How business owners can save tax through pension contributions
If you run your own company – as many of our clients do – you’ll know all about the challenges of keeping a business going in the current environment.
It’s not just pressure from rising costs. Taxes are also creeping up – not least corporation tax which, at 25%, is now at its highest level since 2010.
Businesses must either increase prices or cut costs to keep going. One estimate is you need to increase turnover 19% by the time the next tax bills are due, just to stand still.
The good news, if you’re a director of a limited company, is there’s at least one pain-free way to ease some of that pressure. By focusing on your pension contributions.
A two-in-one benefit
Paying your pensions contributions from pre-tax company income (rather than your personal income) can be a win-win. It lets you ease your company’s tax burden, while also increasing the amount of pension tax relief.
Let’s take a look at this in a bit more detail.
1) Easing the tax burden
Pension contributions are an allowable expense. The payments you make as a company director can reduce the level of corporation tax you have to pay.
While the main corporation tax rate is 25%, there’s what’s known as ‘marginal relief’ for those with profits below £250,000. Businesses with profits below £50,000 are entitled to a ‘small profits rate’ of 19%.
With this in mind, let’s look at a couple of examples. Say your company makes £250,000 pre-tax profit for the 2023/24 fiscal year (Example A). With no other reductions, this will mean a tax bill of £62,500. Reduce those profits by £60,000 (currently the full annual pension allowance) and the tax bill will come down nearly £16,000 to £46,600.
Meanwhile, a smaller company with profits of £60,000 would face corporation tax of £12,150. But, including a pension contribution of £10,000 would be enough to push it into the small profits rate, meaning a final bill of £9,500.
2) Increasing your tax relief
The second benefit is making your pensions more tax efficient.
Personal contributions are usually limited by two factors, they must be within the annual allowance (set at £60,000 from April this year) and must not exceed your annual salary. Paying through your company income instead means avoiding the 100% salary cap. (It also means you avoid having to pay national insurance on this income – currently set at 13.8%).
In fact, as a director of a limited company, you can contribute to your director’s pension from your business as well as employer contributions as an individual, claiming tax relief on both. But be warned. If your company contributions have gone above your annual allowance, you’ll have to pay tax on any excess personal pension contributions.
There are also other restrictions. Contributions shouldn’t be greater than your annual profits and HMRC also demands they are “wholly and exclusively” for the employer’s trade and profession, and commercially reasonable for the work being done. This shouldn’t be a problem if you’re the sole director and the main generator of income.
What else? Some important things to remember
So far, the focus here has been on the impact for your pension, but if your company has employees, the contributions you make to their pensions is just as important. Let’s not forget, pensions are often cited as one of the most important benefits businesses can use to retain employees (a survey from pension provider Penfold last year revealed nine out of 10 employees said their pension would motivate them to either stay with an employer or change jobs.)
Another thing to remember is that, as with all aspects of pensions, the rules are subject to change, particularly when you take politics into account. It’s worth nothing that for the current financial year, the UK government has scrapped the lifetime allowance, that previously meant you could be taxed on all pension contributions accrued over a lifetime above £1 million. It looks likely that Labour (which has a high chance of being in charge after the next election) could be reversing that decision. The lesson here is that, when it comes to pensions, it’s a good idea to take the benefits while you can.
Whichever route you choose, pension contributions as an employer or sole company director are still a complex course to navigate. It’s vital to speak to an expert who can make sure your pension contributions are suitable, affordable, and set up in the most tax-efficient way.
Give us a shout – we’d be happy to go through it with you.