Freelance Pension Tax Deductible?

David333

This is my first year self-employed freelance. If my personal tax allowance is £12,500, and I earn £13,500, can I pay £1000 as a one-off payment into an already open Nest pension and therefore owe HMRC nothing at the end of the tax year? Or am I missing something?

Dazed_and_C0nfused

David333 said:

This is my first year self-employed freelance. If my personal tax allowance is £12,500, and I earn £13,500, can I pay £1000 as a one-off payment into an already open Nest pension and therefore owe HMRC nothing at the end of the tax year? Or am I missing something?

Yes.

Nest operate the relief at source method so if you pay them £1,000 it won't save you any income tax at all.  

But they will add £250 to your (net) contribution giving you a pension fund of £1,250.

If your only taxable income is £13,500 your tax liability will be £186 so what's happening is actually better for you overall despite having to pay HMRC £186.

Note Personal Allowance is £12,570 (assuming you haven't applied for Marriage Allowance).

And I'm assuming the £13,500 is your profit, not turnover.

David333

Dazed_and_C0nfused said:

David333 said:

This is my first year self-employed freelance. If my personal tax allowance is £12,500, and I earn £13,500, can I pay £1000 as a one-off payment into an already open Nest pension and therefore owe HMRC nothing at the end of the tax year? Or am I missing something?

Yes.

Nest operate the relief at source method so if you pay them £1,000 it won't save you any income tax at all.  

But they will add £250 to your (net) contribution giving you a pension fund of £1,250.

If your only taxable income is £13,500 your tax liability will be £186 so what's happening is actually better for you overall despite having to pay HMRC £186.

Note Personal Allowance is £12,570 (assuming you haven't applied for Marriage Allowance).

And I'm assuming the £13,500 is your profit, not turnover.

Thank you so much for this reply, which really helps, but raises more questions! I was just using simple figures to try to think this through. And, yeah, I meant profit rather than turnover, although I do freelance academic-type stuff, so I don't really have expenses; hence, the two figures will be the same (possibly simplified expenses for working from home).

I understand the pension now and that I will be better off. I also have a USS pension, but, since leaving my former employer, I'm assuming I can't pay into it any more, and, in any case, it wouldn't be that different from NEST.

What I don't understand is the £186 figure. Isn't my tax liability 20% on the £1000 and 6% national insurance? Therefore, £260. Plus--and, to be honest, this is my real worry--payments on account, which is half of that again. So I will owe HMRC £390 for every £1000 I make in profit over my personal allowance?

Dazed_and_C0nfused

You might want to read up on the Trading Allowance.  It's an alternative to claiming actual expenses (when the expenses are small).

I was only looking at the tax, you could have Class 2 and Class 4 to pay.

£13,500 - PA £12,570 = £930
£930 x 20% = £186

POA only come into play once your liability (excluding Class 2 NIC) reaches £1,000.

So if you have say £300 to pay for 2023-24 then you wouldn't have any POA due for 2024-25.  And liability for 2024-25, even if it was above £1,000, would be payable in full on 31 January 2026.

David333

Dazed_and_C0nfused said:

You might want to read up on the Trading Allowance.  It's an alternative to claiming actual expenses (when the expenses are small).

I was only looking at the tax, you could have Class 2 and Class 4 to pay.

£13,500 - PA £12,570 = £930
£930 x 20% = £186

POA only come into play once your liability (excluding Class 2 NIC) reaches £1,000.

So if you have say £300 to pay for 2023-24 then you wouldn't have any POA due for 2024-25.  And liability for 2024-25, even if it was above £1,000, would be payable in full on 31 January 2026.

Thank you. I'll look into Trading Allowance.

I assume that I'll have to pay Class 4 NIC (I'm expecting to earn a few thousand over the personal allowance this year), unless I've misunderstood something there.

That's really helpful on POA. If it excludes NIC contributions, then I'd have to earn £17,570 (which would be a payment to the HMRC of £1,300, which would be £300 towards NIC and £1000 towards income tax) before POA came into play. In effect, if I earnt £17,569, I would pay £1,300 and if I earnt £17,571 I would pay £1,950 (this year + half of next year).

[Edit: I misread your point regarding POA liability. It concerns all tax liability above £1000, so Class 4 NICs at 6% and tax at 20%. As a result, the figure would be around £16,420 that I could earn before POA comes into effect, I think]

Bookworm105

David333 said:

That's really helpful on POA. If it excludes NIC contributions, then I'd have to earn £17,570 (which would be a payment to the HMRC of £1,300, which would be £300 towards NIC and £1000 towards income tax) before POA came into play. In effect, if I earnt £17,569, I would pay £1,300 and if I earnt £17,571 I would pay £1,950 (this year + half of next year).

