Exploring self-employment pension options 

Becoming self-employed or starting a business can be a leap of faith. Gone is your reliable and steady source of income, an auto-enrolment workplace pension scheme, and statutory labour rights – hello to a world of new opportunity.

However, becoming self-employed does not mean that you need to be uncertain about your pension arrangements. In fact, you might have more powers than before when it comes to arranging and investing in a pension. Many self-employed people choose to make personal pension arrangements via private pension schemes like the Self-Invested Personal Pension (SIPP) or the Small Self Administered Scheme (SSAS). Both scheme types give you broad investment powers to manage your funds. Despite the names, however, many pension providers offer managed portfolio services within a SIPP or SSAS wrapper so that you don’t necessarily have to make the particular investment decisions.

Your legal obligations as an employer

As a Director of your own company, you may not have any other employees.  If you do employ people, depending on the size of your organisation, and the categorisation of staff, you may or may not need to create a workplace pension scheme for your employees. If you employ staff (who aren’t directors), you may need to arrange for an auto-enrolment workplace pension scheme. Legally, you must auto-enrol any staff who are both between the ages of 22-66 and who earn more than £10,000 per year (£833 a month or £192 a week). You can also enrol employees who don’t meet these criteria.

There are also legal requirements regarding employer contributions. If an employee earns more than £6,240 per year, you must make employer contributions of at least 3%, and the eligible employee must contribute at least 5%, for a total of 8%.

In the UK, workplace pension rules are regulated by the Pension Regulator (TPR), a non-departmental public body sponsored by the DWP that oversees the adherence to workplace pension regulations. If you operate a workplace scheme or think your business might need to and are unclear about your obligations, please visit the TPR website for guidance: www.thepensionsregulator.gov.uk/en.

The numerous rules and regulations governing workplace schemes are beyond the scope of this article. Instead, we’d like to focus on directors of limited companies and how they can best use personal pension arrangements.

Arranging personal private pension schemes

In general, if a business is run by a sole director or only has directors (i.e. no contracted employees/workers), there is no need to arrange an auto-enrolment workplace pension scheme. Similarly, as a director, you won’t necessarily need to enrol yourself into your workplace scheme if you have one. Instead, many directors make personal arrangements by creating a private pension scheme, like the SIPP. Making these arrangements is relatively straightforward. It just involves signing up to a private pension provider as an individual, completing their application process and creating a pension pot, then completing the relevant application and paperwork to register your employer on file. Once that’s been set up, you will be authorised to make personal or employer contributions.

Making personal vs employer contributions

The pension regime in the UK is designed to encourage people to save money through a pension scheme. The primary mechanism for this is tax relief. Tax relief is available to pension holders directly when they make a contribution (via a direct uplift) and while the money is invested in the tax wrapper, shielding them from CGT, income tax, and dividend tax.

When making contributions, we’re often asked whether it makes more sense to contribute personally or via your employer. Let’s explore the differences below.

Personal contributions

Anyone who works in the UK and is a tax resident here is eligible to make personal pension contributions and receive tax relief. Your annual allowance (ie. the total amount you can contribute and receive tax relief on) is currently either; your relevant earnings for the year (your income), or £60,000; whichever is lower. Note that there are conditions and exceptions to this rule, which we will discuss below. Even people who have no relevant earnings (income) can contribute as much as £3,600.

As a company director at your limited company, you can contribute to your pension as an employer or an individual. For those who work as a sole trader, you will not be able to make contributions via your company; you can only make personal contributions (i.e. from your own personal bank account). 

Whenever you make personal contributions, you will be eligible for the basic-rate of tax relief at source. This is to say that we will add 25% to your contribution (where the relief added reflects 20% of the total amount). For instance, if you invest £8,000 in your pension, you will see £10,000 in the scheme when it’s settled – the £2,000 of tax relief reflects 20% of the gross amount: £10,000. 

If you are a higher-rate or additional-rate taxpayer, you can reclaim an additional 20% or 25%, respectively, via the completion of your tax return. Since a higher-rate taxpayer can receive relief of 40%, every pound becomes around £1.66 – the equivalent of a 66% boost. Since Additional rate taxpayers get 45% tax relief, every pound contributed becomes around £1.80 – they effectively receive a boost of around 80%. This makes personal pension contributions an enticing proposition, particularly for higher or additional-rate taxpayers.

Employer contributions

Many self-employed people opt to make contributions via their company, as opposed to making personal contributions, for a number of reasons. Let’s explore some of these below.

Reducing your corporation tax – If a company contributes towards your pension, the cost is considered an allowable business expense from a corporation tax perspective, meaning that you can subtract the contribution cost from your profits for the year. This can reduce your taxable profits and, therefore, your overall corporation tax liability. This means that you can avoid paying corporation tax (anywhere from 19-25%) on any profits which are paid into your pension.

Avoid excessive tax – In making a contribution via the company, not only can you lower your corporation tax, but also avoid paying personal taxes. If instead of putting that money into your pension, you paid it out to yourself as income, you’d be liable to pay income tax. national insurance contributions, and employer’s national insurance contributions. Were you to take that money as a dividend then you’d still be liable to paying dividend tax over and above your dividend allowance.

Get more into your pension – Under normal circumstances, an individual is limited by the annual allowance rules, which were briefly covered above. In short, everyone has an annual allowance which is limited to either £60,000 or their earnings for the year; whichever is lower. We appreciate that many directors opt to take the bulk of their income via dividends, due to their preferential tax treatment. Dividends are not considered ‘relevant earnings’ for the purposes of assessing your annual allowance.

That being said, If you are a director at your limited company and intend to make contributions via the company, the usual annual allowance rules do not apply – instead, there is a definitive limit on how much the company can contribute. You are bound only to HMRC’s ‘wholly and exclusively’ test. As is true for any other form of allowable deduction against profits – you must be able to prove if need be, that the contribution is wholly and exclusively for the purposes of the trade, profession or vocation, and that its value should be at a reasonable level for the individual concerned. Your accountant will no doubt be able to guide you in this regard.

Play to your advantages

As a result of the above, the net benefits of your company making contributions towards your pension scheme oftentimes mean that it’s more lucrative than making personal contributions. This is particularly favourable if you decide to take a relatively low amount of personal income, and instead take the bulk of your compensation via dividends.

As is always the case when it comes to tax treatment, your personal circumstances may impact the suitability and effectiveness of your pension planning, and should therefore be reviewed and considered before forming a view to make pension contributions. To understand the most favourable option for you, you may wish to seek the advice of an accountant, adviser, or pension specialist.