Posted Pensions and remuneration byin
Directors and employees should take independent financial advice before making any decisions around pensions. When looking at pensions you are looking at cash flows usually years into the future and need to deal with professionals who are qualified to give advice in this area (we are not so qualified and the opinions, comments and views expressed in this article are not to be relied upon by the reader).
So, what is the lay of the land around pensions and pay? Well, it is very complex (like taxes). Let us illustrate how it works with reference to a 30 year old male, called Fred, who is just about to start contracting for the rest of his career using a personal service limited company. He is the sole director and shareholder of the company and wants to “optimise” his remuneration to retain the maximum benefit to state pension benefits, if indeed, that has meaning and is possible.
What do we know about state pensions?
(a) The current maximum state basic pension is £113 per week (~£5,900 pa) and any NI contributions may also contribute to an additional earnings related pension, called the second state pension or S2P (which replaced SERPS) if you have not “opted out”. [I told you it was complicated!].
(b) We will be ignoring the additional state pensions calculation as it is fiendishly opaque and irrelevant for Fred as he will retire after 2016 when state additional pensions will be abolished and the only state basic pension will be a flat rate £144 per week (~£7,500 pa).
(c) To be entitled to the basic state pension Fred will need 35 qualifying years of NI contributions. Interestingly, there appears to be no minimum amount of contributions required, you just need a number of “qualifying” years.
(d) The current rates of NI contribution are 12% for the employee and 13.8% for the employer above £153 per week of earnings. These rates kick in from the first £ after £153/week and so in theory one can gain a qualifying year for a state basic pension by receiving pay of £111 pw (in 2013/14) and paying no NICs. Below £111pw (in 2013/14), no pension credit is earned. As an aside this is clearly much “cheaper” than the £2.75 per week (£143 pa) that self employed people pay in Class 2 NICs. From a purely financial perspective (and ignoring the time value of money), Fred can accrue the rights to a £6K pa income for nothing over 35 years.
(e) It currently costs £13.90 per week to make up for gaps in your NIC history.
(f) You can get a pensions statement from the government online by following the links at https://secure.thepensionservice.gov.uk/statepensionforecast/default.aspx
(g) Remember that Fred’s company can make contributions directly to his pension fund which are tax deductible and free of NICs. This is a very efficient way to extract value from a company.
So what is the answer to the question in the article for Fred? Well, as stated at the beginning of this article, it is a complex decision to make as it concerns cash flows both by you and the government way into the future. Will the rules change? Yes, in all likelihood. Will the government reduce the benefit? Maybe, some commentators would argue definitely. Will NIC rules change so that NIC will be charged on dividends making the whole calculation different? Quite possibly! It is a definite possibility that maybe that the answer will be different in the future. Take some advice from an IFA and/or do what you think is right for you.