IT Contractor Pensions

As a contractor, saving for your retirement is solely down to you. That said there are a number of ways you can save for your retirement which are tax incentivized and make a lot of sense. So, it is certainly worth taking the time to consider opening your own pension plan. As any contributions you make will certainly prove their value.

Not planning for your financial future is a mistake that you simply cannot afford to make. Whilst there are organizations out there that can help you in your old age, your retirement should be a time when you can sit back and enjoy life, free from financial burden and not be chasing charities or government welfare offices.

In this guide, I have taken the time to outline all your options for IT Contractor Pensions, so you can start taking advantage of one of the few remaining tax breaks and ultimately maximize your pension pot.

Also See: Best Pension Providers

Best Pension Providers for IT Contractors in May 2023

Do Contractors Get a Pension?

Being your own boss, aka a contractor, has many perks over conventional employment but unlike employees who are automatically enrolled into their employer’s company pension with handsome pension contributions from their employer, as a contractor, the onus is on you to ensure you have adequate retirement savings.

Auto-enrolment does not apply to contractors, even if you are working through your own limited company. This means you will need to familiarize yourself with the pension options that are available, select the best one for you, and identify the optimum contribution levels to help you achieve the retirement that suits you.

Can My Limited Liability Company Pay Into My Pension?

The answer is yes, however, whether or not this is the avenue you should explore is another question. Should you decide to set up a workplace pension for yourself, from your limited company, you need to be aware that the rules vary depending on whether or not you are a sole proprietor, whether or not you have rank-and-file employees, or whether or not your business is a corporation.

The fact is that if you own an LLC you are still considered self-employed and the relative complexity of making contributions from your LLC may not be worth your while. Assuming you do not actually have any employees.

Whilst this is a perfectly acceptable way for you to pay into a pension, as a contractor working through your own limited company, its probably for the best if you decide against this. That said, if you are unsure, or if you have employees, it may be best if you consult directly with a pension planner who will be able to advise you regarding the specifics of your circumstance.

The reason most people would have for choosing this option is the great flexibility you get from a personal pension. Within the workplace pension, you and your company are forced to pay in the minimum contribution each month, regardless of any changes to your income. The other consideration is that your pension will automatically be part of a workplace scheme, giving you less choice on the investments you may wish to consider.

How Tax Treatment of Pensions Works for You

How you benefit from the tax perks and incentives that are available on SEPs will depend on your preferences and current circumstances. Ultimately, we all want to make our contractor pensions as tax efficient as possible and receive tax benefits and perks that maximize our assets. For this reason, it is worth taking a moment to discover which of these options would be best suited to your circumstances.

Tax Calculations for Contractor Pensions

Should you decide to open an SEP IRA it’s important to understand how the tax benefits work for you. If you as a self-employed person are both employer and employee then you can get a tax deduction. The most you can deduct on your business’s tax return for contributions to your SEP-IRAs is the lesser of your contributions or 25% of compensation. Simply put you can contribute up to 25% of your annual income as a self-employed individual into your SEP.

Tax Relief if Paying Through Your Limited Company

Only employers contribute to the SEP IRA plan, not employees. Technically speaking your company, as an entity in its own right, is making contributions to the IRA of an employee, assuming that you are the sole employee of your company.

As an employer you will be able to deduct payments to an SEP IRA for an employee up to set limits. SEP IRAs are funded by tax-deductible dollars and are limited to 25% of an employee’s total compensation or $58,000 (whichever is less) in 2021, rising to $61,000 in 2022.

Also another nice perk is that business owners who start up a SEP IRA may be eligible for a tax credit of up to $500 per year, though terms and conditions apply.

Whether a SEP IRA is the best choice for you will depend on you are planning for your retirement and what amount of your current finances you are willing to invest into the IRA.

Put simply If you anticipate that you could be contributing $40,000 a year within a decade into your retirement fund then the SEP IRA is likely to be the best choice for you.

Making Large One-Off Pension Contributions

As an IT contractor, you may be more comfortable making large pension contributions that sit more comfortably with your income rather than monthly contributions. Unfortunately should you make an excess payment into your SEP IRA then the Income Revenue Service, aka the IRS, will take a chunk of your money in the form of a fine. Excess contributions are included in employees’ gross income. Employees who withdraw the excess contribution (plus earnings) before the due date for their federal return, including extensions, will avoid the 6% excise tax imposed on excess SEP contributions in an IRA. Excess contributions left in the employee’s SEP-IRA after that time will be subject to the 6% tax on the employees’ IRAs, and the employer may be subject to a 10% excise tax on the excess nondeductible contributions.

