This article explains the most tax-efficient way for you, as a limited company owner, to fund your pension.
We’re going to focus on explaining that there’s typically an ‘optimum solution’ here, and why.
Pensions are a remarkably efficient means of saving for your longer-term future. In particular:
You can claim tax relief on money that you put into them, subject to limitations.
Investment growth on the funds within your pension will be largely free of tax.
In retirement, up to 25% of the pension funds can typically be withdrawn tax-free.
You can currently access your retirement funds from age 55.
Before we get into this however, a recap of remuneration and tax structure might provide some helpful context. Sections 2 & 3 explain this. They’re quite technical though. So, if that’s not for you, and you’re simply eager to find out the best way of funding your pension, proceed directly to Section 4!
How are my limited company’s incomings and outgoings treated for tax?
Key Definitions & Points
It’s extremely important to bear in mind that, for tax purposes, the limited company is treated as an entirely separate entity from your own personal tax affairs.
‘Gross Profit’ is your company’s sales revenue, less the costs of your goods sold (typically costs of materials, and return of any VAT).
‘Net Profit’ is Gross Profit less other business costs – such as salaries, expenses and professional services (for instance your accountant’s fees). Also, pension contributions (and some employee protection policies) can be taken into account here, as we’ll see later.
Corporation Tax is applied, at a rate of 19% to Net Profits – resulting in the limited company’s ‘Net Profits after Tax’.
Net Profits after Tax can then be retained within your Company accounts, or distributed to the shareholder(s) as dividends.
How is my own personal income treated for tax?
Many company shareholder/directors pay themselves a salary which is above the ‘Lower Earnings Limit’ (‘LEL’ – £6,396 per annum for tax year 2022/23) – this LEL being the minimum salary needed for them to qualify for basic National Insurance (NI) benefits, such as the State Pension.
They also keep this salary below the ‘Primary Threshold (‘PT’ – £9,880 per annum for tax year 2022/23) – this PT being the point above which they will start paying NI contributions on their salary.
They then take further personal remuneration from their companies via dividends.
But care needs to be taken here, in respect of IR35 ‘Intermediaries Legislation’.
You elect to pay yourself an annual salary of £8,000, and dividends across that year of a further £50,000. These are your only sources of income during the year. You are on a standard Tax Code, and you presently take no other actions which might affect your tax status:
There is no NI payable because your salary falls between the LEL and PT.
Your total income tax liability (on the dividends) is £4,689.75.
Note also that the limited company will have paid Corporation Tax of £11,728 prior to releasing the dividend of £50,000.
What’s the ideal way to fund my pension?
A company or employer can make unlimited (*) contributions to a pension on behalf of an employee or director (providing these are justifiable as wholly and exclusively for the purpose of business).
Pension contributions made by you personally, as an employee/shareholder/director however are typically less favourable – in respect of the tax relief which such contributions attract.
Usually HMRC will allow you to claim full tax relief, at your highest rate of tax, on your pension contributions (on the basis that any tax relief over the basic rate is claimed via your annual tax return).But they place a limit on the amount of your tax-relievable contributions.
What if I make personal pension contributions?
In the earlier example, tax relief would be limited to personal pension contributions up to the £8,000 salary only. And that tax relief would only be at basic rate income tax, 20% in tax-year 2022/23 – NOT your highest tax rate of 33.75%.
This means you could pay up to £6,400 from your own after-tax income into your pension, and HMRC would add £1,600 into your pension on top. This is the maximum tax relief permissible in this example via personal pension contributions.
To put this another way, each £1,000 added to your pension by personal contributions will cost you £800 from your post-tax income.
What’s the better solution? Employer Contributions
Your company could pay pension contributions on your behalf, as an employee – into exactly the same type of personal pension scheme. This is a better option because:
These pension contributions fall under the category of ‘Other Business costs’ outlined in section 2. They thus reduce Net Profits, and therefore reduce your company’s Corporation Tax liability.
Compared to the above ‘personal pension contributions’ example, you’d also avoid losing out on the full extent of your tax relief – where you were paying 33.75% on some dividends and yet only receiving 20% tax relief.
To put this in comparison to the example above, £1,000 added to your pension by employer contributions calls on you to sacrifice just £546.75 of your post-tax income (£1,000 less £190 Corporation Tax less £263.25 dividend income tax).
So this approach to pension planning leaves you £253.35 better off per £1,000 of pension contributions.
Further, this approach allows you to enjoy that benefit for pension contributions which are not limited to your salary (£8,000 in the example used here). Pension contributions can be unlimited (*).
(*)– Note that, whilst contributions are unlimited (where justifiable), there may be personal tax implications for the employee/director if these exceed the ‘Annual Allowance’ (AA). The AA is £40,000 per year in tax-year 2021/22, for those earning less than £200,000. For those with total earnings in excess of £200,000, your AA may be reduced. This is a complex area, and one which is best to discuss with a Financial Adviser, in reference to your own personal circumstances.
What to do next?
If you’d like to learn more, then you can contact Paul Mayhew, of Paul Mayhew Wealth Management, Associate Partner Practice of St. James’s Place Wealth Management. He’ll be pleased to help, with a no-obligation consultation:
e-mail: [email protected]
tel: 07920 888284.
There are also a couple of associated articles in this series which you might find interesting:
The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select, and the value may therefore fall as well as rise. You may get back less than you invested.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.
St. James’s Place guarantees the suitability of the advice given by members of the St. James’s Place Partnership when recommending any of the wealth management products and services available from companies in the Group, more details of which are set out on the Group’s website at www.sjp.co.uk/products.
Paul Mayhew Wealth Management is an Appointed Representative of and represents only St. James’s Place Wealth Management plc (which is authorised and regulated by the Financial Conduct Authority) for the purpose of advising solely on the Group’s wealth management products and services, more details of which are set out on the Group’s website www.sjp.co.uk/products.
The ‘St. James’s Place Partnership’ and the titles ‘Partner’ and ‘Partner Practice’ are marketing terms used to describe St. James’s Place representatives.