“How much should I pay into my pension?”
It’s a common question from freelancers and contractors, especially because when you’re self-employed, you value financial flexibility. Yes, you want to plan for retirement, but you also don’t want to lock away so much that day-to-day life and business management become tricky.
This article explains pension allowances and how they work on a practical level, to help you decide how much to pay into your pension scheme.
Personal pension contribution limits
Personal contributions are when you pay into a pension from the post-tax income in your bank account. In theory, you can contribute any amount, but you only get tax relief on contributions up to your salary or £40,000, whichever is lower. This is called your annual pension allowance. There are some exceptions. If your income is over £150,000, you have a smaller pension allowance. And if you earn £0- £3,600, your limit is £3,600 (including tax relief – more on that below).
Remember that your limit is based on your salary only, not salary + dividend. So if you’re paying yourself the minimum salary of around £8,000 per year, you can only get tax relief for up to £8,000 of personal contributions. If you contribute more than this, you pay a charge in line with your income tax rate.
How tax relief works
Pension tax relief is equivalent to 20% of the total contribution; if you’re a higher rate taxpayer, you can claim an additional 20% or 25%. You get it in one of two ways: as extra money in your pot for when you retire (the most common) or as a tax reduction now.
So if you’re a basic rate taxpayer, this is how it works:
| Personal contribution | £800 |
| Tax top-up from HMRC | £200 |
| Total amount that goes into your pension | £1,000 |
Carrying forward your pension allowance
If you haven’t used all your annual allowance in a given year, you can carry it forward for 3 tax years in certain circumstances. This is handy if you’re self-employed, your income fluctuates year to year and you want to save for a big contribution.
Limited company pension contributions limits
Allowances only apply to personal contributions. If you make pension contributions from your limited company, there are no salary restrictions. This means you can pay in up to a maximum of £40,000, annually.
You therefore have more choice in how to save for your retirement if you have a low salary. Plus, with the contributions coming from the limited company, you can class the contributions as business expenses. This will reduce the amount of corporation tax you have to pay (by up to 19%).
In addition, you don’t have to pay employer’s National Insurance on the contributions, which saves you up to 13.8% compared to paying yourself the same amount as salary.
Auto-enrolment pensions and Salary Exchange are set up and taken care of for you.
Getting started with pension contributions
For most sole directors, contributing from the limited company is a great way to save for retirement. You get more flexibility around your pension allowance and you secure more tax advantages.