Salary Sacrifice becomes even more important as Income Tax and National Insurance changes bite
We were forewarned that this would be a harsh budget; in fact David Cameron reportedly said it would be the worst since the Second World War, but no-one could have predicted all of the cost cutting measures that the new chancellor would have to employ. One of the worst hit areas is personal taxation, with sharp increases to employee national insurance and far more people now caught by higher rate tax. With the state pension age extended the emphasis looks set to fall on personal provision with Contractors turning to salary sacrifice arrangements to bridge the gap to retirement.
One of the areas most affected by the emergency budget is pensions, both directly, through potential changes to higher rate tax relief on contributions and indirectly, through changes to national insurance, the compulsory annuity age and the age at which you can claim your state pension. Contractors need to be aware of how this all affects you as the emphasis is now shifting to an even greater extent to self provision for retirement; below we have outlined the changes and the various ways in which you can counteract them.
National Insurance
The dreaded National Insurance hike has been widely debated and is still set to come in to force in April 2011 for employees. The 1% increase in National Insurance could cost the average worker £167 a year, with higher earning Contractors working via PAYE Umbrellas or caught by IR35 within a limited company set up paying the most. Contractors earning a £100k salary look set to pay an extra £784 pa from this single tax hike alone whilst even lower earners could pay an additional £234.
This will make salary sacrifice an even more appealing option for Contractors as the potential tax savings will increase even further now. A salary sacrifice arrangement allows Contractors operating via a PAYE Umbrella to swap taxable salary for a pension, invested via your Umbrella Company. The ‘employer’ pays directly into your pension on your behalf before you take your salary so you don’t have to pay income tax and national insurance on the contribution. You are then only liable for these taxes on the remaining salary that you take. Contractors operating via a one man ltd company can benefit from a similar arrangement by contributing directly into a pension via your ltd company rather than into a personally funded scheme.
For those Freelancers caught by IR35 and operating via one man ltd companies or working via a PAYE Umbrella there is some good news as the full increase in NI will no longer apply to employers. This will be a relief as you would have otherwise suffered both company and individual national insurance deductions unless you had opted to invest in a tax efficient pension to save personal national insurance liabilities.
State pension
The age at which you can take your state pension is being increased to 66 to try and ease the burden on the state. This will be a blow to older Contractors that have failed to invest personally into a pension whereas there is no even greater urgency for younger investors to start saving.
There is still some good news within the budget on state pensions however because increases in the income will now be tied to the National Average Earnings rather than the lower Consumer Price Index so pensioners will be better off going forward.
Contractors with dreams of getting on to the golf course sooner rather than later must consider investing in to a pension in order to avoid the ever increasing state retirement age. Not only can you achieve your retirement goals sooner, you can also benefit from up to 68% tax relief on pensions contributions.
Annuity Age
A further more positive note is that Osborne has set about the task of abolishing the requirement to use your pension funds to buy an annuity at the age of 75. This will help Contractors retain more investment freedom and potentially allow a greater sum to pass on to your family on your eventual death. Currently annuity providers can greatly benefit from the early death of a retiree and by delaying buying this rigid income you may be able to pass more of your hard earned cash onto the next generation whilst also benefiting from extra ongoing investment growth.
This decision is still in consultation but until it is accepted, Osborne has temporarily increased the annuity age to 77 to help out those that may be nearing the age of 75.
Income Tax
The income tax threshold has been increased by £1000 in today’s budget to £7,475 which will prevent 880,000 lower earning people from paying tax at all. Each £100 increase in the threshold amounts to £20 extra in the pocket so this will represent a significant saving for many and is designed to help soften the blow of some of Osborne’s other initiatives.
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