Tools of the trade: Pension planning for the self-employed

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Bernadette Lewis explains how allowances and tax reliefs are calculated for self-employed clients.

People working and taxed on a self-employed basis have to rely on themselves to build up their pension pots.

Complicating factors for their advisers include relevant UK earnings being less obvious than for employees, and the lack of planning opportunities using employer contributions – in contrast to people in similar situations operating through limited companies.

Self-employed people are subject to the normal lifetime and annual allowance rules, with tax relievable contributions limited to the higher of £3,600 or relevant UK earnings.

Their relevant UK earnings are based on the tax year in which the end date of their chosen accounting period falls. For example, 2017-18 relevant UK earnings could be profits for an accounting period
ending 31 December 2017 or 31 March 2018.

A 31 March end date normally means profits are calculated over the 12 months starting from 1 April, although it’s possible to have longer or shorter accounting periods and to change year end dates.

It is sometimes necessary to estimate relevant UK earnings – for example, if an accounting period ends close to 5 April. If this leads to excess relief at source contributions, most providers have to refund the non-tax relievable amount and return the tax relief to HM Revenue & Customs.

Self-employed people’s pension contributions benefit from tax relief based on the tax year in which they are paid. Personal and stakeholder pension contributions are paid net of 20% basic rate tax (relief at source).

“Making tax digital” is planned to apply to unincorporated businesses from April 2018 for those with annual turnover above the VAT threshold and April 2019 for the rest.

Meanwhile, self-employed people normally benefit from higher or additional rate tax relief claimed via self-assessment when making their balancing payment.

They currently make two income tax payments on account: on 31 January during the tax year and the next 31 July, then a balancing payment plus any capital gains tax on 31 January after the tax year. Payments on account are usually half the previous tax year’s income tax liability.

It is possible to claim reduced payments on account if it is believed this year’s tax liability will be lower than last year’s.

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Bernadette Lewis is financial planning manager at Scottish Widows