Contractors obtain a heavier tax pain. The amount of tax contractors pay increases with the National Insurance Insurance Contributions (NICs) and additional income tax for as high as 80% and their net salary is reduced by up to 25%.
However, freelancers can use a technique where they deviate a percentage of their gross fees straight into a pension strategy. IR35 does not include pensions as these are 5% of expenditures.
This results in contractors having the possibility of converting into a pension £40,000 of their gross fee income, instead of having that income taxed based on the rules of IR35. This can eventually lead to tax relief of 50%.
The burden of IR35 as extra tax
Contractors within IR35 pay higher tax because they are not able to utilize high dividends approach and highly tax-efficient low income. All income is taxed under IR35 if the contractor were employed. This excludes the allowance of 5% for expenses.
This works with both employees and employers NICs are paid in all of the income of the contractor, together with income tax. The contractor’s gross earnings determine the amount of additional tax paid as a result of IR35. This is between 30% and 80%.
Reasons why it is wise to invest in a pension
The tax liability of a freelancer is reduced through pension contributions as the money can be diverted to a pension before the application of IR35 taxes.
An example would be a person being caught by IR35 earning £40 per hour, each £100 from gross income at the top end of their earnings is divided into £50 tax with only £50 as part of their net pay.
The option is to channel it to pre-tax into a pension instead of obtaining it as income. This decreases net pay by £50. The pension contribution is doubled, which leads to tax relief of 50%.
What is the mechanism of pensions?
Contractors can invest up to £40,000 annually without obtaining added tax. This has a £1m as lifetime allowance.
Moreover, here are some of the advantages of pensions.
*Pensions do not equate to saving money to purchase an annuity. Contractors can withdraw their pension funds from age 55 following new rules announced in 2014. This permits contractors to obtain multiple lump sums, direct from their pension fund.
*The pension savings of a contractor can be passed on to their family if they die before age 75. This is honored as long as the contractor has not bought an annuity.
*The pension savings of a contractor are safe as pension funds cannot become insolvent. The law protects a private pension fund.
*If a contractor is not a risk-taker, then he can opt to keep their pension in cash.
Obtaining a contractor pension can lighten the burden of IR35. If you need legal advice, you can contact our firm.