Self employed, Sipp and higher rate tax

NannaH

My husband is going self employed and is likely to become a higher rate tax payer,  projected earnings around £70k after his first year,  he’s always avoided this by paying extra into a workplace pension but this obviously changes with self employment,  he will be a sole trader and will probably do contracting work too , (gas heating engineer).

I understand that he will get 20% tax relief added automatically into his SIPP and then will claim the additional 20% back via self assessment -  is that on all his Sipp contributions?  
 Say he puts £10k into it,  that’s £2500 into Sipp plus £2500 off his Tax bill?  Or does he get a refund of £2500 at some point after paying his tax bill?  How exactly does it work? 

Marcon

NannaH said:

My husband is going self employed and is likely to become a higher rate tax payer,  projected earnings around £70k after his first year,  he’s always avoided this by paying extra into a workplace pension but this obviously changes with self employment,  he will be a sole trader and will probably do contracting work too , (gas heating engineer).

I understand that he will get 20% tax relief added automatically into his SIPP and then will claim the additional 20% back via self assessment -  is that on all his Sipp contributions?  
 Say he puts £10k into it,  that’s £2500 into Sipp plus £2500 off his Tax bill?  Or does he get a refund of £2500 at some point after paying his tax bill?  How exactly does it work? 

His contributions will be based on profits, not earnings, which could be lower.

The SIPP provider will reclaim tax automatically at basic rate on contributions up to his permitted maximum (lower of profits/£40K in the tax year in question).

He then claims any higher rate relief through self assessment (or he can reclaim earlier in the tax year by contacting HMRC).

He can only reclaim higher rate tax relief to the extent he's paid higher rate tax in the first place i.e. if higher rate is only payable on, say, £100 of earnings, then higher rate relief can only be claimed on £100 of SIPP contributions.

If he looks on his SIPP provider's website, all this will be explained. Also useful reading: https://www.moneyhelper.org.uk/en/pensions-and-retirement/pensions-basics/pensions-for-self-employed-people

Dazed_and_C0nfused

NannaH said:

My husband is going self employed and is likely to become a higher rate tax payer,  projected earnings around £70k after his first year,  he’s always avoided this by paying extra into a workplace pension but this obviously changes with self employment,  he will be a sole trader and will probably do contracting work too , (gas heating engineer).

I understand that he will get 20% tax relief added automatically into his SIPP and then will claim the additional 20% back via self assessment -  is that on all his Sipp contributions?  
 Say he puts £10k into it,  that’s £2500 into Sipp plus £2500 off his Tax bill?  Or does he get a refund of £2500 at some point after paying his tax bill?  How exactly does it work? 

There is no fixed extra 20%.

The pension company will add the basic rate relief to his pension fund and the gross contribution. (£12,500 using your example) increases his basic rate band so he can pay more 20% tax and less 40% and have a smaller Self Assessment liability.

The exact personal tax saving depends on his overall tax position.  It could be an extra 20%.  Or more than that.  Or less.

AIUI there is no mechanism for someone who is self employed to get higher rate relief in year, it forms part of his Self Assessment calculation when he submits his tax return.

If he has PAYE income alongside his self employment and pays higher rate tax on his PAYE income then he can get some provisional relief via his tax code but that doesn't alter the fact that the final position is resolved via his tax return.

NannaH

Yes, when I said earnings I meant taxable income. 

So the extra Tax relief means a reduction in his tax bill rather than a refund?   So if his income for the 23/24 tax year is, say £63000 and he pays £10k net /£12500 gross into his sipp, will he will get the full amount of extra tax relief on £12500 which is £2500?  

So instead of owing £12600 in tax, it will be £10100?  

Dazed_and_C0nfused

NannaH said:

Yes, when I said earnings I meant taxable income. 

So the extra Tax relief means a reduction in his tax bill rather than a refund?   So if his income for the 23/24 tax year is, say £63000 and he pays £10k net /£12500 gross into his sipp, will he will get the full amount of extra tax relief on £12500 which is £2500?  

So instead of owing £12600 in tax, it will be £10100?  

Yes, someone who is self employed earning that level of income will see the benefit via a smaller Self Assessment liability.

On those figures it probably would save £2,500 in personal tax (£12,500 taxed at 20% rather than 40%).

But it doesn't take much for that to change, additional allowances available against PAYE income (WFH or uniform cleaning say) might mean he isn't normally liable to 40% tax on that much.

Conversely he might save more if High Income Child Benefit Charge is a factor.

