If you’re the owner of a limited company, you may be wondering how best to take advantage of potential tax reliefs. Contributing to a pension would be a great place to start.
But should you make personal pension contributions or contribute via your limited company? There’s no clear-cut answer to this question. In all instances, we’d recommend meeting with a tax adviser to discuss your options. However, this blog will help you begin weighing up the advantages and disadvantages of each approach by providing a general overview.
Personal Pension Contributions
All pension contributions entail certain tax benefits, so whenever – and however – you decide to pay into yours, you’re taking positive steps. However, the way it works for personal pensions is a little different to contributions that are made via a company. You still receive tax relief when you make a personal contribution, of course, but this corresponds to your income tax band. For example, if you are a higher rate taxpayer, you will receive tax relief of 40-45 (you get 20 automatically, but a further 20 or 25 can be claimed through your tax return). In essence, if you’re eligible for tax relief of 40 , you’ll only need to contribute £600 for a gross amount of £1000 to be added to your pension.
However, if you own a limited company, making a personal pension contribution would offer no savings in terms of national insurance contributions. Moreover, if you decide to make pension contributions through your company, these can be treated as a business expense – meaning that they can be deducted from your company’s corporation tax bill. It’s often advisable, therefore, to go the ‘company route’ if you have the option – and we’ll cover this in more detail in the next section.
Director of a Limited Company: Pension Contributions
As mentioned in the previous section, the amount of tax relief available often depends on the income earned – and therefore the income tax bracket you fall into. However, if you’re a director of a limited company, it’s likely that you’ll take a small salary and a larger amount as a dividend (as this tends to be the most tax efficient method). If so, your personal tax relief is likely to be small, because dividends aren’t classified as ‘relevant UK earnings’. If you exceed the relief limit, you will be charged.
There is an alternative method. Because ‘employer contributions’ to a pension scheme can be treated as a business expense, and are therefore tax deductible, the most effective way for directors to enjoy the tax benefits of paying into a pension scheme is for the company to make the contribution directly. As a result, the company could save up to 19 in corporation tax. In addition, employers aren’t required to pay national insurance on pension contributions, which could represent a saving of 13.8 (the 2018/2019 rate) – and you won’t be required to pay national insurance as an employee, either, which is a further saving of either 2 or 12 .
Do bear in mind, though, that there are still limits to the tax relief on offer (currently 100 of your income with a maximum allowance of £40,000). You may wish to explore the option of bringing forward unused allowances from previous years in order to maximise the tax benefits.
Employer Pension Contributions: Things to Consider
You may be thinking that this sounds like a great idea, but at the same time are feeling concerned about how this could work in practice – wouldn’t you need to set up a company pension scheme? The good news is that this is not necessary. Many personal pension providers have mechanisms in place so that companies can pay directly into their schemes.
The next thing to bear in mind is that any contribution made by the company on your behalf will need to abide by HMRC’s rules. ‘Excessive’ pension contributions will raise a red flag – and so it’s important to ensure that your remuneration package is justifiable (from your salary to your pension plus any other benefits in kind). It’s also important that similar remuneration packages are being offered to other employees.
Whether your financial package is seen as justifiable will depend on a number of factors, including:
- What is offered to other employees at the same level – not just in your company, but other comparable companies.
- What salary would be offered to another candidate, were they recruited to take over your position.
- Your experience, skill set, level of responsibility, and the hours you work.
- The financial performance of the company.
That said, if you do only pay yourself a small salary and have been receiving additional income in the form of dividends, there may be strong reasoning to support further remuneration as a pension contribution. We’d recommend that any increase in contribution – or any large, standalone contributions – is discussed, approved and documented at both directors’ and shareholders’ meetings.
If you’d like to discuss setting up a limited company, or would like more information on how to maximise pension benefits, don’t hesitate to contact IBISS & Co today. With offices in two convenient locations in London and Essex, and a team of experienced tax advisers and accountants, we are equipped to handle all your needs.