Pensions represent one of the few last ‘tax breaks’ available to contractors, providing the opportunity to reduce your tax liabilities, whilst also saving for retirement.

Following significant changes introduced by the Government in April 2015, you have the flexibility to decide how and when you draw your pension income.

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

In this guide, we look at the key pension rules, how to invest money into your pension fund, and the options you have when you reach retirement age.

Get a personalised pension illustration here

Contractor pension flexibility

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

• 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.
• The current lifetime allowance (LTA) for pension contributions is £1,073,100 (2023). The LTA is set to be abolished for the 2024/5 tax year.
• 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.
• 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 3 tax years can be used to make extra contributions. However, you must have been a member of a UK registered pension scheme in the years in question to be eligible for this, but you don’t have to have been an active member during this period.
• 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 25% PCLS can be taken prior to setting this up.
• Under Triviality rules, members of Final Salary schemes whose pension funds are valued under £30,000 have the option to take a lump sum, instead of a regular income. PCLS is available and the remainder is subject to marginal income tax.
• Upon death under the age of 75, any remaining pension funds can be paid out tax-free to beneficiaries as either a lump sum or drawdown pension.

Pension consolidation

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 all of your old pensions into one easy-to-manage pot. Find out more in our guide to consolidating your old pensions.

Professional advice

Most people do not save enough to provide for a comfortable retirement, which may mean that you have to work longer in order 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 you do this via 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.

The options for retirement income are not just limited to pensions but can include making use of alternative investments such as ISAs and buy-to-let property, which can be encompassed 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.