Contractors' Questions: How to maximise my pension under IR35?

Contractor's Question : I'm going to be under IR35 in my next contract and I want to be as tax efficient as possible by making company contributions to a pension scheme. How much can I afford to make every month? I ask as I know a contribution isn't 100% tax deductible. This is a mistake I made last year when my contributions were too high and I still had quite a big tax bill to pay at the end of the year. Is there a formula for working this out anywhere? I've asked my accountant, but he just left me confused as did my financial advisor.

Expert's Answer: Unfortunately this April's Budget and last week's pre-Budget Report have restricted full tax relief on pension contributions for higher earners. However assuming that you do not earn more than £130,000 a year (in this current or any of the past 2 tax years) you should still be free to invest your total contract income as a corporation tax deductible expense, with no additional personal tax to pay.

I think the mistake that you may have made last year was perhaps investing more than your annual contract income which may have been more open to challenge by HM Revenue & Customs. However I really wouldn't expect you to have a problem courtesy of HMRC if you chose to invest a single year's income into your pension, rather than take the contract money out of your company as taxable and NI-payable salary under IR35.

Indeed one of the few crumbs of comfort when IR35 was first introduced was that it specifically stated that pension contributions were deemed to be outside of the maximum 5 per cent allowable as expenses. Sadly back in 1999 pension contributions were still largely limited to a rigid age related percentage of salary and IR35 resulted in a substantial tax hike for many contractors who were caught by the new regime. But since pensions simplification in 2006, the freedom was granted to make employer contributions that were only really limited by an overall annual allowance that applied to everyone (currently
£245,000). Pension investment has therefore been a key method of our trying to make IR35 more palatable for contractors.

It may be counterproductive to give further guidance on this, as it may not fit your personal circumstances. However, you can contact me via the ContractorUK Money Club . I will also endeavour to help clear up the confusion with your accountant!

The expert was Tony Harris, founder of
ContractorMoney , an independent financial advisor to IT contractors.

Tuesday 15th Dec 2009