NannaH

He may well have PAYE income via contracting work on top of his self employment but it would be less than £25k, it would be two days a week maximum. 
Sounds like a tax accountant might be a good idea rather than me doing his self assessment when it gets to that income point as I have no idea whether his PAYE income would use up all his tax free allowance or his Self employed income would or if it even matters. 

Dazed_and_C0nfused

NannaH said:

He may well have PAYE income via contracting work on top of his self employment but it would be less than £25k, it would be two days a week maximum. 
Sounds like a tax accountant might be a good idea rather than me doing his self assessment when it gets to that income point as I have no idea whether his PAYE income would use up all his tax free allowance or his Self employed income would or if it even matters. 

It doesn't really matter.  Some people would prefer to pay basic rate tax on all their PAYE income so they have less to pay through Self Assessment.

Others would prefer to pay as little as possible during the year and pay more via Self Assessment.  It's more money in his account for longer, you just need to be disciplined enough not to spend it all before the Self Assessment needs to be paid 😄

A good accountant is a sensible thing to do.  They could easily save you more in tax than their bill.

dunstonh

My husband is going self employed and is likely to become a higher rate tax payer,  projected earnings around £70k after his first year,  

With that level of income has he considered going limited company instead of sole trader?  
Limited company gives more control over how you take your income.   Its better for pension contributions and overall retirement/succession planning and has reduced liability.  Plus, it has a small financial benefit due to slightly lower taxation than self employed (not what it used to be but still favourable)

NannaH

He considered the ltd. Company route but thought the financial ‘perks’  weren’t worth it any more. In what way is is better for pension contributions?  

He will also receive a forces pension of £6k per annum from 2025 so that will go straight into his SIPP.  
His financial liability shouldn’t be an issue,  he will be doing domestic gas boiler servicing and the odd installation,  for which he will need public liability insurance by law.   He won’t be at risk of not being paid by companies/third parties and he won’t need to keep expensive stock, nor does he need premises. 
He will also keep under the VAT registration limit.  

It does sound like he should talk to someone regarding how he sets himself up - he will employ me as a book keeper, appointment maker etc.  which will also reduce his tax bill. 

Grumpy_chap

If he employs you as well, it may be pertinent for there to be some pension contributions in your name.  That could reduce your future joint taxation.

Also, check whether the forces pension will restrict future pension contributions.

If he expects to earn £70k after allowable expenses, he may have gross turnover exceeding the VAT registration threshold.

Definitely worth engaging an Accountant to advise.

If it were me, I'd go Ltd Co.  No guarantee that is the best solution.

dunstonh

He considered the ltd. Company route but thought the financial ‘perks’  weren’t worth it any more.

It is still better than self employed if you earn over 35k. Plus, you can control when you get paid and if there is an excess in the company at retirement, it can be drawn over multiple years to reduce the tax bill or use reliefs.

On £70k of gross profit, a sole trader would pay £15,432 income tax and £4737.85 NI giving a net income fo £49,830.15

If a limited company, to get that same net income you would pay £5,306.86 into the pension as an employer contribution, £9,950.41 corp tax.  £421.55 NI and £4491.02 personal tax resulting in £49,830.15 net income.  (based on £11901 salary which is optimal for 22/23 tax year and dividends on the rest.. England/Wales taxpayer).   

So, to get the same net income, a limited company could have a "free" pension contribution of £5306.86

In what way is is better for pension contributions?  

Pension contributions can be paid by the limited company.  This reduces corporation tax.  It means you get money out of the company with no personal taxation.  That then leaves the personal allowance and basic rate bands available for more income to be taken without hitting higher rate.

He will also receive a forces pension of £6k per annum from 2025 so that will go straight into his SIPP.  

Not the best way if he has a limited company.   In that scenario, he would draw  less from the company and pay more into the pension via the company.  

His financial liability shouldn’t be an issue,  he will be doing domestic gas boiler servicing and the odd installation,  for which he will need public liability insurance by law.  

What about when he stops work but remains liable for potential issues many years down the road?

It does sound like he should talk to someone regarding how he sets himself up - he will employ me as a book keeper, appointment maker etc.  which will also reduce his tax bill. 

If he employs you to do those things, you will be captured under the auto-enrolment rules.  Whereas if you become a shareholding director on the company, you can share the profits between you and use up both of your basic rate bands and you don't get captured by auto-enrolment.  The tax savings will be cheaper than an employee basis or partnership basis.