[Edit: I misread your point regarding POA liability. It concerns all tax liability above £1000, so Class 4 NICs at 6% and tax at 20%. As a result, the figure would be around £16,420 that I could earn before POA comes into effect, I think]

POA applies when your total of income tax + NI Class 4 is >£1,000
Using the rates for 24/25 tax yr (ie 6% C4 NI) and I have also included the trading allowance to show how it works and, crucially, I have assumed you have no other sources of taxable income outside of your SE activity

SE turnover 17,570
deduct trading allowance -1,000
SE profits = 16,570
deduct PA - 12,570
net taxable income (profit) TY 24/25 = 4,000

Income tax (20%) = £800
Class 4 NI (6%) = 240
Total tax bill = 1,040 (that is >£1k so POA would be triggered)_ 
(as this is for 24/25 tax year there would be no Class 2 NI payable unless you voluntarily choose to pay it )

Payments and dates 
6 April 25 - TY 24/25 ends with final tax liability 1,040 calculated 
31 Jan 26 £1,040 (payment in full for TY 24/25 liability) PLUS first POA in respect of 25/26 liability (£1,040/2 = £520), so total payable £1,560
31 Jul 26 second POA  in respect of 25/26 liability £520

31 Jan 27 amount due for TY 25/26 liability per the tax return calculation less POA to date (520+520) = a + or - amount
if +ve then you must pay it as a "balancing charge"
if -ve then you get a tax refund
obviously you would also have to make a POA at 31 Jan 27 in respect of 26/27 TY 

In terms of appreciating what "on account" actually means in cashflow terms

1. The £520 payment you make on 31 Jan 26 is approx 2 months before the end of the 25/26 TY in which the money being taxed was earned. So at that date you have had approx 9/12 of your annual earnings, but pay tax on only 6/12 of an estimate of what tax may be if the previous year was anything to go by.
2. The £520 payment you make on 31 Jul 26 is approx 3 months after the end of the 26/26 TY in which the money was earned. So you pay the other 6/12 tax some 3 months after you have earned all 12 months income.
3. You then have a further 7 months to 31 Jan 27 before your final actual tax amount due is liable (if a balancing charge then it is 7 months after you earned the income on which the final tax bill is based.)

Compare that to a PAYE person who "loses" money to tax every time they get paid. The downside is of course the bad behaving SE person ends up spending all the money rather than remembering to keep some back to pay the tax due on what they have earned many months previously.

David333

Bookworm105 said:

David333 said:

That's really helpful on POA. If it excludes NIC contributions, then I'd have to earn £17,570 (which would be a payment to the HMRC of £1,300, which would be £300 towards NIC and £1000 towards income tax) before POA came into play. In effect, if I earnt £17,569, I would pay £1,300 and if I earnt £17,571 I would pay £1,950 (this year + half of next year).

[Edit: I misread your point regarding POA liability. It concerns all tax liability above £1000, so Class 4 NICs at 6% and tax at 20%. As a result, the figure would be around £16,420 that I could earn before POA comes into effect, I think]

POA applies when your total of income tax + NI Class 4 is >£1,000
Using the rates for 24/25 tax yr (ie 6% C4 NI) and I have also included the trading allowance to show how it works and, crucially, I have assumed you have no other sources of taxable income outside of your SE activity

SE turnover 17,570
deduct trading allowing -1,000
SE profits = 16,750
deduct PA - 12,570
net taxable income (profit) TY 24/25 = 4,000

Income tax (20%) = £800
Class 4 NI (6%) = 240
Total tax bill = 1,040 (that is >£1k so POA would be triggered)_ 
(as this is for 24/25 tax year and your profits are > £6,725 there would be no Class 2 NI payable)

Payments and dates 
31 Jan 26 £1,040 (payment in full for TY 24/25 liability) PLUS first POA in respect of 25/26 liability (£1,040/2 = £520), so total payable £1,560
31 Jul 26 second POA  in respect of 25/26 liability £520

31 Jan 27 amount due for TY 25/26 liability per the tax return calculation less POA to date (520+520) = a + or - amount
if +ve then you must pay it as a "balancing charge"
if -ve then you get a tax refund
obviously you would also have to make a POA at 31 Jan 27 in respect of 26/27 TY 


note that 25/26 tax year ended on 5 April 26, so your first POA in respect of that TY is made approx. 2 months before the end of the TY to which it relates. The second POA is thus made 3 months after the end of the TY to which it relates. You then have a further 9 months until Jan 27 to calculate the actual liability for 25/26 and pay it - hence the Jan 27 payment date settles up the actual liability as the POA results in either having overpaid it (refund) or underpaid it (balancing payment due) but also then means you will be on your next round of POA related to 26/27 TY 

Thank you so much. This is fantastic and really helpful. It demonstrates that I haven't understood two things.

