Pensions are a fantastic tax planning and investment vehicle, especially for company directors. A brief outline of some of the benefits are as follows:
Tax Relief on Contributions
As a director, you can contribute personally, out of post-tax income, and/or make employer contributions where the business pays into your pension on your behalf.
Making a personal contribution attracts income tax relief at your highest marginal rate whereas an employer payment should attract Corporation Tax relief. There are merits to both methods, and you should consult your accountant and financial adviser on how best to structure your contributions.
Many directors of smaller limited companies will structure their pay as tax-efficiently as possible, which can often mean taking a lower salary with most income taken as dividends. With personal contributions, tax relief is only available on contributions up to 100% of relevant UK earnings, which in most cases will be the director’s salary. Dividends are not treated as relevant UK earnings for pensions, so a director taking most of their pay as dividends may be limited in the personal contributions they can make.
In the scenario above there is greater freedom with employer contributions and in most cases, the business is likely to be able to pay more into the directors’ pension than under a personal contribution. As long as employer contributions follow HMRC guidance they should qualify as an allowable business expense to offset against profits and therefore receive Corporation Tax relief.
For example, if profits pre-pension payments were £40,000 and an employer pension contribution of £20,000 was made, profits subject to Corporation Tax should reduce to £20,000, potentially saving £3,800 (£20,000 x 19%) in tax.
From April 2023 this has become even more attractive, as corporation tax for profits over £50,000 has gone up (see our article on Corporation Tax Changes), which means that if you had a profit of £75,000, a £20,000 employer pension contribution would save you £5,300 (£20,000 x 26.5%) in Corporation Tax.
You are allowed to contribute up to £60,000 per year into your pension, with a maximum saving of £15,900 in Corporation Tax.
Other features and tax benefits of pensions include:
Tax Sheltered Growth: When invested, pension funds grow free of Income Tax, Capital Gains Tax and in most cases pension funds are outside of your estate for Inheritance Tax purposes.
Accessing Your Pension: The minimum age you can access pension funds is currently age 55. Since pension freedom rules were introduced in 2015 there are more ways than ever to access your pension pot. Some of the pension is taxed like earned income however the first 25% of the fund can be taken tax-free and with careful planning you can look to take the remainder of your fund as tax efficient as possible.
Intergenerational Planning: With most new private pensions your fund can be passed onto your spouse or children on death, so the fund remains within the family and can be passed down through the generations. Pension funds should be outside of your estate for Inheritance Tax purposes, which is an important and often overlooked benefit. Do make sure you complete an expression of wish so that your pension fund can pass on to those whom you prefer to receive on your death.
What Next?
The rules around pensions are complex so professional independent financial advice is recommended. We have many years of experience helping company directors set up private pensions, advising on contributions, managing pension investments and helping with the important decisions when you come to retire.
If you would like a review of your pensions or want to consider making a pension payment from your business, please get in touch.