Contractors: Save tax using a limited company pension

  • Are you a contractor or thinking of changing from employee to contracting?
  • Maybe you are changing from Umbrella company to your own company – seeking full control of your earnings?
  • Wondering what will your net pay may be?
  • How can you reduce your income tax?

Well here are three worked examples to illustrate your net pay could be and how you could save on tax by setting up a Limited Company, employing your spouse and using a Company Pension.

Your net salary will depend on a number of factors, the most significant being your daily fee rate earned and pension contribution.

Other factors include the level of expenses allowed and whether or not you can employ family members (e.g. to utilise tax credits and tax bands for familial staff/directors to increase your combined net pay).

In effect, any contribution to an efficiently managed company pension will reduce your tax bill by 52% of the contribution. In other words, for an effective sacrifice of €100 net pay you will have over €200 in a pension fund where growth is also tax free!

All below examples are reflective of the change from Budget 2016 to be effective from 01/01/2016 and assume that directors will be eligible to get the additional tax credit as a ‘self-employed’ person.

3 Worked Examples of How You Save Tax Using This Structure

Note the following is assumed in the examples below:

  • Assuming 46 working weeks i.e. taking 4 weeks of holidays and allowing for bank holidays
  • [In 2 examples] Assumes partner/spouse is not employed or receiving other sources of income.
  • Assumes allowable expenses @ 5% of turnover. *

*Note that payments to spouse/partner would have to be legitimate for services they provide, for example, bookkeeping, administration, company secretarial services etc.

Example 1 – You are a Project Manager on a Daily Rate of €370

  • You earn €370 x 5 days x 46 Weeks = Gross Income of €85,100, expenses @ 5% = €4,255
  • If you pay your spouse as a director and bookkeeper, say €10,000, your gross salary would be €70,845

In this example, your total Gross pay would be €70,845. With no pension contribution, you will have a tax liability of €25,421 and receive net payment of €45,424. Your spouse/partner will also receive net pay of €9,150, having paid tax of €850.

By contributing to a pension, this will reduce your tax bill by almost 50% of the contribution. Therefore a contribution of €12,000 into a pension will reduce your tax liability to €19,461. This means that your net pay is reduced by only €6,040, having contributed €12,000 to your pension fund which will also grow tax free over the life of the pension.*

Similarly, a contribution of €24,000 into a pension will reduce your tax liability by €11,900. Your net pay is reduced by only €12,100, but you now have contributed €24,000 to your pension fund which will also grow tax free over the life of the pension.*

   
GROSS PAY   70,845 70,845 70,845
Pension Contribution   0 12,000 24,000
Tax Payable   25,421 19,461 13,521
NET PAY Self 45,424 39,384 33,324
  Spouse 9,150 9,150 9,150
         
Pension Fund   0 12,000 24,000
         
Total Benefit   54,574 60,534 66,474

*Note: This would be in addition to the expenses claimed

Example 2 – You are a software engineer on a daily rate of €500

  • You earn €500 x 5 days x 46 weeks = Gross Income €115,000
  • 5% is €5,750 in Expenses
  • If you pay your spouse as a director and bookkeeper, say €10,000, your gross salary would be €99,250

In this example, your total Gross pay would be €99,250. With no pension contribution, you will have a tax liability of €40,192 and receive net payment of €59,058. Your spouse/partner will again receive net pay of €9,150, having paid tax of €850.

By contributing to a pension, this will reduce your tax bill by 52% of the contribution. Therefore a contribution of €12,000 into a pension will reduce your tax liability to €33,952. This means that your net pay is reduced by only €5,760, having contributed €12,000 to your pension fund which will also grow tax free over the life of the pension*.

You are better off by €6,240, prior to taking account of the growth of the pension fund.

Similarly, a contribution of €24,000 into a pension will reduce you your tax liability by €12,480. Your net pay is reduced by only €11,520, but you now have contributed €24,000 to your pension fund which will also grow tax free over the life of the pension*.

You are thus even better off by €12,480, prior to taking account of the growth of the pension fund.

       
GROSS PAY   99,250   99,250   99,250
Pension Contribution   0   12,000   24,000
Tax Payable   40,192   33,952   27,712
NET PAY Self 59,058   53,298   47,538
  Spouse 9,150   9,150   9,150
             
Pension Fund   0   12,000   24,000
             
Total Benefit   68,208   74,448   80,688
             

Note: This would be in addition to the allowable expenses

Example 3 – You are a Technical Architect on a Daily Rate of €1,000

  • You earn €1,000 x 5 days x 46 Weeks = Gross Income of €230,000, expenses @ 5% = €11,500
  • Gross Pay: €218,500

In this example, your total Gross pay would be €218,500. With no pension contribution, you will have a tax liability of €102,202 and receive net payment of €116,298.

By contributing to a pension, this will reduce your tax bill by 52% of the contribution. Therefore a contribution of €24,000 into a pension will reduce you your tax liability to €89,722. This means that your net pay is reduced by only €11,520 , having contributed €24,000 to your pension fund which will also grow tax free over the life of the pension*

You are better off by €12,480, prior to taking account of the growth of the pension fund.

Similarly, a contribution of €48,000 into a pension will reduce your tax liability by €24,490. Your net pay is reduced by only €23,040, but you now have contributed €48,000 to your pension fund which will also grow tax free over the life of the pension.*

You are thus even better off by €24,490, prior to taking account of the growth of the pension fund.

Note: This would be in addition to the allowable expenses

       
GROSS PAY   218,500   218,500   218,500
Pension Contribution   0   24,000   48,000
Tax Payable   102,202   89,722   77,242
NET PAY Self 116,298   104,778   93,258
             
             
Pension Fund   0   24,000   48,000
             
Total Benefit   116,298   128,778   141,258
             

Note: This would be in addition to the allowable expenses

Specialist Advice

Contact us here for specialist advice on pensions for
self employed / contractors


Information provided by Liam Burns

This guide is bought to you by Liam Burns who is a chartered tax adviser & accountant

Read more on Tax Saving Tips for Contractors in Ireland >