This article focuses on the scenario of a contractor being forced into operating through an umbrella company structure. To not overcomplicate the example, we are assuming that an individual’s remuneration from the umbrella company equals what is called your adjusted net income, for example:
- the person has no other sources of income (i.e. property and dividends),
- is engaged with only one client and
- is not making payments to anything else that may affect their adjusted net income (i.e. pensions or gift aid).
The IR35 off-payroll reforms have significant implications for the contracting market. Many people, possibly you, are being forced to accept assignments inside IR35 due to the widespread blanket approach by many firms.
Many contractors are choosing (or feel forced) to engage with an umbrella company. Operating through an umbrella company, instead of a Personal Service Company (PSC), has a significant impact on your retained income for several reasons. At a high level, some of these reasons are:
- Your income (less acceptable expenses, fees, levies), is taxed at your marginal rate of taxation.
- In a PSC, you pay Corporation Tax on your profits, but directors often do not draw out funds to sit within certain tax thresholds. Working through an umbrella company, you do not have that level of control.
- Your income will be subject to National Insurance contributions and the income is under a different tax regime than dividends.
- Your expense options are limited.
The percentage of your earnings that you retain (after tax and deductions) is likely to reduce. As a consequence, you really should be focused on tax-efficient ways to save/invest for your future.
Options to consider include pensions along with other more sophisticated tax efficient investment schemes. The remainder of this article focuses on pensions. If you want to know more about the other schemes, you can get in contact.
Why Pensions?
They are a great way to save for your future and reduce your tax liability. After all, if you are a higher rate taxpayer (40%), you can receive 40% income tax relief on contributions that fit within your higher rate tax band by claiming tax relief over the basic rate via your annual tax return. Using a pension helps reduce the overall amount of tax you pay on your income whilst you save for your future.
As an example: Let’s assume your taxable income in the year (after any allowable expenses) is £100,000.
Paying £1,000 each month into a pension may sound like a lot. However, what is the real cost?
- To have £1,000 go into your pension each month, you would only need to pay £800 as this payment attracts basic rate income tax relief at source, grossing the amount up to £1,000.
- You then reclaim Higher Rate Tax relief via your self-assessment tax return, saving you a further £200 in tax.
- This means, annually, you would have contributed £12,000 to your pension for a net cost of £7,200. That is a tax saving of £4,800.
Can you think of another way to reduce the amount of tax you pay by £4,800 in one year?
If your adjusted net income is greater than £100,000, saving into a pension can become even MORE tax efficient due to an anomaly in the tax rules.
If your adjusted net income is between £100,000 to £125,000, you end up paying 60% tax on the income between £100,000 to £125,000. The reason is, for each £2 of taxable income between £100,000 to £125,000, you lose £1 of your personal allowance. A great way to mitigate this unfair tax quirk is to pay into a pension.
Using the example above, if your taxable income is £120,000 and pay the £12,000 into a pension, the net cost would be ONLY £4,800, saving you £7,200 in tax.
You really should seek advice as to the level you should pay into a pension to reduce the total amount of tax you pay. Feel free to contact Wilcox Day Wealth Management for a no-obligation initial discussion.
The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select, and the value can therefore go down as well as up. You may get back less than you invested.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.
This article was provided to us by Geoff Day at Wilcox Day Wealth Management Ltd. Please note that this does not imply an endorsement by us.
You can review further articles that may be relevant; please visit www.wilcoxday.co.uk or www.wilcoxday.co.uk/contractors
Wilcox Day Wealth Management Ltd is an Appointed Representative of and represents only St. James’s Place Wealth Management plc (which is authorised and regulated by the Financial Conduct Authority) for the purpose of advising solely on the Group’s wealth management products and services, more details of which are set out on the Group’s website www.sjp.co.uk/about-st-james-place/our-business/our-products-and-services. The ‘St. James’s Place Partnership’ and the titles ‘Partner’ and ‘Partner Practice’ are marketing terms used to describe St. James’s Place representatives.
February 14th February
