Pensions for Company Directors
Pension contributions are one of the few remaining tax allowances available to limited companies. Company directors can make contributions to their pension schemes through personal or company contributions.
• Personal Contribution – made up to a maximum contribution of £32,000 per annum, in which the pension scheme has a limit of £40k to claim back basic rate tax. As a personal contribution, this will be funded out of net income, after tax has been paid, so this is not often an attractive option.
• Company Contribution –up to £40k per annum, treated as an allowable expense for Corporation Tax purposes and funded out of the company’s pre-tax profits.
Directors of limited companies can take advantage of the tax allowance provided by pension schemes to reduce the tax liabilities of the company and increase their pay-outs. Put simply if a company director swaps a portion of their dividend for their pension allowance they will pay substantially less tax to HMRC and therefore extract far more personal profit. Based on an example of a company director having 100K profit for remuneration if they were to take this as salary and dividend they would bank £68,382 paying £31,618 to HMRC. However, if they were to take this as salary, dividend and pension (up to the annual allowance – in this case) they would bank £46,512, put £40,000 in their pension pot and only pay £13,488 to HMRC as opposed to £31,618 !
To fully understand the benefits pension’s contributions have on tax liabilities, you will need to understand the following essential concepts.
Can pension contributions reduce income tax?
Contributions made to a pension scheme reduce the income tax based on the rate of your income tax bracket. You can claim personal tax relief on the following rates:
• Basic taxpayer rate: 20%
• Higher-rate taxpayers: 40% pension tax relief
• Additional-rate taxpayers: 45% pension tax relief
The basic rate tax relief will be invested in the pension contract whereas any higher or additional rate tax relief will have the impact of reducing the individuals tax bill.
Can pension contributions be backdated / carried back?
Carrying back pension contributions allows you to make contributions above the annual allowance and receive tax relief. They allow you to make use of any annual allowances that you may not have used during the previous three years, provided you were a member of a registered pension scheme. To carry back, you must make the maximum allowable contribution of £40,000 in the current tax year. However, you cannot receive tax relief on contributions in excess of your earnings on a tax year, and you will only receive higher tax relief rates to the extent you have paid for it.
Can pension contributions reduce dividend tax?
If the Company distributes profits by way of a pension contribution instead of paying a dividend then overall tax is reduced.
Can pension contributions reduce corporation tax?
Limited companies contributing to a pension can bring significant tax advantages. Pension contributions are treated as allowable business expenses that offset your company’s corporation tax bill. For the year 2018/2019 and 2019/2020, the Corporation Tax Rate is 19%, which can be a burden for your limited company.
Unlike personal contributions, an employer can contribute more than an employee earns up to the current annual allowance of £40,000. If the employee is able to take advantage of the carry-forward option, the limit can go up to £160,000. For this to be effective, you will need to satisfy what is called a ‘wholly & exclusively’ requirement, but as a shareholding director, this should not be a problem.
If you are a company director interested in taking advantage of the tax benefits of pension contributions feel free to contact Claire at firstname.lastname@example.org who will be happy to advise you on the best course of action for your financial circumstances.