IR35¹ is legislation that defines when an individual is within or outside their employer’s control for income tax purposes. This regulation has been designed to stop freelancers and contractors who are in a position of working with one client while being employed by another business from enjoying the benefits of both situations and avoiding paying taxes on any earnings they make through the work they do.
Have you ever wondered why?
This rule was introduced because employers were losing out financially. After all, individuals weren’t declaring their self-employment status correctly. Employees inside IR35 can be affected if they have two clients – say a personal contract between themselves and Client A, as well as employment with Client B. Income, generated via A, will still go into your pension pot but not benefit from any contribution limits which may apply to the pension scheme. As an individual, you may contribute to a personal pension of up to £40,000 or more throughout your working life.
When it comes to accessing pensions later in life – those inside IR35 should expect a higher level of tax because capital gains tax rates apply at 40% (and potentially more elevated in the future). In contrast, those outside IR35 will be taxed at 20%.
What does this mean for you?
This doesn’t mean that all self-employed workers should ditch their pension, but it’s essential to weigh up the pros and cons of saving into a personal or stakeholder pension. It may not matter if you’re a higher rate taxpayer inside IR35 because your salary is only high enough for basic rate tax – this means as long as you have less than £45,000 (£31,850) gross income year, then any contributions you make are free from taxation.
How Much Tax Do You Pay inside IR35?
If a person pays into their employer’s scheme, they have been produced through PAYE as they earn (PAYE), then any payments made towards pensions will only be charged at the introductory rates of income tax which means that 20% is charged for every £20,000 earnings.
If a person is self-employed and their income derives through an umbrella company or Limited Company (IR35), contributions to pensions will be charged at the higher tax rates, which means that 40% is charged for every £80,000 (£120,000) pounds earned.
There has been some speculation as to whether these changes would affect those in this category on very high salaries? The answer seems to be no!
The reason being that any payments made towards pensions will only be taxed at an introductory rate if they earn less than £100,000 per annum from employment. So there won’t be any different when it comes to January 2018 because inheritance taxes are not affected by IR35 status.
The annual allowance for pension contributions is capped at £40,000. This means that if you earn more than this amount, then the government will reduce your contribution to basic and so do not get much of a financial benefit from any pension savings as it may only be worth paying into one pension scheme (depending on how many ones you are already in).
Let me explain.
For example, if someone earns £130,000, they would have their annual allowances reduced by 40%, which is around £20,800 (£131k x 20%), meaning that they can now contribute up to £19200 annually. If we consider other changes such as tax relief rates decreasing, then people who make over £100k per annum probably won’t see too much of a benefit in saving into pensions.
For someone earning £40,000 per year and paying basic rate tax (currently 20%), this means that they can contribute up to £1000 throughout their working life before they start producing any additional taxes on pension savings which would be around £1300 (£2000 x 30%) once we account for the fact that they have already contributed to their pensions.
How Does IR35 Affect Pension Contributions?
Let’s have a closer look:
It depends on the type of work you do. For example, if you are a contractor, then saving into your employer’s company pension plan would be subject to tax at 20%. If this sounds like you, then there are significant savings for individuals who have contributed to an occupational pension while working in revenue-generating roles caught by IR35 according to HMRC1 classification.
In such cases, it could make sense not just financially but also with regards avoiding being caught by IR35 regulations altogether and therefore ending up on PAYE plus National Insurance Contributions alone – all payments which mean you end up making less take-home pay than before.
There are two main types of occupational pension plans that can be used to avoid this happening:
A defined contribution scheme2 is a type of savings plan where the amount you get depends on how much money you have saved and what rate it earns (if any) over time. The more you save into your plan now, the bigger your eventual pot will be. Your employer may contribute too if they offer an automatic enrolment scheme in their workplace. If not, then don’t worry – employers automatically deduct contributions from salary, so all employees still benefit from tax relief even though they might never see evidence of it.
Stakeholder pensions are another option for those looking to make use of their tax relief. They are a low-cost type of pension plan that includes contributions from both employer and employee (or someone else who wants to support you).
