Pensions represent one of the few last ‘tax breaks’ available to contractors. They provide the opportunity to reduce your tax liabilities while saving for retirement.

Following significant changes introduced by the government in April 2015, you can decide how and when to draw down your pension income.

This means you can tailor your retirement strategy to your personal needs and lifestyle.

In this guide, we examine the key pension rules and allowances, stakeholder pensions vs SIPPS, how to invest in a pension fund, and your options when you reach retirement age.

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Key pension features for contractors

Pensions offer contractors flexibility at retirement, alongside the upfront tax benefits that they receive on their investments today:

Annual Allowance

Each individual has an annual tax relief allowance, up to which pension contributions can be made in the tax year. This is currently set at the higher of £60,000 or 100% of total taxable earnings in the current tax year.

You can make employer contributions up to the £60,000 limit from your own limited company, regardless of the split between salary and dividend income.

Lifetime Allowance

The Lifetime Allowance (LTA) for pension contributions – £1,073,100 during the 2023/4 tax year, has been abolished from 6th April 2024 onwards.

Employer vs. Personal Contributions:

Alternatively, you may decide to make personal contributions to your pension.

Under current legislation, higher and additional rate taxpayers benefit from full tax relief at 40% or 45%.

You should talk to a financial adviser to decide whether to make contributions via your company, or personally (out of post-tax income).

Read our comprehensive guide to pension contributions and tax relief for limited company owners.

Carry forward rules

If you want to make large one-off contributions, you may be able to take advantage of ‘carry forward’ rules, whereby the unused pension allowances from the previous three tax years can be used to make extra contributions.

However, to be eligible for this, you must have been a member of a UK-registered pension scheme in the years in question, but you don’t have to have been an active member during this period.

Accessing your pension

Pension income can be drawn from the age of 55, as a lump sum or regular income, without restriction, but subject to your marginal rate of income tax.

A Pension Commencement Lump Sum (PCLS), also known as Tax-Free Cash can be taken from any pension, usually up to a limit of 25% of each withdrawal.

The remaining 75% can be taken as a regular income or lump sum and will be subject to income tax at your marginal rate.

The traditional option of purchasing an annuity is still available, and the 25% PCLS can be taken before setting this up.

Triviality rules

Under Triviality rules, members of Final Salary schemes whose pension funds are valued under £30,000 can take a lump sum, instead of a regular income.

PCLS is available, and the remainder is subject to marginal income tax.

Death benefits

Upon death under 75, any remaining pension funds can be paid tax-free to beneficiaries as either a lump sum or drawdown pension.

Bear in mind that the government has proposed bringing unused pension pots under Inheritance Tax (IHT) from April 2027 onwards.

Pensions for limited company contractors

Most limited company owners contribute to either a stakeholder pension or a SIPP, although you can join the government-run NEST scheme if you’re a sole employee of your company.

Stakeholder pensions

Stakeholder Pensions are suited for contractors and other limited company owners seeking a straightforward and cost-effective approach to pension saving.

Typically, charges are capped at a maximum of 1.5% of the fund value per year, which helps to ensure that fees remain manageable and predictable.

Investment options are somewhat limited compared to SIPPs; the provider usually manages pre-selected funds, which means less individual control over specific investments.

Self-invested personal pensions (SIPPs)

If you want access to a wider range of investments and more involvement in your pension planning, a SIPP might suit you. It is a popular choice for contractors.

You have greater control over investment decisions, which can be attractive for knowledgeable investors

ii offers a Which? Recommended SIPP. Unlike many other providers, ii charges a fixed monthly fee rather than a percentage of your pension pot.

You can find out more about SIPPs here.

Pensions for umbrella company contractors

If you’re an umbrella company contractor, your provider will offer you access to their workplace pension via auto-enrolment.

All employers have to offer their employees access to a pension scheme.

This is often the best way to contribute to a pension scheme as an umbrella employee. However, you can opt out if you want to and make your own arrangements.

Read our pensions guide for umbrella company employees.

Can you consolidate old pension pots?

If you’re a contractor, chances are you have at least one workplace pension from an old employer. Many contractors have three or more.

More and more pension providers now offer consolidation services, whereby you transfer your old pensions into one easy-to-manage pot.

Read our guide to consolidating your old pensions.

Always seek professional advice

Most people do not save enough to provide for a comfortable retirement, which may mean that you have to work longer to provide for your family and personal needs. The state pension is unlikely to cover even your basic needs.

Investing in a pension is a tax-efficient way to put money away, whether through your company (contributions are an allowable business expense), or take advantage of tax relief on personal contributions.

Find out more about how pension tax relief works, and compare the pros and cons of personal vs. company contributions here.

Retirement income options are not just limited to pensions. They can include alternative investments such as ISAs and buy-to-let property, which can be combined to provide a bespoke, tax-efficient retirement strategy.

This guide provides an overview of how pensions work for limited company contractors. For professional advice, we recommend you contact an IFA