Higher rate tax relief at risk in next budget – future proof your pension

Whilst many are excited by the prospect of a fresh start for politics and the economy, there is concern that rumoured changes to Capital Gains Tax (CGT), National Insurance and tax relief on pension’s contributions may have a negative impact on Contractors pockets.

Here, we look at the impact of the new Coalition’s budget on your finances as a Freelancer and prepare you for what the 22nd June may bring...

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With George Osborne’s emergency budget fast approaching, a number of key issues are starting to surface which may affect Contractors.

The most obvious is the possibility of changes to the tax relief available on pension contributions. This is a difficult issue for the new Chancellor who will be keen to continue encouraging self provision for retirement but is also under pressure to reduce the budget deficit.

Is it all over for pension’s tax relief?

In previous years, changes to pension tax relief tended to apply only to new levels of contribution and have almost always favoured Contractors that have invested regularly .The most recent example of this was the pensions cap announced under Alistair Darling which saw tax relief capped on contributions over £20,000 for higher earners. However, higher rate tax payers that had been contributing regularly to a pension were able to continue benefitting from their existing rate of tax relief on pensions contributions up to the level that they had been already making. For these savvy investors, the pensions cap only applies to contributions over and above the level that they were investing at before the changes were announced.

In light of this, we urge Contractors that are not already investing regular monthly or quarterly contributions into a pension to start doing so now. This may protect you from costly tax relief restrictions in the future and ensure that you can continue to take transfer funds from contract to personal hands as tax efficiently as possible.

On a more positive note, the Coalition is set to abolish the current 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.

National Insurance – Have the Tories gone back on their word?

The dreaded National Insurance hike that may have lost Labour the election has reared its ugly head again under the new Coalition Government. The 1% increase is set to come in to force in April 2011 and could cost the average worker £167 a year, with higher earning Contractors working via the Danbro Umbrella 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 whilst even lower earners could pay an additional £234 and plans to potentially back track and force through an increase in employers NI after all could similarly increase the tax take. This will make salary sacrifice an even more appealing option for Contractors as the potential tax savings will increase.

For those of you caught by IR35 and operating via one man ltd companies or working via our Umbrella, there is some good news as the full increase in NI will probably not now apply to employers. This will be a relief as you would have 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.

Buy to Let and investments to be hit by higher CGT?

In order to pay for Nick Clegg’s income tax break for low to medium income workers, the Tories have reportedly had to compromise on Capital Gains Tax which now looks set to increase substantially. This could cause a rush to sell second properties and investments before the new limit comes in to play so Freelancers need to keep their wits about them over the coming months.

There is likely to be an increase in Capital Gains Tax from 18% to 40% and the tax may soon be payable on profits far below the current £10,100 annual limit. . Industry insiders believe that the higher rate of CGT will come in to play in April 2011, whilst some are even speculating that it will begin immediately following the budget announcement. Rather worryingly, there are even concerns that the CGT increase may be back dated to the beginning of this tax year, although this seems unlikely.

The CGT increase is likely to apply to ‘non-business’ assets such as second homes and investment shares in a bid to reduce the Governments budget deficit. If you own a second property then you need to tread carefully as any changes to the CGT rate may seriously affect your overall returns. This will hit Contractors that invested in property to fund retirement as you could now face up to 50% tax on your ‘property pension’.

Contractors that are concerned about the impact of this 40-50% tax on your investment should consider investing in a pension as an alternative method of funding your retirement. Unlike second properties and other investments, pensions are not subject to CGT at any time and can represent a tax efficient way of taking your contractor income out of your ltd company or the Umbrella. You can use our salary sacrifice arrangement to save up to 48% tax as we pay into your pension on your behalf before income tax or national income are deducted. Helping you save tax now, whilst investing in your future.

To benefit from our exclusive Contractor rates call on 01253 600140 or email chris.james@danbro.co.uk.