First, I'd thought that POA was half of the current tax liability, but it seems that it's the entirety made at two different times. I'm hoping to be back in PAYE in the 25-26 tax year, with this year being my only one in self-employment, which is why POA so concerns me. Just to confirm: if my SE turnover was £17,000, using the rest of your figures above, I wouldn't be liable for any POA?

Secondly, I hadn't looked into trading allowing at all. This morning, I had a quick look and because I have minimal expenses I assumed that I would claim simplified expenses for working at home at the flat rate of £26 a month (£312 a year). Above, you seem to suggest that I can just automatically get (ticking a box on the self assessment form?) £1000?

Thanks again for all of the information and help!

Bookworm105

David333 said:

Bookworm105 said:

David333 said:

That's really helpful on POA. If it excludes NIC contributions, then I'd have to earn £17,570 (which would be a payment to the HMRC of £1,300, which would be £300 towards NIC and £1000 towards income tax) before POA came into play. In effect, if I earnt £17,569, I would pay £1,300 and if I earnt £17,571 I would pay £1,950 (this year + half of next year).

[Edit: I misread your point regarding POA liability. It concerns all tax liability above £1000, so Class 4 NICs at 6% and tax at 20%. As a result, the figure would be around £16,420 that I could earn before POA comes into effect, I think]

POA applies when your total of income tax + NI Class 4 is >£1,000
Using the rates for 24/25 tax yr (ie 6% C4 NI) and I have also included the trading allowance to show how it works and, crucially, I have assumed you have no other sources of taxable income outside of your SE activity

SE turnover 17,570
deduct trading allowing -1,000
SE profits = 16,750
deduct PA - 12,570
net taxable income (profit) TY 24/25 = 4,000

Income tax (20%) = £800
Class 4 NI (6%) = 240
Total tax bill = 1,040 (that is >£1k so POA would be triggered)_ 
(as this is for 24/25 tax year and your profits are > £6,725 there would be no Class 2 NI payable)

Payments and dates 
31 Jan 26 £1,040 (payment in full for TY 24/25 liability) PLUS first POA in respect of 25/26 liability (£1,040/2 = £520), so total payable £1,560
31 Jul 26 second POA  in respect of 25/26 liability £520

31 Jan 27 amount due for TY 25/26 liability per the tax return calculation less POA to date (520+520) = a + or - amount
if +ve then you must pay it as a "balancing charge"
if -ve then you get a tax refund
obviously you would also have to make a POA at 31 Jan 27 in respect of 26/27 TY 


note that 25/26 tax year ended on 5 April 26, so your first POA in respect of that TY is made approx. 2 months before the end of the TY to which it relates. The second POA is thus made 3 months after the end of the TY to which it relates. You then have a further 9 months until Jan 27 to calculate the actual liability for 25/26 and pay it - hence the Jan 27 payment date settles up the actual liability as the POA results in either having overpaid it (refund) or underpaid it (balancing payment due) but also then means you will be on your next round of POA related to 26/27 TY 

Thank you so much. This is fantastic and really helpful. It demonstrates that I haven't understood two things.

First, I'd thought that POA was half of the current tax liability, but it seems that it's the entirety made at two different times. I'm hoping to be back in PAYE in the 25-26 tax year, with this year being my only one in self-employment, which is why POA so concerns me. Just to confirm: if my SE turnover was £17,000, using the rest of your figures above, I wouldn't be liable for any POA?

Secondly, I hadn't looked into trading allowing at all. This morning, I had a quick look and because I have minimal expenses I assumed that I would claim simplified expenses for working at home at the flat rate of £26 a month (£312 a year). Above, you seem to suggest that I can just automatically get (ticking a box on the self assessment form?) £1000?

Thanks again for all of the information and help!

POA is calculated with reference to the "most recent confirmed" information available to HMRC at the time, that means it is based on the previous years actual tax return. So in the first year there is always a delay because the POA will not be calculated until the full year's tax return becomes actually due, which technically means 31 Jan in the year after the end of the tax year, hence 24/25 is due Jan 26. So in reality:
- 24/25 first year of trading, no POA, 
- 25/26 2nd yr trading with POA based on Yr 1 24/25 actuals
- 26/27 3rd yr trading with POA based on Yr 2 25/26 actuals
- et seq

In your case therefore where you expect to end your SE and revert to PAYE, you can ask HMRC to reduce or stop (or increase) the POA if the year to which it is paying towards won't have any non PAYE anyway or your SE profits significantly vary year on year.

Understand your Self Assessment tax bill: Payments on account - GOV.UK (www.gov.uk)

re expenses, you seem to have grasped that profit = turnover - (allowable!) costs
in your case you seem to have very few costs, so as others have mentioned if your actual costs are less than £1,000 it is a no brainer to claim the trading allowance instead as 17,000 - 312 is more net taxable profit than 17,000 - 1,000 !!

