If you have a limited company, contributing to a pension can bring significant tax advantages.
Pension contributions can be treated as an allowable business expense and offset against your company’s corporation tax bill.
If you run your own business and it’s incorporated as a limited company, you can make personal pension contributions to a pension or you can make contributions through your company.
Both options bring tax advantages, and what’s right for you will depend on your individual circumstances, but here’s a summary of some of the tax implications for each option.
Making personal pension contributions
When you pay money into your pension you receive tax relief that reflects the rate of income tax you pay. This means that, as a basic rate taxpayer, you effectively only pay £100 to save £125 into your pension.
Although there’s no limit to the amount you can pay into your pension, there are limits to the amount you can contribute and still receive tax relief. The limit is currently 100% of your income, up to a maximum of £40,000. See my blog on Tapered annual allowance https://www.nealford.co.uk/tapered-pension-annual-allowance/
If you earn less than £3,600 annually or don’t earn anything, the maximum amount you can contribute to your pension within the tax relief limit is £3,600 (including government tax relief).
Making personal pension contributions as the director of a limited company
If you own a limited company and you take both salary and dividends, the dividends don’t count as ‘relevant UK earnings’, so only the amount of money you take as income will be used to calculate your pension tax relief limit.
This means that if you take a small salary and a large dividend from your company, your pension tax relief limit will be low. If you exceed your limit, you’ll face tax charges.
Therefore, if you want to increase the amount of money you can pay into your pension and still enjoy the tax benefits, you can either increase your salary, or make the pension contribution straight from your company as an employer contribution. There are other benefits to doing things this way too, as we’ll explain below.
Making employer pension contributions directly from your limited company
Your limited company can contribute pre-taxed company income to your pension. Because an employer contribution counts as an allowable business expense, your company receives tax relief against corporation tax, so the company could save up to 19% in corporation tax.
Your contributions must abide by the rules for allowable deductions. The rules state that the pension contributions should be ‘wholly and exclusively’ for the purposes of business. To figure out whether this is the case, HMRC looks for certain evidence, for example whether other employees are receiving comparable remuneration packages.
Another benefit is that employers don’t have to pay National Insurance on pension contributions. The National Insurance rate for 2019/20 is 13.8%, so by contributing directly into your pension rather than paying the equivalent in salary, you save up to 13.8%.
This means that in total, your company can save up to 32.8% by paying money directly into your pension rather than paying money in the form of a salary. Depending on your circumstances, this may or may not be more beneficial to you than paying personal pension contributions.
Please note that tax rules change regularly, and the actual tax benefits you receive will depend on your individual circumstances. If you would like us to assist you with your tax planning, please feel free to get in touch on 01625 266 342 or email us at firstname.lastname@example.org