Speaking to clients that work as professional service contractors or working through their own limited service company many are reviewing the use of these going forward with new UK legislation from 6 April 2020. The new legislation aims to ensure workers operating through personal service or limited companies are paying the right levels of tax and national insurance and will crack down on “disguised employment”.
The personnel arrangements are not something we can address but for people going “on-payroll” as employees and reviewing the viability of keeping their limited company here’s a few financial planning ideas to distribute retained earnings and cash into a pension and use tax reliefs to improve your financial affairs for the future and keep as much cash as possible.
“Disguised employment” is where contractors operate in exactly the same way as their permanent counterparts but end up paying less to the public purse because of the operation of the service company.
Financial planning guide for closing a service company
If you are going on-payroll the validity of retaining the old company may be limited.
Distribute retained earnings and cash in a tax efficient way and improve your financial position.
Close the company and access retained cash and earnings efficiently
If moving “on-payroll” the administrative costs to maintaining a limited company may be lost money. Just closing the company and distributing cash from the company will usually be taxed as income at your marginal tax rate if paid as dividends and if above £25,000 at income tax rates, the table below has England, Wales and Northern Ireland and Scotland income tax rates for 2019-20. Dividend taxes are 7.5%, 32.5% or 38.1%, depending on your marginal rate of personal tax.
Paying the costs for a solvent liquidation means distributions from a liquidation are treated as capital and subject to Capital Gains Tax and the existence of entrepreneurs relief means gains are taxed at 10% above the annual capital gains tax allowance. There is a very simple worked calculation below on the benefits.
Worked example of solvent liquidation versus informal strike off
A single director/shareholder wishes to close their company on 30th April 2019 with £80,000 of retained workings.
Upto £160k pension contributions + 25% immediate credit
Carry forward allows you to make pension contributions in excess of the annual allowance and receive tax relief. Carry forward allows you to make use of any annual allowance that you may not have used during the three previous tax years, provided that you were a member of a registered pension scheme.
£40,000 is the most you can pay in to your pension each tax year that ends each April. The UK government has created a carry forward that lets you take advantage of any unused allowance from the previous three tax years. That’s up to £40,000 from each year, so you are able to make a pension contribution of up to £160,000 plus receive basic pension tax credit plus higher rate tax relief if a higher income tax payer.
Remember investments go down in value as well as up so you could get back less than you invest. You normally can’t access your money until any time after your 55th birthday (57 from 2028) so pension are long term investments. There are additional rules about how much you earn, whether you are in Scotland where different income tax levels apply. So this is not advice, speak to us related to your personal situation.
Accessing your pension with tax free lump sum
If you’re 55 or over you can take 25% as a lump sum without paying tax. If you do this, you can’t leave the remaining 75% untouched. You must either:
- buy a guaranteed income (annuity)
- get an adjustable income (flexi-access drawdown)
- take the whole pot as cash
You should consider financial advice when accessing your pension as it is important to leave money to generate an income in later life.
Updating as we get more enquiries
We shall update this article from time to time as we get more questions from people this helps.