prior three years as well.

    You can't use prior year allowances until you've used the current year allowance. Once you've used the current year allowance, you should use the remaining allowance from 3 years ago first, the one from 2 years ago will still be available in the following year (it will be three years old then). Note, though, that the previous years' allowances may be reduced if the combination of salary and pension contributions in those years is too high. Read the annual allowance pdf they've linked to here Pension carry forward rule | Hargreaves Lansdown, they've done a reasonable job on this I believe.

    Caveat on pensions: You asked about turning current into future income. Pension income may be WAY in the future, depending on how old you are. Are you wanting to kick your income down the road until you are 40, or until you are 60? It makes a difference.

    2. Max out your tax-efficient income.

    You are eventually going to have to take money out of your company to be able to use it personally, and that is going to trigger tax. If you retain all the money until closing down, and then use ER, you'll pay 10% on retained profits (if ER continues to be available, which is uncertain, and probably unlikely if Komrade Korbyn becomes PM). So any money you can take out now with reasonable tax efficiency is worth doing. If you don't need it, sock it into an ISA or something, but get it out of the company.

    2A) Pay yourself a salary up to the point where NI kicks in (currently £700 / month). This money is a business expense and so saves on CT without incurring any NI or Income Tax.
    2B) If the rules allow you to claim travel expenses, use it to the max. (I'm not saying push the rules, I'm saying don't leave anything out that you can legitimately claim). Have your company reimburse you for everything.
    2C) Add up your salary and any other income you have, and subtract that amount from the higher rate tax threshold, and pay yourself dividends of that amount.

    Don't pay yourself enough dividends to take you into higher rate dividend tax. Chances are pretty good you'll be able to extract the funds later, either through ER or perhaps dividends after you've stopped work, for less than that.

    Remember the personal savings allowance -- no tax on interest on your personal savings, up to £1K if basic rate and £500 if higher rate. If you get to interest between those two amounts it is one more reason to stay out of higher rate. But remember to look down the road -- interest rates may go up, so the amount of interest will perhaps increase more than the allowance. So it may be worth it to use cash ISAs if you are going to be pulling out a lot of funds that you aren't using. The rates aren't as good but the tax exemption may be quite valuable down the road. Once you get over £20-25K in savings it may be time to start thinking about that factor.

    Finally, everything I'm saying here is talking about a full year of contracting. Presumably if you make the jump you'll not be doing so right at the end of the tax year. So you'll have a year where you have permie income and contracting income. All the calculations for that will be somewhat different -- you may have enough income from your permie job that you can't really take any income from contracting, other than £2K dividends, tax efficiently. Every case will be different.

    It's possible I've missed something but if so someone will chime in.

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