Are There Specific Pensions for Those inside IR35?
Yes, there are certain advantages to pensions for those inside IR35. They may be able to use salary sacrifice arrangements and input periods and make contributions from trading stock. There could also be tax implications on pension funds which would need discussing with an accountant or financial advisor before taking action.
Another strategy would be to negotiate reduced PAYE on any income earned which comes within IR35’s scope (such as trading stock) through schemes such as salary sacrifice or pensions input periods. It may also make sense for certain high earners to consider the possibility of taking finance from their pension pot, which can be tax-free as long as it’s not needed for retirement.
There is a range of options available to contractors who wish to use pensions for themselves and their families. The first thing that needs exploring is the scope of your contracting work. If you know it falls inside IR35, then there may be restrictions on what you can do, but if not, then there are different considerations that apply.
If you’re inside IR35’s scope:
The other strategy is to take advantage of the annual allowance, which is 2017/2018 means that anyone who has a pension pot from previous years, as well as this year, can put up to £40,000 into their tax-free pension. However, if they are within the public domain and fair market value assessment (FMVA) applies, there will be an extra cost based on how much income earned is less than salary sacrifice contributions (£30 per £100).
One way to reduce the tax paid on pension contributions is by using a limited company. This will be discussed in more detail later.
The article would provide information about how you can avoid paying too much income tax when saving for your retirement through pensions and salary sacrifice arrangements, as well as looking at whether it’s worth taking finance from a pension pot that could be tax-free if not needed for retirement. It would also consider ways to mitigate risk, such as using salary sacrifice or input periods and considering IR35 implications before withdrawing funds.
I want this post to help people understand what they need to do with their pensions that fall within IR35 so that they are able to get the best possible advantage out of them.
What About Using an Umbrella Company for IR35?
If the company is inside IR35, then a payroll provider can have them paid on their normal salary. This will not release any liability from the employer, and it should only be considered if there isn’t another option. There is a risk that the umbrella company will have an option to be outside IR35 by default, in which case it could become necessary for them to put this inside IR35 again.
If you’re considering using an umbrella company, remember they can only work with employers and not employees.
It can be worse,
Umbrella companies are subject to some of the same rules as their clients, so if your client falls within IR35, then they will too. They cannot perform certain functions such as offering pension input periods or salary sacrifice schemes without running afoul of HMRC regulations on those activities; these may be unwise even if permitted by law because they would violate anti-avoidance legislation enacted specifically for tax avoidance purposes.
Got Questions? Check These First
How much more tax will I pay inside IR35?
This is a difficult question to answer without knowing the individual’s pension pot and age. Generally speaking, if someone pays tax on their salary of around £50k, they would be paying more than £14,000 through IR35.
It may also make sense for certain high earners to consider the possibility of taking finance from their pension pot, which can be tax-free as long as it’s not needed for retirement.
How is tax calculated on IR35?
If you make £100 from IR35 and your allowance is £11,500, then the amount of tax paid will be:
£30.00 (20% x £50)
This means that you’re paying 20% of the income as tax which is calculated at a rate of 50%. The other 30% would go towards National Insurance Contributions for those employed in employment with IR35 status.
Why does IR35 compliance matter?
It’s important to be aware if you’re in or out because it will affect how much tax you pay and what benefits your employer can offer.
Who pays IR35 tax?
The company, not you, pay IR35 tax. It’s just a way of taxing your income because they can’t see what proportion comes from pensions and what proportion comes from other sources, so it’s easier to lump them all together as an employment income.
To sum it all up:
If you are out of IR35 and have a pension fund in the UK, you may want to consider salary sacrifice arrangements, which will mean that your income is reduced. You could also negotiate reduced PAYE on any income earned, which comes within IR35’s scope through schemes such as salary sacrifice or pension input periods. It may also make sense for certain high earners to consider the possibility of taking finance from their pension pot, which can be tax-free as long as it’s not needed for retirement. Remember, though, that all these decisions are dependent upon taxation at the time, so please consult an accountant before taking action.