Should you accidently make a contribution to the SEP-IRA that is over the contribution limit then contact the IRA immediately and see how you can correct this mistake.

Choosing the Right Time to Start a Pension

The old adage that the best time to start a pension is yesterday is right. The sooner you start saving into a pension fund, the better, however, it’s never too late to start.

New research by the Pew Charitable Trusts found that just 21.9% of nontraditional workers—defined as contingent, gig, alternative, or independent workers—participate in a workplace-based defined contribution plan. Defined contribution plans are those where employees contribute, and the employer generally matches what they put in—such as 401(k)s and 4013(b) plans. When these plans do become available to them, nontraditional workers are quick to sign up. Among those who had access to a plan, 77.5% decided to participate in it. Pew Charitable Trusts surveyed 1,000 freelancers for the research.

Whilst it is hard to come by accurate data it sadly appears to be the case that the majority of IT Contractors are currently without any retirement plan in place. Though there has been a recent push in Congress to create a new national savings plan to help those without pensions, with the proposed program modeled after the federal Thrift Savings Plan.

However, till then you are on your own and opening an IRA or similar pension plan is one of the best ways to grow your wealth, taking advantage of the government bonus, plus investments, and with the added benefit of compounding, even small pension contributions can become significant amounts over time.

Of course, the younger you are when you start saving into a pension, the less you will need to contribute monthly. The general rule of thumb is that you should half your age when you start saving, and that is the percentage of your salary that should be saved into a pension pot. Therefore a 20-year-old will only be saving 10% of their salary into their pension fund, whereas someone who starts their pension savings at 40 will need to part with 20% of their salary to achieve a similar pension pot amount when they reach retirement.

The other advantage of starting to plan for your retirement when young is that you have enough time in the market to engage with higher-risk investments. And high-risk, often means bigger returns in the long run. As a young investor time is on your side, and you have the luxury of hopefully being able to ride out any market volatility and come out on the other side. Older investors are always advised to take a more cautious approach which is often less lucrative.

Available Pensions for Self Employed People

Getting your pension scheme right the first time is an important part of the pension process. As an IT Contractor, you will have certain requirements that need to be met such as having the flexibility to contribute as much or as little as you like in line with your changing income.

The other major considerations are the fees and charges at the pension scheme you are considering. High fees can soon start to eat away at your investment gains, and the fees charged from one pension provider to another can vary in amount and structure. It’s therefore important to find a pension provider that suits your unique circumstances.

Choosing a Retirement Plan

The investment opportunities presented by each of the different schemes, and also the options within these plans that the provider will offer, are another factor that requires careful consideration. You may have certain moral or religious requirements on how you would like your money invested, or you may just be looking for funds that have performed well historically.

There is also the question of how much of an active role you would like to take in investing your money. Some pension schemes will allow you to pick and choose all your own investments, while others have more of a ‘set it and leave it’ type approach whereby your investments are managed by professionals.

Given the greater flexibility surrounding how you access your retirement pot when the time comes to, you may also want to consider what your specific plan has in place in terms of drawdown.

You should also ask yourself if you have any retirement schemes or plans already in existence. A surprising number of people have old workplace pensions that they have forgotten about, such as your first job in the local diner or mall, and which could perform better should they be consolidated into one, well-managed pension fund.

401(k)

The 401(k) is a defined contribution plan that offers contractors a quick, easy, and flexible way to save. A one-participant 401(k) plan is sometimes referred to as a “solo-401(k),” “individual 401(k)” or “uni-401(k).” Whilst very similar to the general 401(k) plans it is exempt from discrimination testing, as there are no employees.