Tax-free allowances on property and trading income - GOV.UK (www.gov.uk)

Bookworm105

PS I made a mistake in the example re NI 

As the example ends with taxable net profit of £4,000 that is BELOW the Class 2 threshold of 6,275 so you would NOT be given an automatic "credit" towards your NI based state "benefits", most importantly your state pension.

Please consider carefully if you are at an age where a gap in your pension history will have an impact on your state pension entitlement, if it does, then as a SE person you can voluntarily pay Class 2 NI to buy a full year. To do that you tick the relevant box on the tax return and pay £179.40 on top of your tax return to buy 24/25 at the 24/25 TY rate
Rates and allowances: National Insurance contributions - GOV.UK (www.gov.uk)

As it appears you expect to return to PAYE work and therefore a company pension of some sort a state pension "qualifying year" gap may not be too significant to you at this stage, but make sure you understand your position so you make an informed choice of whether to voluntarily pay Class 2 or not.
There are time limits beyond which it is not possible to make up gaps by paying NI retrospectively (or it gets more expensive to do so as you are forced to pay Class 3 instead of Class 2)

You can easily check gaps here:
Check your National Insurance record - GOV.UK (www.gov.uk)

David333

Bookworm105 said:

PS I made a mistake in the example re NI 

As the example ends with taxable net profit of £4,000 that is BELOW the Class 2 threshold of 6,275 so you would NOT be given an automatic "credit" towards your NI based state "benefits", most importantly your state pension.

Please consider carefully if you are at an age where a gap in your pension history will have an impact on your state pension entitlement, if it does, then as a SE person you can voluntarily pay Class 2 NI to buy a full year. To do that you tick the relevant box on the tax return and pay £179.40 on top of your tax return to buy 24/25 at the 24/25 TY rate
Rates and allowances: National Insurance contributions - GOV.UK (www.gov.uk)

As it appears you expect to return to PAYE work and therefore a company pension of some sort a state pension "qualifying year" gap may not be too significant to you at this stage, but make sure you understand your position so you make an informed choice of whether to voluntarily pay Class 2 or not.
There are time limits beyond which it is not possible to make up gaps by paying NI retrospectively (or it gets more expensive to do so as you are forced to pay Class 3 instead of Class 2)

You can easily check gaps here:
Check your National Insurance record - GOV.UK (www.gov.uk)

Thanks again. I hadn't realised that NICs are based on taxable profit, not just profit (in my defence, that first link you sent doesn't include the word 'taxable' anywhere on the page, so I don't think HMRC are clear!). I'm going to have to go back to my spreadsheets and work out what that means. I think I'll almost certainly earn around £15,000. I have about 22 qualifying years towards my pension, having been working since about 15, and I have time to get the rest, so I'm not too worried, but I might do it for since I won't be paying any Class 4 (although some websites suggest Class 4 are paid on profits not taxable profits!).

I agree on trading allowance, and that sounds fantastic.

I actually registered as self-employed in the 23-24 tax year, but I haven't sent in my self-assessment yet. I earnt very little. I'll try to get my head around POA!

Bookworm105

David333 said:

Thanks again. I hadn't realised that NICs are based on taxable profit, not just profit (in my defence, that first link you sent doesn't include the word 'taxable' anywhere on the page, so I don't think HMRC are clear!). 

to be fair, many people may have income from a mix of employment and SE so it would be misleading to end up up with people doing the tax calculation on each source individually and thinking they get individual allowances. In your case, because your only (apparent) source of income is SE I decided to be pedantic over profit and taxable profit to ram home how your PA would be "used up" as you have no other source of income before reaching the taxable total
.
sadly of course people these days want instant answers, not "learnings", so most online calculators give a single figure answer and don't expect people to want to understand how it came about or even worse recognise they may have a mix of income sources.

Differentiating between profit and taxable profit has real meaning when it comes to understanding your business performance as allowances can mask a poorly performing business. I have a friend who is getting huge amounts of research tax credit but has never sold anything to a customer - is that a viable business once the research credit dries up ?

Look at this example National insurance calculator - Which?
15,000 "profit" into the calculator gives £145.80 NI payable
That is the figure people want to know so everything else is hidden 
Now work it out manually so you understand what is going on....
15,000 "profit" - 12,570 PA = 2,430 taxable profit @ 6% C4 NI = 145.80

HMRC calculator is even worse as it only allows a weekly or monthly "profit" to be entered which almost by definition will never be correct as self employed income month on month is rarely stable.
Estimate your Self Assessment tax bill if you're self-employed - GOV.UK (www.gov.uk)
£1,250 pm "profit" (ie, 15,000 pa) = 145.80 NI annual answer