Small business owners often have the option to make pension contributions via their company, instead of taking dividends to make personal contributions, which leads to savings on dividend tax and corporation tax. Various tax rules apply, and we recommend that the company’s financial adviser and accountant work closely together when a business owner is seeking to optimise their pension contributions through their company.
Annual pension contribution limits
Making large, tax-efficient personal pension contributions can be tricky for business owners who primarily take remuneration through dividends. This is because personal pension contributions are limited to relevant UK earnings, which do not include dividend or rental income.
In contrast, pension contributions via the company are not restricted by relevant UK earnings. Company pension contributions are only limited to your annual allowance plus any available ‘carry forward’, which can total up to £160,000 in a tax year.
The standard allowance for pension contributions for each tax year is £40,000, but the allowance is reduced (tapered) for those with total income above £200,000 and over £240,000, including certain types of pension contributions. You may be able to make higher contributions if you have unused annual allowances from the prior three tax years.
Tax-saving potential
Contributions can make it easier to extract money from the company without paying dividend or income tax. Furthermore, using company profits in the company year to make pension contributions can lead to significant corporation tax savings.
In the simplified illustrative example (see table below), a married pair of business owners have each been members of a pension plan for the past three years, but not made any contributions in either the current or prior tax years. This creates the potential for them to pay up to £160,000 each into their pension plans and for the company to make a large saving on corporation tax. Corporation tax is set to rise from its current rate of 19% to 25% from 1 April 2023 (this applies to companies with over £250,000 in profits).
Protecting business owners’ interests
Extracting money from a corporate account can also protect the business owner’s interests, as once the contributions are outside of the company, they are no longer assets that belong to the company (as long as the company is still solvent). If the company runs into hardship or falls into insolvency, the contributions that have been made to the business owner’s pension cannot be clawed back to repay any outstanding creditors, or for liquidation fees.
Know your company tax-year end and consider your options for paying into a pension plan. To find out more call the Lumin team on 03300 564 446, or get in touch via our contact form.
This article is for general information purposes only and does not constitute financial advice or a personal recommendation. Past performance is not a reliable indicator of future results. Investments can rise or fall in value, and you may receive less than you originally invested. Tax treatment depends on individual circumstances and may change in the future.