The 401(k) lets you make annual salary deferrals up to $20,500 in 2022, ($19,500 in 2021 and in 2020; $19,000 in 2019), plus an additional $6,500 in 2022, in 2021 and in 2020 ($6,000 in 2015 – 2019) if you’re 50 or older

Savings Incentive Match Plan for Employees (SIMPLE IRA Plan)

A SIMPLE IRA is a great way of kickstarting your retirement planning, especially if you feel that perhaps yesterday is when you should have started. With a SIMPLE IRA you can put all your net earnings from self-employment in the plan: up to $14,000 in 2022 ($13,500 in 2021 and in 2020; $13,000 in 2019), plus an additional $3,000 if you’re 50 or older (in 2015 – 2022), plus either a 2% fixed contribution or a 3% matching contribution.

A self-employed 401(k), SIMPLE IRA, and SEP IRA are the main pension plans generally used by contractors. Each of them is slightly different and has its own particularities which you should make sure you understand in full before picking the one, or ones, that best meet your requirements.

Consolidating Existing Retirement Schemes

If you have been employed previously, it’s likely you have a pension plan still in existence from your old job. If you have previously had several different jobs, then you may still have several old pensions. Consolidating all these small pensions into one larger pot is a great way to save on fees and can help you manage your investments with greater efficiency.

There are two ways to effectively consolidate your pensions. A financial adviser will be able to help you locate all your old pensions and move them into one, efficient pension scheme in order to maximize your returns.

Alternatively, you can engage the services of an online pension consolidation service, such as is offered at Charles Schwab, which will help you locate all your pensions and move them across to their platform on your behalf.

Before you consider consolidating all your existing pensions, you should check the details of your old pension plans, and any associated costs you may incur by moving them all to one provider. Be aware of any final salary pensions you may have in place as these will require careful consideration.

Should You Engage the Services of a Financial Advisor?

Ensuring you have an adequate income in your retirement is critical in order to guarantee you peace of mind in your old age and one free from financial burden. A financial adviser will be able to take into account your unique circumstances, time frames, and how much you will need to enjoy a comfortable retirement. Other factors that they will also consider when dealing with you and your finances is your risk appetite, and then based on this profile will implement a robust plan in place that takes advantage of all the benefits available to you. They will recommend the best pension product for you as an individual.

The obvious downside should you decide to seek professional advice, is the associated cost. There are now online platforms that can offer you a similar service, albeit less personalized, so you can plan for your retirement yourself. Whether you decide to take financial advice is a very personal decision.

What is the Best Pension for Self Employed Contractors?

As a pension is almost always invested in order to grow your pot for your retirement, finding the best pension for you will largely depend on your investment knowledge and experience as well as how much time you can dedicate to taking care of your investments.

We also have a guide on the best pension providers for the self-employed available to read.

Therefore I have split the best providers online into two main camps – best personal pensions providers for experienced investors and best personal pension providers for ready-made funds. The latter will allow you to adopt a ‘set it and leave it’ type investment style, whereby the fund you invest in is maintained and adjusted over time in line with fluctuations to the marketplace, allowing you to take a hands-off approach.

Best Personal Pension Providers for Experienced Investors

If you feel your investment knowledge is up to the challenge of managing your own investment portfolio then I have selected the following providers, who present a simple, low-cost solution, whilst providing you with an impressive range of investment opportunities.

It is important to take into consideration the size of your pension pot when ascertaining the most cost-effective solution for you. Larger pension pots will often find a flat monthly fee a more appealing solution, whereby smaller pots will benefit more from a percentage fee.

Best personal pension providers for ready-made funds

The providers I have selected below have been picked out mainly for their ease of use, flexibility, and low-cost solution. Within these options, you can set up an account in a moment, pick the fund you feel is best suited to your investment style and or risk appetite, and leave the rest to the platform to manage.

It is important to note that whilst investing your pension pot is a necessary part of growing your wealth to provide for your retirement, as always with investments there is an element of risk to take into account and the value of your pensions can fall as well as rise. It is possible therefore that you will end up losing the money you invest.

Should you be saving into a pension through your limited company in order to reduce your corporate tax bill, then the options listed above will allow you to set up personal or company pension contributions so you can take advantage of the associated tax perks.

Accessing Your Pension At Retirement

When you are able to access your pension plan depends on the small print of the respective plan you have opted for. The IRS allows withdrawals at the age of 59 ½, and whilst you can make withdrawals from your IRA and 401(k) before in most cases this will result in fines.

In any case once you are the required age threshold you can withdraw funds from the plan, in line with your unique retirement plans. Whether you decide to stop working entirely, move to consultancy, or just cut back your hours is down to you.