Contractors working through their own one-person or husband-and-wife contractor limited companies won’t be forced to operate a state-run pension scheme, following the latest pension reforms announced by the Department of Work and Pensions. Umbrella companies will have to run such a scheme, but the contractors they employ will be able to opt out.
This is according to an expert independent financial adviser (IFA). He explains: “Limited company contractors who pay themselves a salary below the National Employment Savings Trust (NEST) threshold, or have alternative approved pension plans in place, won’t be required to put in place this new pension. But contractor umbrella companies have until August 2014 to provide contractor clients with a scheme.”
All firms, including umbrella companies and contractor limited companies, will be covered by the rules from August 2014. The IFA feels the reforms are broadly positive, ensuring that all contractors start to make private financial provision for their retirement, as the state will be increasingly unable to provide anything other than a basic financial safety net in old age.
Latest pension reforms
By October 2012 organisations employing more than 120,000 employees will have to have begun contributing to a pension scheme. This currently excludes contractors and contractor service providers, as even the largest umbrella solutions providers fall short of the initial threshold.
“The new rules mean that employers will be obliged to fund a pension scheme for their employees and will be required to make contributions of what will ultimately be 3% of a worker’s salary,” continues the IFA expert. “Employees have a three-month qualifying period and must be earning over the threshold of £7,475. Even then, the employee can choose to opt out.”
If an employee does not opt out, they must make contributions of 4% of their gross earnings, and the state will contribute an extra 1%, making a total of 8% with the employer’s contributions. Initially, though, the rate will be 1% from each contributor when the rules come into force, rising to the full 8% by 2017.
Limited company contractors can simply choose to pay themselves a salary below the threshold. This is already common practice for many, who pay themselves a lower salary and then draw dividends paid from company profits.
For limited company contractors inside IR35 or paying themselves a salary above the threshold, they can choose to opt out, join a private pension scheme or join the NEST scheme.
Choosing the right scheme: contractors and umbrellas don’t have to choose NEST
“2012 sees the rollout of the National Employment Savings Trust (NEST), which was introduced earlier this year by the then Labour government,” says the IFA expert. “However, under the terms of the deal struck between government and the private sector scheme provider, the provider can recoup its start-up costs by deducting 2% of all early contributions made by UK workers joining the scheme.”
The IFA expert explains that the start-up costs make NEST an unattractive option for pension savers, as few private pension plans charge investors start-up fees at all. He adds that NEST is particularly unfair on those joining early, because it reduces the value of those early contributions that have the greatest potential to grow in value.
Employees have a three-month qualifying period and must be earning over the threshold of £7,475
IFA expert
“Contractors and umbrella companies can choose between NEST and a private NEST-equivalent scheme, so it is possible to invest in a pension pot that is not front-loaded with high start-up costs.”
The IFA expert also warns contractors, and umbrella companies seeking a pension solution for their contractor clients, that the organisation behind NEST is not quick to respond to questions about how the scheme runs. “We tried calling, but NEST only responds to website enquiries. We have submitted a straightforward enquiry about start dates, which remains unanswered. That doesn’t bode well for more complex enquiries.”
Implications for umbrella companies and umbrella contractors
Although limited company contractors will remain largely unaffected, umbrella company contractors who choose to opt in will be required to contribute 7% of their salary to a pension scheme.
Why such a high figure? Th IFA expert explains: “In an umbrella company, it is the contractor who will ultimately have to fund the 3% employer’s contribution, which means their overall contribution will total 7%. That alone may persuade many umbrella company contractors to exercise the opt out of the scheme.”
The IFA expert says many umbrella companies are already seeking a private pension alternative to NEST, so that their contractors won’t be forced to subsidise the start-up costs of the private sector provider behind NEST. And, he says, umbrella companies are also looking for more flexible private plans over which they and employees can have greater control.
“Behind all of these changes is the recognition by the coalition government that the state won’t be able to provide as generously for future generations in their retirement as it has done in the past,” says the IFA expert. “These latest rules could be what prompts many contractors without any private pension arrangement to take action now and contact an independent financial adviser, because contributions made early in a contractor’s career can have a greater chance to grow and ultimately provide for a much more comfortable retirement.”