Saving for your pension is an important part of planning your future. Whilst you can make personal contributions, as a company director, you also have the option to pay into your pension directly from your limited company. However, there are differences between the two methods, which mean that company pension contributions can be more tax efficient.
Why Personal Pension Contributions are Less Tax Efficient
Personal pension contributions are made from your salary or other personal funds. You can claim tax relief on these contributions if you pay into your pension like this. You also do not have to justify the payments to HMRC. However, there are limitations to making tax-efficient pension contributions in this way. You can only make personal contributions up to the value of 100% of your relevant earnings. This includes employment and other types of income, but it does not include dividends. Dividends, rather than salary, are a key part of many company directors’ incomes because of the tax benefit. So if you pay yourself in this way, it restricts the size of your personal pension contributions to the level of your salary. Moreover, raising your salary to make higher contributions is not tax efficient. That’s because you would have to pay additional income tax and National Insurance Contributions (NIC) on the increased salary. Your company would also have to pay the employer’s National Insurance Contributions on the extra salary.
What Makes Company Pension Contributions More Tax Efficient?
The key difference between company and personal pension contributions is that contributions from your company are allowable business expenses. As a result, these payments reduce your company’s liability for Corporation Tax. In addition, the relevant earnings threshold does not apply to company contributions. This means you can make pension contributions directly from your company which are more than your relevant earnings. The income you take from your company, in salary and dividends, is not affected. If you want to pay more into your pension, you do not need to increase your salary, as you would with personal contributions. Also, your company does not have to pay extra employer’s National Insurance Contributions as it would with a higher salary. The other benefit is that you do not have to pay extra personal Income Tax, as you would if you paid yourself a higher salary to increase your personal pension contributions. In short, when you make company pension contributions, you can still pay yourself a tax-efficient income with most of it taken as dividends.
What Are the HMRC Rules?
HMRC sets the rules for what’s allowed with pension contributions. To top up your pension tax-efficiently, it’s important to understand the allowances and limits set by HMRC.
1) 100% of Relevant Earnings
When you make personal pension contributions, they cannot exceed 100% of your relevant earnings each year. HMRC define what are relevant earnings. If these are greater than the annual allowance, the annual allowance is the most that you can pay in. This rule does not apply to company pension contributions.
2) Annual Allowance
This is the maximum amount that you can pay into your pension scheme in a tax year. £60,000 is the annual allowance for the 2023/24 tax year. This applies to both personal and company contributions. However, you can use this alongside the Carry Forward rule.
3) Carry Forward
If you have not used all your annual allowances from the last 3 years, it’s possible to carry these forward into the current tax year. To do this, you must have been a member of a registered pension scheme over the previous 3 years and you must also use the current tax year allowance first.
4) Company Income
Payments into your pension as company contributions must not exceed your company’s profit for the year.
5) Lifetime Allowance
This is the maximum amount you can withdraw as a lump sum or retirement income without paying extra tax. The lifetime allowance is £1,073,100 in 2023/2024. While you can build up a pension pot greater than this, you will incur additional tax on the excess. This is called the lifetime allowance charge. If you took your pension on or after 6 April 2023, there is no lifetime allowance charge. Tax reliefs, as described in this article, are those that are currently applying and are liable to change.
How to Save for Your Pension in a Tax-Efficient Way
To top up your pension as a company director, you’ve got the option of making company contributions. These can have many tax advantages over personal contributions. However, always check that your payments are in line with the HMRC’s rules. Get advice on how to save for your pension in a tax-efficient way. Call us on 0345 224 3175 to book an appointment. Alternatively, book a call here.